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HEADLINE STORIES __ OF 1976 ■■■■■■■■■ REMARKS BY John J. Balles PRESIDENT FEDERAL RESERVE BANK OF SAN FRANCISCO Luncheon Meeting Portland Branch Board of Directors and Guests Medford, Oregon April 8, 1976 John J. Balles I’m very happy to visit again the beautiful state of Oregon, where Nature and Man have collaborated so well to create the perfect living and working environment. W hile I'm about it, I should congratulate you also for Oregon's superb soft-sell industrial-development program. One might think that people would actually stay away from this state because of the activities of the James G. Blaine Society and the solemn pronouncements from Salem— but no, these things only whet the interest of outsiders and make them more determined to come here. There's just no other way to account for the growth in Oregon's population, which in the first half of this decade jumped almost 10 percent— twice the national rate— or for the continued strong expansion of the state's $13-billion economy in the face of the troubles of its all-important customer, the national housing industry. This m orning, the Board of Directors of our Portland Branch met here in Medford to discuss current econom ic develop ments and various Federal Reserve operat ing topics. The Board, which consists of Medford's own Frank Servoss and four other distinguished Oregonians, helped bring me up-to-date on the regional economy— and in this way provided a crucial input into my preparation for fu ture meetings of the Federal Open Market Committee, which plays such a vital role in setting the nation's monetary policy. This grass-roots participation in the policym ak ing process, to my mind, is one of the best features of the System which the founders of the Federal Reserve developed more than 60 years ago, since it guarantees that regional leaders will have some say about national policy decisions. Crucial News Story Most of my remarks today will center on the headline stories—some real, some phony, and some quite scary— that have appeared in the newspapers the last sever al months. To begin with, no one can possibly downplay the importance of that crucial news story, the year-long recovery of the national economy. Real GNP, the measure of the nation's total physical production, rose at an 8 -percent annual rate in the second half of last year, and it continued to advance strongly in the quarter just completed. The business re covery since last spring has generated more than 2 million new jobs, has ex tended the length of the average w ork week, and has reduced the unemploy ment rate from about 9 to 7V.z percent. Moreover, the rate of rise in consumer prices currently, at 6 percent, is only half as high as the 12 -percent rate of late 1974. However, there's a time bomb inside the economy which could erupt into scare headlines at some later date. I refer to the potential impact on prices of a Federal budget which is still not under control. Now, people have suggested a number of reasons for the terrible inflation that we've experienced over the past decade, but the underlying cause of this problem has been the tendency of Federal deficits to expand in good times as well as bad, pulling monetary policy off course in the process. After all, the Treasury has to be financed, and yet there is strong resistance in C o n gress to high and rising interest rates. In view of such pressures for low rates and associated rapid money growth, deficit financing usually results in excessive monetary expansion. Huge deficit financing apparently was needed last year to offset the effects of the worst recession of the past generation, but substantial deficits have troubled us not just for a year but for an entire decade. Indeed, for that period as a whole, the Federal government and its agencies went into debt to the tune of almost $300 bil lion. The deficit is estimated at $74 billion for the current fiscal year alone, and on top of that, the congressional Budget Committees now project a $50-billion def icit for fiscal 1977, despite the lack of need for further stimulus for the strengthening economy. Unless Congress makes a better effort to bring the budget under control, we are likely to be faced with a persistent inflationary problem for the rest of the 1970's. And sooner or later, inflation leads to an unsustainable boom—which then collapses, resulting in recession and rising unemployment. Money in the Headlines In contrast to the scare headlines that may yet haunt us in this regard, let's consider the scare headlines that we've been read ing for at least a year about the Federal Reserve's supposed failure to expand the money supply fast enough to support the business recovery. A look at the numbers is instructive. A year ago, the Fed adopted a growth range of 5 to V/i percent for M i—that is, currency plus bank demand deposits—and a growth rate of 8 V2 to IOV2 percent for M 2—which consists of Mi plus bank time-and-savings deposits other than large certificates of deposit. Over the past year, M-, increased about 5 percent and M 2 by more than 9 percent— both within the target ranges, although with significant month-to-month fluctuations. But more to the point, their growth during the past year was roughly in line with the average money-supply growth rate of the preced ing five-year period—and yet throughout most of that earlier period, the Fed was sharply criticized not for going too slowly but rather for stoking the fires of inflation with an over-rapid growth of the money supply. This comparison, I think, illustrates the tightrope-walking skills required of the monetary authorities. Money growth over the past year obvious ly has been adequate to finance a vigorous recovery, a drop in the unemployment rate, and a slowing in the rate of inflation. In addition, we have seen some decline in interest rates. But where would we have been if we had followed the advice of our critics a year ago and increased the money supply at an annual rate of 10 percent or more? Am ong other things, it is likely that the rate of inflation would now be in creasing, and the stage would have been set for another boom-bust cycle. Banking in the Headlines Next, let's consider the scare headlines we've been reading the last several months about the health of the banking system. It seemed to me in this case that some of the most prestigious papers in the country were acting like first-year journal ism students, belying that motto about all the news that's fit to print. Their problem seemed to be that the so-called news was a) out-of-date and b) misleading. The gist of these stories seemed to be that the Fed and other agencies permitted the era of go-go banking to get out of hand, and then locked up all the evidence of poor lending practices. Published lists of year-old problem-bank situations were misleading at least partly because of confusion about the meaning of the term "problem bank/' The institu tions appearing on the regulators' lists were identified because of certain problems— many of them minor problems—as being in need of extra su pervisory monitoring. But most have now made substantial progress in solving their problems, and thus are in no danger at all of imminent failure— if indeed they ever were. But then why didn't the regulatory agencies release all this problem-bank information themselves? Simply because it would be counterproductive to include examination reports with all the wealth of other material that is routinely made avail able to the public. Since it is confidential, an examination report contains candid and confidential remarks about the most intimate details of bank's customers and its performance, on the part of both the examiner and the banker he is dealing with. Disclosure of examiners' reports would destroy this confidential relation ship, making the reports much less meaningful— and in many cases, hamper ing the effort to bring problem situations under control. Missing News Stories Now, the story that should have appeared in the headlines would cover the underly ing causes of the banks’ difficulties, in cluding the worldwide turmoil of the past decade. That tumultuous period encom passed Vietnam, Watergate, O PEC, the collapse of Bretton Woods, and (almost concurrently) the worst inflation and the worst recession of the past generation. Admittedly, amid this turmoil, several ma jor bank failures occurred here and abroad, but the ensuing forecasts of a replay of the 1930's turned out to be far off the mark. Indeed, by January 1976, only 121 of the nation’s 15,000 banks— and none of its large banks— were listed on the F D IC ’s checklist of serious problem cases. And don't forget the biggest news of all— while shareholders suffered losses, not a single depositor lost any money in the several bank failures of the past few years. Many banks of course made mistakes during this difficult period. Some forgot that they were supposed to be cautious with other people’s money, and instead took unnecessary risks with that money to serve their borrowers. At any rate, there was a swing by many banks away from their cautious behavior of a generation ago toward a stronger risk-taking stance. But now, the pendulum has swung back again. Responding to the riskier atmos phere of the mid-1970's, banks have adopted more cautious credit policies, and have thereby improved their own financial health. Another important story that failed to make the headlines was the essential role the banking system played in stabilizing the economy at a critical time, at some cost to itself. At mid-1974, bank funds in many cases were the only funds available to small-and medium-sized firms, as m on ey and capital markets tightened drastical ly in the face of double-digit inflation. Moreover, public utilities had nowhere else to turn for funds at that time, since they were unable to obtain needed fund ing through internal sources or through the capital market. The resultant heavy loan demand strained the liquidity of many banks— but it helped to support the economy at the time it was most needed. Later, as the economy recovered, the financial environment did too, so that today the nation's banking system is healthy— and getting even better, despite a few problem cases. Regulators in the Headlines Now, because of the public's confusion over what is news and what isn't, we're being treated to headlines today about Congressional reform of the bankregulatory system—a development we may not otherwise have encountered. Don't get me wrong; I'm not saying that improvements cannot be made in this complex system. At the San Francisco Fed, we have already set up a special financialmonitoring unit to ensure that we don't run across any unwelcome surprises in the banks that we supervise, and at the nation al level, Chairman Burns has made a num ber of suggestions to Congress regarding possible regulatory reforms. But that's not the same as a wholesale overhaul of the entire system, as some critics propose. But this passion for reform seems to occur in a number of fields. As a result, a lot of babies have been thrown out with the bathwater in recent years— a useful tech nique perhaps if you’re aiming only at zero population growth, but a technique which in this case could bring about zero econom ic growth. As you've probably heard, the shape of the banking legislation has changed con siderably as it has worked its way through the halls of Congress. But no matter what the final outcome, I believe it's worth while to mention some of the more om i nous features of the proposals that have been circulating recently. Indeed, the nation's future financial stability could be endangered by proposals that would introduce political factors into Federal Reserve operations and policy. The pro posal for Presidential appointment and Senate confirmation of Reserve Bank presidents—and for rather short terms at that—would mean that political accepta bility would replace professionalism as the primary attribute of these officials. The Fed thereafter would have great difficulty in attracting highly professional, careeroriented talent to staff the top executive positions at the various Reserve Banks. Other legislative provisions would deprive these Reserve Bank presidents of their voting rights on the Federal Open Market Committee during their current terms, and would deprive directors of their re sponsibility for selecting Reserve Bank presidents and holding them accountable during their incumbency. These features, I fear, would weaken that element of direct regional participation in Federal Reserve activities which the founders of the System were so anxious to foster. I see problems also with legislative pro posals which would require the Federal Reserve Chairman, in his quarterly reports to Congress on monetary policy, to specify the intended or expected levels of interest rates over the succeeding twelve months, and to specify also the expected impact of monetary policy on employment, produc tion and prices. However, interest-rate movements depend on many factors out side the Fed's control, such as expecta tions of borrowers and lenders about the future course of inflation, so that we could mislead the public if we attempted to make precise forecasts about rates. Again, the looseness of the relationship between monetary policy and econom ic develop ments makes it doubtful that we could come up with precise projections of em ployment, production and prices, and the proposal practically guarantees confusion because of the constant updating of fore casts that would be required. I could go on at length, but I'll mention just one other proposal that is missing from the legislation now under study, but which could surface at any time to create damage. I refer to the proposal for an audit of monetary-policy operations by the General Accounting O ffice—an action that would leave the way open for C o n gress to exercise direct responsibility for the conduct of monetary policy. For the future health of the economy, I think it's essential for us to separate the people who print the nation's money from the people who spend the money. Otherwise, if we limit the central bank's activities to operat ing a printing press, we’ll create the tinder for an inflation that, Latin-American style, could destroy the econom ic and social fabric of the nation. Concluding Remarks To sum up, you should now have a pretty fair idea of what I think should have appeared in the papers these past several months, as opposed to what actually did appear. The real econom ic news is that the business recovery progressed faster than anyone expected— not that some vestiges of the recession still remain. The real financial news is that the banks met the economy's basic needs for funds throughout the worst inflation and the worst recession of the past generation— not that some sour loans were incurred in the process. The real regulatory news is that the authorities helped support the financial system through bad times while bringing about a reaffirmation of tradi tional banking virtues— not the reverse, as has frequently been charged. The task of regulatory authorities is to see that the worst does not happen when the econo my becomes badly strained, and I think we successfully performed our job.
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