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For release on delivery
Expected at 10:00 a.m. EST
March 10, 1983

Statement by
Nancy H. Teeters
Governor, Board of Governors of the Federal Reserve System




before the
Subcommittee on Consumer Affairs and Coinage
Committee on Banking, Finance, and Urban Affairs
United States House of Representatives
March 10, 1983

I am here today on behalf of the Federal Reserve to
discuss the expiration of the federal preemption of state usury
laws governing business and agricultural loans and the effect
of high interest rates on farmers and businesses.

The preemption

was passed as a provision of the Depository Institutions Deregu­
lation and Monetary Control Act of 1980.

It authorized lenders

to charge a rate up to 5 percent above the Federal Reserve d i s ­
count rate on business and agricultural loans of $1,000 or more
in those states wi t h ceilings less than this variable limit.

The preemption is scheduled to expire at the end of this month.
The Board has been concerned about the adverse impact
that usury ceilings can have on the availability of funds in
loca:. credit markets.

Usury ceilings tend to reduce the supply

of credit in states subject to unrealistic limits by encouraging
lenders to channel funds into other investments or to geographic
areas permitting a more competitive return on similar invest­
ments.

Credit thus may become unavailable to all but the

strongest potential borrowers, as non-rate lending terms and
credit standards are set to compensate for the uncompetitive
interest rates that are legally permissible.

Moreover, given

the growth in money market mutual funds into a large competitive
industry and the rapid deregulation of deposit rates at our
financial institutions, the cost of funds to financial insti­
tutions in local communities has become increasingly sensitive
to national money market developments.

This creates a much

greater need for these institutions to earn a competitive return
on their assets.




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2 -

Despite the Board's opposition to artificial constraints
on credit availability, we continue to have reservations about
federal intrusion into an area long regulated by the individual
states.

The Board prefers that usury ceilings be addressed by

corrective action at the state level.

In this regard, the law

did provide states with the authority to override the federal
preemption of their ceilings.

Information collected by Board

staff indicates that, as of the middle of last year, a dozen
states had at least partially overriden the federal law.

Among

these twelve states, however, eight had no usury ceilings on
business loans and four had either usury ceilings that were
indexed or ceilings that were fixed so high they had no effect
on credit flows.

Those states that were most affected by usury

ceilings generally have not acted to override the preemption.
In fact, many states have moved to relax their regulation of
interest rates since the passage of the Deregulation Act.
Currently, only about ten states have fixed usury ceilings on
business and agricultural loans, and less than half of these
could be considered binding.
In this respect, the focus of federal law preempting
state interest rate ceilings may have narrowed.

But at the

same time, it should be emphasized that permitting the federal
preemption of state business and agricultural loan usury laws
to expire will not resolve the financial problems of businesses
and farmers.

These problems have resulted from more fundamental

economic difficulties.




Fortunately, economic and financial

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conditions are now beginning to improve.

Interest rates are

now well below their levels of one or two years ago, with
short-term rates a*' much as 10 percentage points below their
e arlier peaks, and long-term rates down about 4 to 5 percentage
points.

More important, the economic recovery that appears to

be underway should bolster business activity and help to restore
a more profitable base for operations.
Continued success in lowering interest rates depends
on our reducing the lingering doubts about the progress against
inflation and on our cutting back on credit-absorbing federal
budget deficits.

Monetary and fiscal policies need to be directed

toward removing these obstacles and achieving vigorous, and
lasting, noninflationary growth.
To summarize, the Board feels that, with regard to
usury ceilings, state action rather than federal law should pre­
vail whenever possible.

Many states have acted to reduce the

constraining effect of their usury ceiling on credit avail­
ability, and financial conditions have improved considerably.
These factors generally weaken the current need for a national
law preempting state usury ceilings on business and agricultural
loans, but do not eliminate the need for further action to
relax interest rate ceilings at the state level.
If the Congress desires to extend the current law, i
would like to note again a feature that is of concern to the
Federal Reserve Board.

The law established a variable rate

ceiling based on the Federal Reserve discount rate.




The Board

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continues to be opposed to use of the discount rate as an index
to w h ich the Federal usury ceiling is tied.

The discount rate

has an important role in the conduct of m o n etary policy, and
cannot always be counted on to reflect an appropriate base rate
for the cost of funds.

Moreover, because the discount rate is

an administered rate that applies generally to very short-term
borrowing by banks and other depository institutions, movements
in this rate may not be representative of interest rate movements
in markets that involve longer-term lending.