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For release on delivery
1$15 PM E.S.T.
April 3f 1985

Remarks by
Paul A. Volcker
Chairman, Board of Governors of the Federal Reserve System

before the
Federal Home Loan Bank System's
14th Annual Thrift Outlook Conference
Washington, D,C.

April 3, 198 5

I am pleased to be here with you today as part of
the 14th Annual Thrift Industry Outlook Conference sponsored by
the Federal Home Loan Bank Board.

I think it is a first for

a Chairman of the Federal Reserve Board.

I suppose that

history reflects the fact that there have been traditional and
long-standing differences between the thrift industry and the
banking industry, and some of that rubbed off in the form of
suspicions about the respective regulators.
But I suspect Ed Gray's invitation reflected a
reality today.

By law and by circumstance, the central bank,

as lender of last resort and as an agency concerned with
financial stability more broadly, has to be concerned about
the health of all depository institutions.

And it's also

obvious that, in today's environment, thrift and banking
industries are becoming so intertwined they cannot be easily

Therefore, I will touch upon issues relating to

both familiar central banking themes and those relating to
financial institutions more generally*

- 2 -

You know central bankers have a unique, if not curious,

It's said thatf like puritans, we have a haunting

fear that someone, someplace is happy.

I'm not sure I need

have that fear in the midst of a savings and loan meeting,
because your industry, as much as any other, has been under
more or less continuous strain and pressure in recent years.
Some of those strains reflect high and fluctuating interest

But your industry, like the banking industry, also has

strong new elements of competition from outside, and the nature
of the industry has been changing more radically than at any
time in its history.
Let me begin with a few comments about conditions in
the thrift industry generally.

Declines in interest rates late

last year have provided a little breathing room for many

While the industry as a whole obviously remains

vulnerable to any reversal of that trend, well and conservative y
managed institutions have been actively reducing that

- 3 -


A solid core of the industry seems to be in a

position to return to health, and to do so while maintaining
a traditional orientation toward housing finance.

I admire

those many in the industry who have absorbed hard shocks, but
have responded by finding new ways to conduct their business
consistent with the need to maintain prudent standards, sound
lending practices, liquidity, careful pricing of both assets
and liabilities, and to the extent possible, conservation of

Those managers are conscious of the fact that the

business of being a thrift is getting harder and much more
competitive, but they remember the importance of confidence
and self-reliance.
I would be less than frank if I did not also reflect
my concerns that, faced with similar problems, a few associations
at the fringe —

presumably not the ones represented at a

conference like this —

seem to be, more or less consciously,

reaching out in credit and investment areas —- areas typically

- 4 -

removed from residential housing that may seem to generate
high fees and rates in the short-run, but at the expense of a
level of risk not characteristic of the industry in the past
or of the future stability of those particular institutions*
That risk taking is, of course, in effect underwritten by a
Federal insurance system designed with other purposes in

We have seen the incongruity of some weakly capitalized

institutions with poor earnings growing at very rapid rates
of speed*

We wonder how prudently those funds are being

employed in the effort to capture a quick return —

and how

consistent that behavior is with the basic purposes of your
industry and the Federal institutions that support it.
Against that background, I am particularly encouraged
by the fact that the Federal Home Loan Bank Board, under Ed
Gray's leadership, is aware of the challenges confronting the
thrift industry and has taken steps to deal with excesses.


Federal Reserve has been supportive of these effortsf particularly those designed to place some limits on direct investment,
to encourage rebuilding of net worth, and to place constraints
on extraordinary growth.

It seems to us those approaches are

valid efforts to help protect the stability of the financial
system as a whole, and are indeed in the long-term interest of
the savings and loan industry itself.

Indeed, the approaches

parallel and supplement measures we and other banking regulators
are taking, or have taken, and we certainly welcome the Bank
Board working in complementary ways in these areas.


time, we believe there will be a need to take further constructive
steps to limit risk and to encourage profitability and a
rebuilding of real net worth on a continuing basis.
It is also worth noting the efforts being made by the
Bank Board to strengthen its supervisory staffs and procedures.
There has, as you know, been a lot of deregulation —


and loans today have a lot more flexibility on both the asset

- 6 and liability side of the balance sheet.

I see no inconsistency

between that kind of deregulation and an insistence —
by adequate supervision and regulation —
flexibility be used responsibly.


that this

In today's environmentf with

the myriad of complex financial arrangements and exotic
financial products, more effort rather than less is required to
encourage and maintain the prudential standards upon which
confidence in the system —

and the insurance system itself


Those same comments might be applicable to the

commercial banking system as well.

I do think that we

commercial bank regulators have been fortunate in inheriting
an examining staff and expertise that is relatively well equipped,
but we too are conscious of the added challenges of today's more
complicated environment.
All of this is relevant to existing supervisory
authorities and law, but I also believe all of us are sensitive
to the need for new banking and thrift legislation to provide
a clearer and more orderly framework for the operations of all
depository institutions.

I wish I could deliver a brieff cogent analysis of
the substance and prospects for legislation in 1985, but I

The Congress, as you know, has been preoccupied with

other matters.

I have sensed apparant consensus on important

elements of a legislative package, including particularly the
need to deal with certain loopholes that have been increasingly

But, at the same time, that consensus apparently

cannot be expressed in legislation without also dealing with
other highly controversial issues.
questions —

Moreover, additional

such as interstate banking and deposit insurance

are forcing their way onto the agenda.


It's understandable

that they have, but it does further complicate the legislative
I am also aware that two important issues for the
thrift industry come up for renewal in October —

net worth

certificates and interstate acquisitions of failing institutions.
These matters provide a kind of deadline for legislation, but

— 8 —

it is hard for me to see those issues, urgent as they are f
dealt with in isolation.

We urgently need a more comprehensive

The themes of last year's debate are familiar by now
and I will not dwell on them.

We still believe that it is

vitally important for the Congress to close the nonbank bank

To me, an essential corollary is also to close a

parallel avenue for undercutting the traditional separation of
banking and commerce —

what I call "non-thrift thrifts.11

Unless the Congress deals with both aspects, commercial firms
that want to be in banking, and have direct access to the
payments mechanism, will be free to seek savings and loan or
savings bank charters instead of commercial bank charters.
After all, the powers available under thrift charters overlap
those of banks substantially, and thrifts could well provide
a more attractive vehicle for commercial firms wishing to enter
banking than a "nonbank bank."

- 9 -

The concept of a "thrift test11 to determine whether
a thrift would continue to retain certain broader investment
powers and other traditional privileges —
FHLB advances and commercial ownership —
wide agreement*

including long-term
has gained rather

But translating that conceptual agreement

into a valid statistical test remains a challenge*

To our

mind, the essense of that test should be whether an institution
in fact, from its own portfolio, supports housing credit, which
is the traditional rationale for Federal support and encouragement
of thrifts.

In my view the "test" needs to be more closely

drawn than in legislative proposals introduced last year if it
is to be meaningful.

Simply originating and selling mortgages

an activity that is broadly and freely engaged in by commercial
banks, mortgage banks, and others —

does not seem to me

sufficient to justify that special Federal support for deposit

The question is who is willing to hold that paper.

I do not sense we are so far apart on a valid test that the


- 10 differences cannot be reconciled, but it is an important
Another area of common concern among regulatory
authorities is the strong movement among states to authorize
new powers for both thrifts and banks far beyond those
authorized at the Federal level.

There has traditionally

been a role for the dual banking or thrift systems.
room for flexibility and experimentation.

It provides

But what is going on

now seems to me to be assuming a quite different character from
the traditional dual system.

Liberalization of powers by the

states is clearly driven by short-term competition for jobs,
rather than any coherent well-developed conception as to what
the financial system should be and what is consistent with
safe, sound, and efficient thrift and banking systems as a

And, as more and more states are driven to action by

job-protective incentives, there will in the end be no net
job creation.

- 11 -

There are a number of areas of liberalization of powers
that seem to me to pose no particular problem from a prudential

But wide open real estate developmentf now

permitted by some statesf to me and other Federal regulators,
including the Bank Board, raises the most pointed concerns.
It is an area where risks are particularly large and demonstrable,
Both bank and thrift regulatory agencies are attempting
to deal with the issue within present law from the standpoint of
their responsibilities to protect safety and soundness.


our approaches may varyf and we want to work v/ith the affected
institutions to develop sensible guidelines, the basic point
is that at some point we must, as administrators of the Federal
"safety net" which supports the system as a whole and individual
institutions within itf assert a fundamental federal interest in
what state-chartered institutions and their parents can do from
the standpoint of safety and soundness.

While our existing

authorities provide us with some scope for defending that

- 12 fundamental interestf I also believe any new legislation should
clarify Congressional intentions in that respect.
Finally, I should also record my concern about
initiatives taken by commercial firms to set up so-called
"consumer banks" or "family banks" all over the countryf presumably with the intention of integrating those banking
operations with other parts of their business.


attractively packaged in terms of purported advantages to the
consumer, the possibility of commercial corporations using
limited purpose banks or thrifts to get into deposit taking and
to gain access to the payments mechanism seems to me a clear
threat to the traditional separation of banking and commerce
and to the competitive position of freestanding thrift and
banking institutions.

In the end, I believe the system as a

whole would be weakened —
be ill served*

and consumers and businesses would

Indeed, that approach is difficult to integrate

with the philosophy underlying deposit insurance and the Federal
safety net, which was never intended to support ordinary
commercial enterprises.

- 13 I recognize none of this is going to solve the pressures
on your industry arising from external economic factors —


particularly the historically high and volatile interest rates.
The thrift industry has always been in the forefront of those
supporting the effort to restore price stability, an effort
that is absolutely fundamental to a more stable financial
environment and sustained lower interest rates.

The problems

you face today are, in substantial partf an overhang —


I should say a hangover -- from the inflationary process, when
confidence in financial markets was greatly impaired.
A lot of progress toward stability has been made.
But the fruits of that progress in terms of lower interest
rates and more settled markets have not yet been at all fully
Inevitably, that process takes time.
know, the state of the Federal deficit —

But, as you well

both because of its

immediate economic and financial effects and because of its
bearing on inflationary expectations —

has worked to limit

- 14 -

the benefits on markets from the progress against inflation
that has been made.
The hard fact is we do not now, nor are we likely to
in the future, have the capacity to save enough domestically to
finance both federal deficits and the rising levels of investment needed to support growth and productivity.

Thus far in

the expansion period, we have been able to bridge the gap only
by drawing on a growing net inflow of foreign savings to supplement our own.

But that capital inflow implies a large cost.

That cost takes the form of a huge and growing trade deficit,
with sharply adverse impacts on the industrial, mining, and
agriculture sectors of the economy.

Looking ahead, it implies

a growing external debt and interest burden for the next generation,
Let me cite a few figures.

Net domestic savings


by individuals, by businesses, and by state and local governments —

has in fact increased quite rapidly over the past few

years, amounting to some 9 percent of the GNP in 1984.


- 15 near the higher end of the range prevailing over the postwar

Nevertheless, about a quarter of our net needs for

investment, including housing, and for deficit financing last
year, amounting to 2-1/2 to 3 percent of the GNP, had to be met
from foreign sources.
So far, that foreign capital has been readily available
and has played a key role in containing pressures on domestic
interest rates.

Among other things, it has enabled us to

maintain a reasonably satisfactory level of homebuilding and
house sales.

Even so, interest rates, as you know, have remained

high both historically and relative to current inflation.


out that net flow of savings from the rest of the world, pressures
on our financial markets would have been still greater and
interest rates would have been still higher.
Monetary policy can't cure the basic imbalance between
real savings and the demands on those savings.

We want to

provide enough money and credit to support sustainable growth
in real output and employment, while moving toward greater

- 16 -

price stability.

But too much money would only risk reigniting

the inflation that we have worked so hard to bring under
As a practical matter, we probably can't do much right
now, by monetary policy or otherwise, to change ingrained
savings behavior.

It seems to me that the only constructive

alternative to balance internal savings and investment is to
attack the problem from the other side of the ledger by reducing
the Federal deficit.

At current and projected levels, that

deficit amounts to approximately 5 percent of GNP, an amount
equivalent to over half our net domestic net savings.
large capital inflows —


and the related trade deficits

will not be sustainable indefinitely.


But, unless something

is done about the deficit, declines in the capital inflow would
be reflected in stronger pressures on financial markets.


that event, the thrift industry would be impacted from two

The credit sensitive housing industry would be

- 17 -

vulnerable, and the cost of your deposits could be under renewed
For those reasons, deficit reduction seems to me to be
the main "bread and butter" issue for the thrift industry before
the Congress.

I know many of you feel the same wayf and I know

you will continue your efforts to bring the importance of the
issue home —

home in the literal sense of explaining it to

your customers, as well as to the Congress.
We have allf as the old Chinese proverb saysf been
destined to live in interesting times.

The thrift industry

has had more than its share of tough challenges.

My respect

and admiration of the way thoughtful leaders of your industry
have faced up to those problems has only increased as we have
consulted and worked together.

I particularly appreciate the

opportunities to work together with some of you on our Federal
Reserve Thrift Industry Advisory Council.

The lines of

communication have been open with themf as well as with

- 18 the Federal Home Loan Bank Board.

I can also tell you those

lines are busy, but there is never a "busy signal."

We have

found large areas of philosophical and practical common ground.
I have also frankly explained to you our concerns


our concerns as an institution concerned with the health of the
financial system as a whole, with certain developments in the
banking and thrift world.

Some of those problems need legislative

solutions, but many we collectively can work on together.


Home Loan Bank Board is helping to lead the way, and I sense
they need and deserve your active support.
I know most of you share those concerns, and I believe
that, in a context of responsible national budgetary policies
and prudent attention to risk taking by individual institutions,
we should be able to look forward to renewed strength and
vitality in both the banking and thrift institutions.

That is

our common goal, and I sense that leaders in both the banking

and thrift industries not only share that vision, but are
working toward it,

* * * * * * * *