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Thursday, November 16, 1967
Approximately 10 a.m., Pacific Time
(1:00 p.m., EST)


Remarks of
Board of Governors
of the
Federal Reserve System
at the
75th Convention
of the
United States Savings and Loan League

San Francisco, California
November 16, 1967

It is a great pleasure to address this final general session
of the U. S. Savings and Loan League's 75th Convention.
The Federal Reserve System and the savings and loan industry
have many common goals and objectives.

We all want the U. S. to have

the best possible savings and credit system.

We want to see our economy

increase its output of useful goods as rapidly as possible with a minimum
waste of productive resources.

I, like most of you, am particularly

concerned with the problem of building a better urban environment and am
mindful that it will require a vast amount of physical capital investment
made possible by mortgage and bond financing based on a rising flow of
At the same time, we all are troubled by the threat of infla­

A long period of relatively stable prices did much to stimulate

the great expansion of your industry.

In the United States, in contrast

to many countries, thrift institutions have flourished because depositors
have known that they would get their money back and that when returned
it would be worth as much as when deposited.

Any threat to price sta­

bility is a threat to your industry.
While we have had to wage repeated battles with inflationary
pressures, recently this fight has turned more critical.

Halting infla­

tion will require a great effort on the part of the whole country.
Either the burden of this battle will be shared evenly by all, or it
will be paid for by disproportionate sacrifices on the part of individual
industries and specific sectors of the econorrçy.


Because of the strong forces now at work in the economy, no
matter which method of fighting inflation is adopted, you, as savings
and loan executives, will not find your tasks simple.
to discuss one approach to your dilemma.

Today, I want

Speeding up innovations and

improving the management of the relationships between your assets and
your liabilities--or more simply your portfolio policies— can greatly
ease these problems.
Interest Rate Movements
Over the past two and one-half years, we have seen interest
rates rise to record levels.

The entire postwar period has witnessed

increased fluctuations in interest rates.

How can your associations meet

the problems raised by these fluctuations?
Before discussing this major question, let me answer briefly
a separate question often asked.

Since monetary changes have frequently

produced sharp shifts in interest rates, why can't the Federal Reserve
keep interest rates down and stop these fluctuations?
In posing these questions, I recognize that some— I hope a
small minority— probably will think that the answer is simply the Federal

It is not, in fact.

admit I am torn.

But when I meet such a viewpoint, I must

I am never certain whether I ought to wish that the

Federal Reserve could control interest rates, or whether I should be
happy that the Federal Reserve doesn't have to bear the weight of trying
to decide the level of interest rates in addition to its existing burdens.


The reasons behind interest rate shifts are both simpler and
far more complex than the incorrect answer--the Fed.

The simple answer

is that interest rates rise when either more capital and credit are
desired or less is furnished.

Unless an equivalent increase occurs in

the amount people save or in the amount of money being created, when
people decide to invest or spend more or change the type of assets they
hold, interest rates rise.

The complex answer requires an understanding

of a large number of complicated relationships that lie behind this
simple statement.
Controlling Interest Rates
Changes in the flow of Federal Reserve funds can cause con­
siderable shifts in interest rates primarily because they are often at
the margin and tip the whole scale.
Changes in one or all of the underlying forces which determine
rates may either be exaggerated or offset for short periods by shifts in

Sharp short-run changes in interest rates come primarily

from speculation (more politely, changes in expectations).

Such expecta-

tional shifts cannot continue independently to dominate interest rates.
If not validated by events, sooner or later they fade away.

The degree

to which interest rates over a longer period can be held down by bank
creation of more money is limited.
the fabric of our economy.

It may also be very expensive to


People rarely hold money for itself, but rather for what it
can buy.

What money will purchase depends on how rapidly it is spent

compared to the amount of goods that can be produced.
creases demand.

More money in­

It can bring about lower interest rates only if the

economy has sufficient resources to turn out enough goods to more than
satisfy this demand.

If the ability to expand supply is limited, newly

created money merely raises demand faster than output.

Prices rise in

Such rising prices for goods and services can themselves

stimulate new desires for credit.
At the same time, if prices are rising, this means the value
of money is falling.

People will be less interested in holding cash and

some will be willing to retain deposits or savings and loan shares only
at the higher interest rates that will compensate them for the loss in
purchasing power of such assets.

Thus, while the demand for credit spirals

upward, the willingness of savers to supply funds at the old interest
rates diminishes.

Interest rates rise.

Experience in many countries

has been that the faster money was created the faster interest rates

If all resources are fully employed, increasing money faster

than the ability to produce goods raises prices and, therefore, interest
Suggestions have been made at this Convention as to possible
basic changes in relationship of the Federal Government and the Federal
Reserve to the mortgage market and your industry.

The Federal Reserve


demonstrated by action its resolve to assure the continued liquidity
of all sound financial institutions.

At the same time it is concerned

when suggestions are made for additional indirect subsidies from the
Federal budget to housing, your industry, or any other group.
A great deal more thought is required of the logic and pro­
cedures to be used when public measures are adopted in an attempt to
ease directly the impact of tightening general credit conditions on
the availability or price of residential mortgage credit.

Care must

be taken to insure that such measures do not have undesired results
opposite to those intended through increasing prices and inflationary

Furthermore, we believe that the extent and form of the

subsidy element involved in such proposals should be carefully con­
sidered and revealed.

Many schemes which involve subsidized credit

may work to penalize those most in need of housing while subsidizing
those with more than adequate funds to cover their own requirements.
The Long and Short of It
An examination of the supply and demand for funds leads to
an optimistic view of the intermediate and long-run future for low
interest rates.

While people's saving and spending desires change

sharply for short spells, they have been stable over longer periods.
Unless these desires shift radically, the Government's budget and mone­
tary policy--the so-called fiscal/monetary mix— should be the primary


determinate of interest rates in the next several years.

Firmer tax and

spending policies together with easier monetary policies can give lower
interest rates.
Most projections of the economy show that with normal growth
and a more balanced fiscal policy, in 1970 interest rates should be far
lower than in the past two years.

Because of their basic value to the

economy, I hope we have the courage to vote for the mix that will bring
lower interest rates.

With government saving up, lower interest rates

can make it easier to mount a vigorous attack on some of our most criti­
cal problems--the need for better housing, better cities, and a more
rapid capital expansion.
Some people worry about a shortage of mortgage money over
the long run, but I don't.

A mortgage shortage can be caused only by

a failure to live up to our fiscal responsibilities.
will fail now or in the future.

I don't think we

When the war in Vietnam ends, we are

more likely to find the situation similar to '63 and '64 when mortgage
money was in surplus than we are to suffer through shortages of mortgage
This optimistic view of the longer run future need not, of
course, apply to any specific shorter period.

Interest rates will con­

tinue to move up and down as businesses, individuals, and the Government
demand or offer more funds to the market.

In fact the postwar period

has witnessed a more stable economy accompanied by more frequent shifts
in interest rates--almost certainly not unrelated phenomenon.


Discussing the short-run action of interest rates reminds me
of the famous story of the financier, J. P. Morgan.
do a favor for a friend to repay one done him.
at the offer.

He once offered to

The man eagerly jumped

He said, "Mr. Morgan, you are known as one of the most

successful investors in Wall Street history.
savings but not enough to retire on.

I've accumulated some

Tell me what>
will happen to the

stock market--I want to be able to retire early."

Morgan gave him an

immediate and complete answer, "Predicting what the stock market will
do is simple— it will fluctuate!"
Interest Rate or Income Risks
Knowing that the stock market will fluctuate may not be very
valuable information for the average man.

The analogous knowledge that

interest rates will fluctuate is, however, one of the most valuable
pieces of knowledge available to a savings and loan executive.
of this knowledge has frequently been neglected.

Yet use

Recent history shows

far too few S&L's developing strategies or portfolio policies aimed at
reducing the costs and offsetting the risks of fluctuating interest
This neglect has been expensive.
if it continues.

It may grow still more costly

To make certain that it doesn't, thrift institutions

individually and as an industry need to reexamine their strategy of
meeting interest rate fluctuations.


Why Is a Portfolio Strategy Necessary?
The reason a strategy is needed should be clear.
-- When interest rates rise, long-term assets
carrying rates fixed previously become worth
-- To the extent associations' income is limited
to prior interest rates on outstanding mortgage
contracts, they have no earnings gains out of
which to increase their payments to share­
-- Funds withdrawable on demand can and may be
transferred to the bond markets or the money
market where higher rates are available.
In other words, the securities markets offer higher rates than
the associations because the income of the associations is relatively
frozen by existing contracts with borrowers.
move into market assets.

If the associations have to sell long-term

assets their problem is compounded.
market interest rates.

Savings are withdrawn to

They will sell on the basis of current

This may mean having to show sizable capital

losses on balance sheets.

(For those not too familiar with how to analyze

this problem, I might suggest you borrow a copy of my book Financing
Real Estate (McGraw-Hill 1965) from your library.

It deals with this

problem in some depth.)
I have never understood why this point--that fixed long-term
assets carry a risk of losses caused by interest-rate shifts— has been
neglected by so many institutions.

I suppose it was because past interest

rate fluctuations came when the margins between mortgage and share rates
were much larger and thus pressures were less.

It also may be because


under our accounting conventions, we don't show the loss in capital values
which occur with rising interest rates.

It is assumed that with suffi­

cient liquidity long-term assets won't have to be sold.

The fact that

interest is lost compared to current reinvestments is neglected.
The Neglected Costs
By failing to recognize this risk that capital values and rela­
tive income will fall as rates fluctuate, institutions make incorrect

They fail to consider all the costs of long-term loans in

comparison to maintaining greater liquidity.
This confusion is clearest in some recent debates.

When long­

term rates were much higher than short-term rates, managers thought it
was too expensive to maintain liquidity.
term mortgages or bonds.

They invested too much in long­

They made wrong decisions because they failed

to include an allowance for the cost of illiquidity in their calculations.
Our accounting conventions allow us to show higher income by neglecting
these risks.

They force us to report lower incomes if we take the safer

steps which probably increase long-run profits.
Since interest rates will fluctuate, an interest-rate risk

Failing to insure against this risk is like failing to insure

against other risks.
fire or car insurance.

For a period, anyone may save money by not carrying
When the insurance isn't needed he has a higher

income and lower expenses.

We frown on such an understatement of ex­

penses because we know that in most cases it pays to insure.
fire, the house or business will be lost.

In case of


The same is true of interest-rate risk.
carry insurance against this risk.

We are not forced to

If we don't adopt a safe policy our

income looks higher.

If interest rates change, however, we suffer from

a lack of protection.

The losses can be severe enough to threaten the

entire .institution.

In most cases, insurance against these risks as

against others is worthwhile.
How to Insure Against Interest Shifts
Tremendous strides have been made in recognizing how these
risks can be insured against.

Most of the ideas put forth still require

a good deal of work and analysis.

Some have been adopted; some not.


three which I feel have shown greatest promise are:
-- Maintaining greater liquidity.
-- Obtaining variable interest rates on
-- Offering a greater variety of intermediateterm certificates and long-term bonds.
Let me discuss each briefly.
Greater Liquidity
The advantages of liquidity are manifold.
don't fluctuate in value as interest rates shift.
they can be liquidated without capital losses.
assets are reinvested at the higher rates.

Short-term assets
If cash is needed,

If rates change, liquid

Banks have traditionally held

far more liquidity than S&L's because of their different historical back­

Do such large differences still make sense if an association

is buying its funds in a broad or national savings market?


Liquidity can be gained in many ways.
the Home Loan Banks.

It can be pooled as in

Without discussing the many technical problems in

this sphere, it can be pointed out that when considered as insurance,
liquidity costs far less than many believe.
Variable Interest Rates
The advantages to lending institutions of variable mortgage
interest rates are also clear.

If carefully drawn and explained, the

variable rates are fair to borrowers also.

They enable the borrower and

the lender to share gains and losses as interest rates shift.

Thus, they

reduce the need for insurance against the risks which arise if one or the
other is not protected in the mortgage contract.
is a real saving.

Doing away with a risk

Everyone is better off.

Most discussion has been concerned with variable rates on the
single family mortgage.

Winning acceptance for a new idea is hard.

takes work and understanding.


Progress will be made, but it may be slow.

Meanwhile, let me suggest an innovation which might be simpler to adopt.
Why shouldn't interest rates on mortgages on income properties
vary with the income from those properties?
On the surface, such an idea doesn't seem difficult to imple­

Such mortgages could require that higher interest rates be paid

when the income of the property rises.

They might also have a pre­

payments penalty which increases with the amount of capital gain made
when the property is sold or re-financed.


Variable income provisions are, of course, the basis of most
current agreements between landlords and tenants in shopping centers.
Various forms of so-called "sweeteners" are becoming more common in the
lending agreements between income property owners and insurance companies,
pension funds, and endowment funds.

It might make a great deal of sense

if they became part of lending practice on all types of income properties.
It seems proper that there be a sharing of risks between borrower and
Create a Greater Variety of Liability Instruments
While changing assets and the return to assets can give some
protection against interest-rate risks, programs to create different types
of liabilities seem more hopeful and immediate.

Your associations have

been experimenting with different types of certificates in the past
several years.

These programs should be expanded and shaped to meet your

problems head on.
Sometimes I feel that not enough emphasis has been given these
programs because their logic has not been fully explained.

All deposit

institutions should understand completely the purpose and potential gains
from offering different maturities of shares, certificates, and deben­
tures at varying interest rates.

Only with such knowledge can they

formulate a logical strategy for their use.


13 -

-- Because of interest-rate risks, the value of
shares or deposits to an institution varies
with the length of time they are certain to
-- Longer term certificates may also create sig­
nificant savings in marketing and other costs.
-- Savers have differing needs for rate of return,
liquidity, and convenience.
-- A program to shape an association's liabilities
to its customers' needs makes all better off.
It may be fairer and cheaper to pay savers for
giving up liquidity than to insure against their
-- Associations compete in many different markets.
Some competition comes from other associations,
some from banks, some from Treasury bills, some
from corporate bonds. The best way to compete
is to tailor a different instrument to compete
with each of these markets, insofar as it is
possible to do so. Each instrument may have to
carry a separate rate.
You are all familiar with the differences among savers.
are primarily concerned with liquidity and convenience.
to sacrifice interest for these advantages.
on demand meets their need.


They are willing

A passbook normally payable

Others are more interested in yields.


larger sums to invest and more sophistication, they can search for higher
When market rates rise an association's attempt to hold the
money of rate-sensitive savers by increasing the rate paid on all shares
is both expensive and inefficient.

Losing their funds, particularly if

it means taking capital losses, may be expensive also.


Recent trends in differentiating savings instruments ought to
be pushed further.

They should lead to a variety of different instru­

ments, but also to greater penalties than now exist for liquidating
longer term contracts.

We might expect to see passbooks, six-month to

three-year certificates, and 10- to 15-year debentures all being used
side by side.

Rates would vary with maturity.

Penalties for obtaining

cash prior to maturity would also vary depending upon the length of the
initial contract.
I recognize that these are proposals involving not only changes
in management policy, but also to some extent in supervisory attitudes,
regulations, and in some cases even in applicable statutes.

But the

first step toward all these changes is insuring a clear understanding of
how and why these changes can benefit the association, its savers, and
its community.

That is a job I would urge you to undertake.

The past several years have certainly been interesting (to say
the least) for all financial institutions.
in the demand for funds.

Vietnam brought major shifts

As total demands for goods and services fluctu­

ated above and below the economy's ability to supply them, the amount of
credit demanded and created by our financial system varied.
rates shifted rapidly.

Most recently the course has been upward.

term rates have reached record high levels.



15 -

Most people would agree, I believe, that the country would be
better off with interest rates that averaged lower over the long run.
Whether they would also agree on taking the steps necessary to bring about
those lower rates, I am not so certain, but I am an optimist on that score.
Our housing and other urban needs are great.

As a result I believe that

we will support the fiscal/monetary programs necessary for lower rates.
Over the long run, I don't fear a mortgage shortage.
While with an optimum policy mix the long-term trend of interest
will be down, this may not be true in any specific period.
continue to fluctuate above and below the trend line.
major problems for you as savings and loan executives.
up to unequivocally and consistently.

Rates will

This fact creates
It must be faced

Portfolio strategies must be

adopted that will decrease your risks and enable you to fulfill your
role as major mortgage lenders more consistently.
has been made along these lines.
provements lie ahead.

Considerable progress

I am confident that still greater im­

They will lead to a consequent strengthening of

your associations, of the entire credit and financial sphere, and of our
whole economy.