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Federal Reserve Bank of St. Louis
QUESTIONS AND ANSWERS
for
WBBM Business Breakfast
"Financial Forecasts for 1987"
January 29, 1987
GUIDE TO QUESTIONS COVERED
I.
Regional
Economic outlook for Illinois and Chicago in 1987
The Midwest and high tech
Regional growth and energy prices
Is manufacturing dying?
Outlook for steel industry
Outlook for auto industry in 1987
Outlook for manufacturing in 1987
II.
Page
1
4
6
8
9
10
11
International
Outlook for countries with debt servicing problems
Fall in the dollar -- good or bad for the country?
How else could we correct our trade problem?
How much of a fall in the dollar will we need?
Dangers associated with the decline in the dollar
Why hasn't our trade deficit improved yet? #1
Why hasn't our trade deficit improved yet? #2
Foreign investment/capital inflows and our standard of living
Meaning of the United States' net debtor position
Foreign investment in American industry -- good or bad?
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13
14
15
16
17
18
19
20
21
III. Financial System
Recently proposed capital guidelines for banks
Recapitalization of the FSLIC
Handling bank failures
Future changes in the banking system
Commercial bank activities and Glass-Steagall
IV.
22
23
24
25
26
Monetary Policy
Monetary policy and a banking cr1s1s
Implications of rapid debt growth
Money and inflation
Tax Reform Act implications for economy/monetary policy
Use of credit to finance hostile corporate takeovers
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1
QUESTION:
What do you see as the 1987 outlook for the economy in Illinois?
ANSWER:
Illinois is a diverse economic area.
doing as well as the nation as a whole.
On average it has not been
This is expected to continue--slow,
but positive growth.
But for a better understanding of the economic outlook for Illinois, it is
helpful to consider the various geographic areas of the state separately.
We generally look at three separate areas in Illinois, namely, the
eight-county Chicago metropolitan area, the metropolitan areas outside of the
Chicago area, and the nonmetropolitan areas.
1.
Q~tlook for Chicago metropolitan area
Employment in the Chicago metropolitan area since the first quarter of
1983 has been increasing at about the same rate or slightly better than the
national average.
Employment growth has been particularly strong in
construction, trade, and services, as the restructuring away from a
manufacturing to a service economy continues.
Manufacturing employment now
represents about 20 percent of total employment in the Chicago area, about the
same as the national average, so that the general restructuring of the economy
from a manufacturing to a service economy will be less of a drag on Chicago
area employment growth in the future than it has been in the past.
Employment growth in the Chicago area has been particularly strong in the
suburban collar counties of DuPage, McHenry, Lake, and Kane.
These counties
are being led by the service, trade, and high technology industries.
Employment in construction has been unusually strong, partly in anticipation
of the new tax law, and especially in the downtown area.
Although
construction employment gains cannot be expected to continue at past rates, a
slower rate of growth is not expected to be a serious drag.
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Furthermore,
2
these declines may be offset as our manufacturers become more competitive in
world markets.
Overall then, in the Chicago area, employment growth is expected to
continue moderate. about the same as the national average.
2.
Outlook for Illinois metropolitan areas outside the Chicago area
The employment growth rate in metropolitan areas outside the Chicago area
since the first quarter of 1983 has been about half that in the Chicago area.
Some of these areas such as Rockford, Decatur. and Peoria are important
manufacturing centers. As such they have suffered from the general
restructuring from a manufacturing to a service economy.
But they have also
suffered because of the focus of their manufacturing sectors on agricultural
and capital goods equipment.
Both of these sectors were heavily impacted by
the earlier strength of the dollar and foreign competition.
The decline in
the dollar should relieve some of the pressure from foreign competition but
indications are that real spending on capital equipment is expected to show
little or no growth this year.
An upturn in the market for agricultural
equipment also does not appear likely this year.
The results of economic development efforts in these areas. however, are
encouraging.
The building of the Diamond-Star plant in the Bloomington-Normal
area will provide new jobs.
It will also serve as a customer for supplier
companies in the area.
The outlook for Illinois metropolitan areas outside of the Chicago area
appears to be continued slow employment growth.
3.
Outlook for the nonmetropolitan areas of Illinois
The slower rate of employment growth in Illinois since the first quarter
of 1983 relative to the nation is largely due to the continuing decline in
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employment in the nonmetropolitan areas of Illinois.
All sectors except
manufacturing--services, trade, construction, transportation and utilities,
finance, and government--in Illinois nonmetropolitan areas have shown
substantial declines in employment.
Manufacturing showed a slight increase.
These declines generally reflect problems of agriculture in rural areas.
With
problems persisting in the agricultural sector during the coming year,
employment is not expected to increase in nonmetropolitan areas of Illinois,
although the rate of decline will probably slow.
l/21/87
Eleanor H. Erdevig
Ext. 5790
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4
QUESTION: Much of the spectacular growth outside the Midwest, in areas such
as New England and the Bay Area, has been associated with technology and
technology intensive industries such as electronics, computers, and defense
systems. Can we expect the Midwest to follow these same growth patterns in
coming years?
ANSWER:
First of all, as we have seen over the past two years, these
industries are not immune from broad declines and industry shakeouts.
Domestic sales of "office, computing, and accounting machinery" leveled off in
1985 and 1986 following rapid gains since 1982 while the electronic components
industry--especially semiconductors--has been losing market share overseas.
Prior to 1985, the U.S. ran a balance of trade surplus in so-called high
technology goods thoughout the 1970s and early 1980s.
However, the trade
balance for these industries in recent years has slipped into red ink so that
we must be careful not to conclude that these industries provide an economic
panacea for any region--but especially the Midwest.
We cannot expect that the Midwest will experience significant growth in
those industries already recognized as technology superstars such as computers
and electronics.
By now these industries are firmly entrenched in their home
regions--computers in the Northeast, electronics in the Bay Area, and defense
and aviation in Los Angeles.
The existing concentration of these industries
in their original locale is a strong magnet for further expansion--much as the
historical development of the auto industry in the Midwest has remained a
strong factor in attracting foreign investment to the Midwest (cite Isuzu in
Lafayette and Mitsubishi in Normal as recent examples).
On the positive side, the Midwest economy remains moderately strong in its
technology resources and we can expect that its strength in technology will
contribute to future economic growth.
We can expect that technology can help
the Midwest by rejuvenating its aging industries and by spinning off new
industries from the technological foundation of its existing industries.
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The
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Midwest's technological strength comes from its indigenous industries such as
autos, machine tools, construction and farm machinery, and chemicals that have
always been heavy investors in R&O and who continue to be wellsprings of new
products and processes in the Midwest region.
However, for some of these industries, product demand has declined despite
the development of new products.
For others, the region has lost market
share--perhaps temporarily-- to overseas competitors.
But whatever the case
may be, we can expect some snapback as these industries react to the initial
shock of foreign competition and dwindling markets.
The Midwest is reacting
by taking the lead in factory automation in many industries such as autos and
by renewing technological commitment in others such as steel.
These efforts
can both rejuvenate existing industries and create new ones to employ the
area's workforce.
So too, the Midwest economy already supports several widely-recognized
high tech industries with robust long-term growth prospects such as
pharmaceuticals-drugs and, to a lesser extent, communications equipment (both
of which are concentrated in Indiana and Northeastern Illinois).
The
challenge confronting Midwest policymakers is to foster these industries and
to build off of the existing technological base by fostering the much-touted
entrepreneurial climate and by encouraging technology transfer from our public
research centers into the private sector.
1/21/87
Bill Testa
Ext. 5791
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QUESTION: Can we expect the recent falloff in energy prices to alter the
regional growth trends that we have witnessed in recent years?
ANSWER:
Higher energy prices were only one of many effects on regional
growth differences that favored the South and West in recent years--the others
being the U.S. defense buildup, a strong dollar, increased foreign competition
in auto and steel and machine tools, changing world agricultural markets, and
the continued natural dispersion of industry to lower cost and underdeveloped
regions of the United States.
However, there is widespread agreement that
rising energy prices contributed to regional growth differentials.
Throughout the latter 197Os, there were two effects of higher domestic energy
prices which sparked the growth of the mineral-rich states of
Southwest--Louisiana, Texas, Oklahoma, and New Mexico--along with Western
states of Colorado, Wyoming, Montana, Alaska, California, and North Dakota
(West North Central Region).
The first of these effects was the 'industrial
location' effect such that high energy prices increased the importance to
businesses (and residences) of operating in warmer climes.
While this may
have contributed to a lagging Midwest economy, a much more significant effect
of higher energy prices was to favor the products that the energy producing
regions specialized in while lowering demand for products that the industrial
states produced.
The surge in the energy production industries--mining and
drilling--resulted in growing employment and income for workers in both the
oil fields and downstream activities.
At the same time, many products of the
industrial heartland experienced lagging demand--either because they consumed
much energy--large autos and gasoline--or because their production methods
heavily consumed energy and thereby raised final product price (e.g. primary
metals and industrial chemicals).
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The collapse in energy prices has clearly revealed that the latter effect
of energy prices was most significant.
Unemployment rates in mineral rich
states--especially Louisiana and Texas--have risen above national levels
while, at the same time, these states have amassed unemployment compensation
debt to the federal government.
This slowing of growth in oil production
industries, combined with a production cost reduction for Midwestern
manufacturers, will tend to narrow regional growth differentials to a modest
degree.
1/21/87
Bill Testa
Ext. 5791
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Federal Reserve Bank of St. Louis
8
QUESTION: Manufacturing is dying. We're turning into a nation of service
industries. We cannot have a strong economy if we're all taking in each
other's laundry. What should we do about it?
ANSWER:
This is a common perception, but it doesn't square with the facts.
Manufacturing is not dying.
On the contrary, total manufacturing output (in
the industrial production index) was at an all-time high in December.
Although some manufacturing industries remain well short of high production
levels of the past, others have expanded enough to raise total factory output
to a new peak.
Concerns about weakness in manufacturing often focus on employment, rather
than output.
Total employment in manufacturing, at around 19 million, is 2
million below the peak reached in 1979, and about even with levels reached 2
decades ago.
The decline in manufacturing jobs since 1979 resulted partly
from improvements in production methods and technology.
able to produce more with fewer workers.
Our factories are
Factory output has doubled since the
mid-196Os when manufacturing employment was about the same as now.
In the
long-run, productivity improvements raise incomes and the general well-being
of society. But individual workers may face serious adjustment problems.
The trend toward a higher proportion of employment in service industries,
broadly defined, has been underway for decades, and is likely to continue.
Because of productivity gains in manufacturing, we can have a strong
manufacturing sector, with rising factory output, and still have an increasing
share of the work force taking jobs in other industries.
1/21/87
Phil Cummins
Ext. 5784
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9
QUESTION:
What's the outlook for the steel industry?
ANSWER:
Steel remains burdened with excess capacity, in this country and
around the world.
Among the major markets for steel, auto and truck
production in 1986 was at a record level in terms of units, but each unit uses
less steel, on average, than in previous decades.
generally expected to fall in 1987.
Motor vehicle output is
Heavy capital goods have recovered only
partially from the recessions of 1980-82, and capital spending plans suggest
little or no growth in 1987.
Commercial construction has been at high levels
but is declining, nationwide.
Construction of industrial structures remains
far short of the good levels of the late 1970s.
1/21/87
Phil Cummins
Ext. 5784
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10
QUESTION:
What's the outlook for the auto industry in 1987?
ANSWER:
Industry analysts generally expect weaker auto sales in 1987,
following all-time high sales in 1986.
domestic models rather than imports.
Most of the decline is foreseen in
Auto makers probably will not repeat the
widespread use of very low financing rates and large rebates that boosted
sales but sapped profits in 1986.
Also, the new tax law, which eliminates
deductibility of sales tax and lengthens depreciation, caused some car and
truck buyers to accelerate purchases in late 1986.
1/21/87
Phil Cummins
Ext. 5784
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QUESTION:
What's the outlook for manufacturing in 1987?
ANSWER:
We expect the current business expansion, underway for over four
years, to continue in 1987.
We think total manufacturing output will rise in
1987, perhaps somewhat faster than in 1986, to meet growing demand, domestic
and foreign.
Manufacturing output was sluggish from mid-1984 through most of
1986, but it rose more than one percent from October to December.
The sharp
fall in the dollar since early 1985 has made our manufactured products more
competitive with goods made abroad, and the effects of this enhanced
competitiveness should be increasingly evident in 1987.
1/21/87
Phil Cummins
Ext. 5784
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12
QUESTION: What are the current economic prospects for countries experiencing
debt servicing problems?
ANSWER:
In some respects their conditions have been improving.
Their
collective economic growth is expected to pick up in 1987 to about 2.9 percent
from about 2.3 percent last year.
Perhaps most importantly from the
socio-political viewpoint, the decline in their per capita real income
experienced in 1982-83 period has been arrested; the IMF projects an increase
of about 0.7 percent in 1987.
The inflation, which has been the major problem
in many of these countries, also seems to be getting under control.
At the
projected 29 percent for 1987, it is still high, but much better than the
almost 100 percent in 1985, and the 62 percent last year.
Their exports are
also projected to rise, thus improving their capacity to service their debt.
A 4 percent growth in exports is being projected by the IMF; that is up from a
l percent growth in 1986.
In some other respects, however, their situation has deteriorated
somewhat. Their debt as a percent of their exports of goods and services stood
last year at its highest level of 293 percent, and is expected to improve only
marginally this year.
Their debt stands at some $573 billion, and is expected
to increase further to some $586 billion in 1987.
1/22/87
Joseph G. Kvasnicka
Ext. 5812
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13
QUESTION:
Is the decline of the dollar good or bad for the country?
ANSWER:
For some hard pressed U.S. producers who were priced out of the
world markets by the high dollar over the past several years, or who were
unable to compete with low-priced imports, the decline is good news.
for the country as a whole, the declining dollar will necessarily mean
downward pressure on our collective standard of living.
1/22/87
Joseph G. Kvasnicka
Ext. 5812
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However,
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QUESTION: Is there some other way that we could correct our trade problem
without suffering the consequences of the declining dollar?
ANSWER:
In the short run, an expansion of demand abroad through faster
economic growth would help.
In the long run, and in a very fundamental sense,
the only way we could reduce our trade deficit without a substantial decline
in the value of the dollar would be through an increase in the productivity of
our factories through more investment financed by our increased saving,
combined with a restraint on wage increases in excess of productivity.
That
would make us as a nation more competitive worldwide, and would lead to an
improvement in our trade balance without cutbacks in our standard of living.
1/22/87
Joseph G. Kvasnicka
Ext. 5812
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QUESTION: How much of a depreciation of the dollar will we need to correct our
balance of payments deficit?
ANSWER:
It is difficult to estimate that precisely.
For one thing, it will
depend a lot on what our rate of economic growth (and thus of imports) will
be. It will also depend on what rate of economic growth will take place
abroad; that will determine, in part, how fast our exports will be growing in
the future.
It will also depend on what sort of inflation, if any, we will
permit to develop in our country, and on how much that rate will exceed the
rate that may develop abroad.
The developments in terms of inflation will, in
turn, depend on what kind of real productivity growth we and our trading
partners abroad will record.
In the final analysis, the market will have to
incorporate all these adjustments before the "appropriate" exchange rate will
emerge.
1/22/87
Joseph G. Kvasnicka
Ext. 5812
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QUESTION: What are the dangers associated with the decline in the value of
the dollar?
ANSWER:
There are several.
First, it will tend to increase the
inflationary pressures in our country.
As prices of imported goods and raw
commodities that are used in the process of production rise as a result of the
depreciation of the dollar, this will tend to put upward pressure on our
prices in overall terms unless we are very careful in the conduct of our
monetary policy.
Second, the declining value of the dollar will be
necessarily associated with a reduction in the foreign capital inflows.
In
the past, these inflows supplemented the supply of capital available for
investment, and thus have kept our interest rates lower than than they
otherwise would have been.
A reduction in the foreign capital inflows will
thus tend to put upward pressure on our interest rates.
This pressure could
be quite substantial if we were to experience a precipitous, disorderly
decline in the value of the dollar before our balance of payments deficit
began to decline parallel with the decline in the capital inflows.
1/22/87
Joseph G. Kvasnicka
Ext. 5812
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QUESTION: Why hasn't the depreciation of the dollar decreased our trade
deficit as yet?
ANSWER:
First, the depreciation so far has been less, in overall terms
{i.e. globally), than is generally believed by those who focus only on the
major currencies such as the German mark and the Japanese yen.
Currencies of
some of our major trading partners {e.g. Canada, South Korea, Taiwan) have not
appreciated much, if at all against the dollar.
Second, some foreign
producers have been able to absorb a good part of the appreciation of their
currencies by reducing their prices and profits; that has kept our imports
high.
Third, some of our own exporters took advantage of the declining
dollar, and boosted their prices, effectively negating the potential impact of
the dollar's depreciation; that has kept our exports from rising faster than
they have been.
1/22/87
Joseph G. Kvasnicka
Ext. 5812
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18
QUESTION: With the decline in the dollar we've seen since the first quarter
of 1985, why hasn't there been an improvement in the trade balance?
ANSWER:
TWO POINTS.
l. If the decline in the dollar is going to have an impact on U.S. trade
it must first be reflected in the prices of traded goods--higher U.S. prices
for imports, which will discourage imports, and lower foreign currency prices
for U.S. exports, which will encourage U.S. exports.
Apart from petroleum, by
mid-1986 we were finally seeing price increases at the importer level and by
the end of the year import price increases were substantial.
When those price
increases get through the marketing system to the final buyer import demand
will slow.
2. Foreigners still consider the United States to be a good place to
invest.
Foreigners have the alternative of investing abroad, or in the U.S.,
or buying goods and services abroad, or from the U.S.
To the extent that they
choose to invest in the U.S. and net capital inflows continue, these capital
inflows must be balanced by a continued U.S. trade (current account) deficit.
This is a part of the reason that the U.S. government continues to call for an
increase in economic expansion abroad.
Not only would accelerated growth
abroad tend to result in an increase in U.S. exports but would encourage
investment abroad rather than in the United States.
1/22/87
Jack L. Hervey
Ext. 5795
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QUESTION: In recent years, we experienced large inflows of foreign investment
and capital. Won't that help moderate the expected retardation in growth in
our standard of living?
ANSWER:
To the extent that the foreign capital inflow increased our
productivity above and beyond what our interest payments on that capital in
the future will be, yes.
A substantial portion of foreign capital inflow,
however, went into financing our federal deficit and other "non-productive"
projects.
The associated foreign debt, amounting currently to over $200
billion, will be a standard-of-living depressing burden on future generations
of Americans.
1/22/87
Joseph G. Kvasnicka
Ext. 5812
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QUESTION: The United States' net international debtor position continued to
"worsen" in 1986. What does this mean for the U.S. economy?
ANSWER:
At the end of 1985 the United States was a net debtor to the rest
of the world by about $110 billion.
By comparison, in 1981 the U.S. was a net
creditor by about $140 billion, and in 1984 by about $4 billion.
Some
estimates indicate that in 1986 the U.S. will be in a net debtor postion of
around $250 billion.
What this means is the value of foreign assets held by U.S. residents is
less than the value of U.S. assets held by foreign residents.
There is
nothing inherently wrong with being a net debtor in the sense that we owe
someone else more than they owe us.
Focusing on the issue of "net debtor"
ignores consideration of the relative size of the economies, the capital base,
or the ability to service debt.
What is of considerable concern is the use to which these net capital
inflows (or the increase in the net debtor position) are being applied.
To
the extent that this capital is being used to fund productive investment that
will be able to service the debt, the economy is the better off for these
inflows.
To the extent that this capital is being used to fund nonproductive
expenditure, such as certain forms of government expenditures and private
consumption, the economy must suffer a loss in its future real standard of
living (from what it otherwise would have been) as the servicing of that debt
must come out of future real income.
1/22/87
Jack L. Hervey
Ext. 5795
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21
QUESTION: Foreigners seem to be buying up American industry. Shouldn't there
be more restriction on the ease with which foreigners can buy U.S. industry?
ANSWER:
No.
One can think of situations where for national security
reasons the U.S. government might want to restrict foreign ownership of
certain firms. (Those issues can be handled under existing regulations.)
But
as a general rule, there is little reason to artificially restrict foreign
investment in the United States.
Would you rather have Honda building its
auto plants in Korea and hiring Korean workers than in Ohio, or Mitsubishi in
Brazil rather than in Illinois?
The Japanese have invested considerable sums
in Brazilian agriculture during the past 15 years and our Midwestern soybean
growers unhappily must continue to live with that fact.
Foreigners do not invest in the United States out of the goodness of their
hearts but rather they do so based on economic considerations and a desire to
maintain access to the U.S. market.
Certainly they do compete with existing
U.S. firms, but they do so within our economic environment.
to U.S. employment, and U.S. output.
They contribute
And besides, if we pay attention, and we
had better, we may learn something about how "to run a railroad."
1/22/87
Jack L. Hervey
Ext. 5795
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22
QUESTION: The Federal Reserve recently proposed new capital guidelines for
the nation's banks. What will be the likely impact of these new proposals?
ANSWER:
We require banks to hold capital to provide depositors and the FDIC
with a cushion against loss.
The new guidelines are designed to address two
important developments. the growing internationalization of the banking
industry and the growing popularity of some new banking products that are
substitutes for bank lending.
Over the last 20 years. the market for many banking services has become
international in scope.
For instance, approximately a third of First National
Bank of Chicago's business is done outside of the U.S.
becoming more important in the U.S.
Foreign banks are also
This has made it important for the
different national regulators to agree on how much capital a bank has and
whether that level of capital is adequate for the amount of risk the bank is
taking.
This will ensure that no country's banks are being given an unfair
advantage.
The proposed guidelines were arrived at after lengthy discussions
with our British counterparts and will ensure that British and American banks
are being required to hold similar amounts of capital.
We hope to reach
similar agreements with other countries in the future.
The guidelines are also designed to respond to changes in the lending
process.
Over the last five years. bankers have been devoting less energy to
funding loans and more energy to guaranteeing loans that are funded by other
people.
For instance. the ratio of standby letters of credit to total assets
doubled between 1980 and 1986.
This shift has little impact on bank risk. but
it does mean that we have to make sure that banks that substitute guarantees
for loans are forced to hold the same amount of capital as those that just
make loans.
1/21/87
Herb Baer
Ext. 6199
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Federal Reserve Bank of St. Louis
23
QUESTION: Interest rates have fallen dramatically but Congress is still being
asked to provide the FSLIC with more money. Why?
Experts have estimated that the FSLIC may need as much as $25
ANSWER:
billion to deal with its problems.
billion.
rates.
Right now, the FSLIC only has $1.9
Five years ago, the industry's main problem was high interest
At that time a few of the most unhealthy S&Ls chose to increase the
riskiness of their loan portfolios by lowering loan standards and making
highly speculative investments.
Recent problems in agricultural and energy
states have caused many of these risky loans and investments to go bad.
Unfortunately, the decline in interest rates has not been enough to offset
these losses.
industry.
Fortunately, these problems affect only a part of the
But if the FSLIC is not given the funds it needs to deal with these
problem institutions, it will either be forced to get into the business of
running S&Ls or letting managers with nothing at risk make decisions that may
cost FSLIC even more money.
A major question, of course, is who will bear the
costs of recapitalizing the FSLIC--should it be healthy thrifts or the
taxpayer.
1/21/87
Herb Baer
Ext. 6199
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Federal Reserve Bank of St. Louis
24
QUESTION: 138 banks failed last year--the greatest number since the depression.
What are regulators doing to make sure that this doesn't happen again?
ANSWER:
not bad.
First, I think its important to realize that failures per se are
Banks are in the business of taking risk and whenever you take risks
there is a chance that things won't work out the way you expected.
More
important than the number of bank failures is whether the losses exceed the
bank's capital.
Actually, in the banking industry we've generally been fairly
successful in dealing with the problem banks before the losses pile up.
However, there is room for us to improve our record.
regulators are currently considering.
1. Requiring banks to increase capital
2. Requiring riskier banks to hold more capital
3. More frequent inspection of banks
1/21/87
Herb Baer
Ext. 6199
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Federal Reserve Bank of St. Louis
Several options that
25
QUESTION:
What important future changes do you expect in the banking system?
ANSWER:
Forecasts of future changes in banking are subject to a wide margin
of error.
For example, the rosy prospects for electronic payments foreseen
two decades ago are corning to pass only slowly, while interstate banking and
interest rate deregulation have come much faster than many expected.
In
general, without providing a timetable, I foresee a number of major trends
with respect to the structure of the financial services industry.
I expect a further dismantling of geographic and product restrictions, and
continued consolidation, particularly by regional institutions, and a further
homogenization of the functions of financial institutions.
With respect to
regulation, I foresee a trend toward regulation by function along the American
Express model cited recently by Sears.
I also think we will see greater
reliance on supervision as opposed to detailed regulation of banks'
risk-taking activities and the tailoring of bank capital standards and deposit
insurance premiums to the riskiness of the institution.
Within the industry
itself we can expect to see greater reliance on swaps, futures, and other
esoteric devices for managing risk; the development of completely integrated
financial packages for consumers that will include insurance, payment
accounts, savings and investment vehicles, and financial planning; and
continued technological progress in handling, processing, and transmitting
financial data.
Finally, increased interpenetration of national markets will
move us ever closer to the full integration of financial markets globally.
l/21/87
Larry Mote
Ext. 5809
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
26
QUESTION: Commercial banks have been moving more and more into activities, such
as securitization and the underwriting of commercial paper, that closely resemble
activities prohibited by the Glass-Steagall Act. Do you view this trend as
dangerous?
ANSWER:
No.
Although such activities do involve varying degrees of risk,
so do commercial lending and other traditional banking activities.
The point
is that the risk, rather than being inherent in the activity, depends on how
it is conducted.
The simple fact is that the role of investment banking
activities in the collapse of the banking system in the 1930s has been greatly
exaggerated.
Only a few, relatively large banks were involved and such
activities had nothing to do with the failures of thousands of small banks.
Today the regulatory and supervisory safeguards leave little room for a
repetition of the abuses of the 1920s.
Nonetheless, the supervisory agencies
will be scrutinizing banks 1 activities in these areas very closely,
particularly if the Glass-Steagall prohibitions were to be repealed.
1/21/87
Larry Mote
Ext. 5809
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
27
QUESTION: Will the Fed print its way out of a banking crisis, leading to
renewed inflation?
There are three things that would need to be done to ensure that
ANSWER:
the failure of several large banks did not imperil the nation's economy.
The
first is to make sure that we deal with failing banks in a timely manner.
This would make sure that the nation's banks continue to be managed in a safe
and sound manner.
The second would be to make sure that the FDIC had enough
money to meet its commitments.
This might force the government to run a
slightly bigger deficit, but under any reasonable scenario the required funds
would be small relative to the over $2 trillion in outstanding government
debt.
The third thing we would have to do is maintain the money supply at the
level it had reached before the failures.
This might require us to supply
additional reserves but would certainly not cause the money supply to balloon
and would not cause any appreciable change in the rate of inflation.
1/21/87
Herb Baer
Ext. 6199
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
28
QUESTION: Total nonfinancial domestic debt has grown exceptionally rapidly in
this recovery. Does it pose a serious problem either for the stability of the
financial system or for sustained growth of demand for goods and services?
The recent growth of debt is of major concern to the Federal
ANSWER:
Reserve and we are watching it very carefully.
The ratio of domestic debt to
nominal GNP, which stood at 140 percent in 1982, reached 170 percent in late
1986.
Although much of the growth in debt prior to 1982 was accounted for by
the federal government. since then household borrowing has increased sharply.
Consumer credit grew by 77 percent between year-end 1981 and year-end 1985.
That the increased level of debt threatens financial stability is suggested by
the increase in personal bankruptcies to record levels and the high mortgage
delinquency rate.
On the other hand. the rise in household debt is more than
counter-balanced by an increase in household financial assets.
Moreover. the
level of the debt itself is largely explained by changes in the age
distribution of the population and at least part of it reflects the use of
credit cards purely for convenience.
Though a potential threat. the level of
debt does not now constitute a clear and present danger.
There has been some concern for several years that the growing debt burden
of consumers might eventually slow the increase in spending. provoking a
recession.
At least up till now. such fears have proved unfounded.
To be
sure. there is a danger that the Federal Reserve. in its determination to
avoid such an occurrence. might produce a monetary policy with an inflationary
bias.
However. I am confident that we can avoid that problem if we keep in
mind the costs incurred in slowing inflation in the early 1980s.
1/21/87
Larry Mote
Ext. 5809
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
29
QUESTION: U.S. monetary growth over the past sei11~ra~1 fe.?.Jrrs; 'h:t'.£ ~r;r Un: most
rapid for any comparable period in peacetime 1t1r.t:t';,ry7.. T'l:1:.1.arclr.ci thi .Pml .of last
year it accelerated to an annual rate of over 2rti :pi'!rte1it. 'what dtie!'. tM'.:i prnrtend
for inflation in the future?
ANSWER:
This is perhaps the most worrisome p:roJfl;ej:fr cvrr~'TT:P.Y f11-1::·m,_g
monetary policy makers.
The experience of the pa5tr ti-·J/2 :<J!::clS:S-•-'h',
particular, the sharp and continuing f1ff:: in the
'f.11''.!C.t1"'lie
¥E?'1ir.:icHy o:l
money---tells us clearly that the relatively simple a;1;;:rl r;·el\a;.ble r,eraiionship
between money growth and subsequent inflation observed iin H,e 196O~ ilrid 1970s
is of little predictive value today.
On the other l':!c,:.'.l'rd., (_t>T-ituri:es of monetary
experience tell us that money and the price level are posit)~ely ,elated over
longer periods.
The prudent course appears to be that of supp1iying sufficient •money to
maintain real growth while keeping a vigilant eye on real sector measures,
such as capacity utilization, new orders, trade developments. ~tc .• that might
signal a reacceleration of inflation.
When several of these meas11rif'.s appeat·
to be giving signs of severe pressure on our 1:apacity t.o -produce" :policy
should move toward restraint in a prompt but gradual :n@nner.
l /21 /87
Larry Mote
Ext. 5809
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
30
QUESTION: What do you see as the major implications of the Tax Reform Act for
the economic outlook and for monetary policy?
ANSWER:
It is extremely difficult to predict the effects of a measure as
complex as the recent tax act.
Nonetheless, our best estimate is that the
elimination of the Investment Tax Credit and the tightening of depreciation
rules, together with the delay in reducing marginal tax rates, will have a
slightly negative impact on demand in the short run, more than offset in the
long run by the effects of lower marginal rates.
I do not believe that it is
possible to fine-tune monetary policy to offset any of these impacts.
l/21/87
Larry Mote
Ext. 5809
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
31
QUESTION: Much of the new credit being created in recent years has been used
to finance hostile takeovers of corporations. Do you believe that this is a
productive use of credit?
ANSWER:
There are two questions here.
One has to do with the desirability
of hostile takeovers per se, which does not admit of a simple answer.
The
fact is that some hostile takeovers are highly desirable in that they result
in the replacement of inept or overly conservative management by a more
effective management group.
The willingness of the hostile bidder to pay a
premium over current market to obtain control is a measure of his confidence
in his ability to turn the business around.
not work out.
Of course, all such takeovers do
The threat of hostile takeovers may lead current management to
follow a very short-sighted policy of maximizing current earnings without
regard for longer-term growth.
But, on balance, I see the discipline imposed
by the very threat of a hostile takeover as a positive force for efficiency.
The second question reflects a misconception, the notion that financing a
hostile takeover uses up real resources that could be put to productive use
elsewhere.
The only such resources used up in a takeover are the services of
the lawyers, accountants, and investment bankers involved in carrying out the
transaction, a minor percentage of the value of the transaction.
However, the
credit extended to buy out existing shareholders frees those shareholders to
extend credit to, or purchase equity in, other firms.
The primary source of
concern here is the widespread substitution of debt for equity in the capital
structures of the corporations taken over.
1/21/87
Larry Mote
Ext. 5809
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis