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Arthur F. Burns Papers
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The original documents are located in Box B1, folder "American Bankers Association (3)"
of the Arthur F. Burns Papers at the Gerald R. Ford Presidential Library.
Copyright Notice
The copyright law of the United States (Title 17, United States Code) governs the making of
photocopies or other reproductions of copyrighted material. Gerald R. Ford donated to the United
States of America his copyrights in all of his unpublished writings in National Archives collections.
Works prepared by U.S. Government employees as part of their official duties are in the public
domain. The copyrights to materials written by other individuals or organizations are presumed to
remain with them. If you think any of the information displayed in the PDF is subject to a valid
copyright claim, please contact the Gerald R. Ford Presidential Library.
Some items in this folder were not digitized because it contains copyrighted
materials. Please contact the Gerald R. Ford Presidential Library for access to
these materials.
October 5, 1970
Mr. Nat S. Rogers, President
The American Bankers Association
90 Park Avenue
New York, New York 10016
Dear Mr. Rogers:
In further reference to the concern you expressed in
your letter of September 2 regarding the Board's recent action
on reserve requirements, I am enclosing for your information a
staff analysis that I requested before leaving the country for
the Fund and Bank meetings in Copenhagen. You will notice that
we also heard from Messrs. Donald Graham and A. W. Clausen on
the same subject.
I believe you will find that the memorandum addresses
itself to the substantive issues raised in your letter, and we
thank you once again for communicating to us the views of the
American Bankers Association.
Sincerely yours,
Arthur F. Burns
Enclosure
EAL:ck
FORD & LIBRARY GERALD
BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM
Office Correspondence
Date October 5, 1970
To
Chairman Burns
Subject: Comments on letters received in
connection with Board's recent action
From
The Staff
on Regulation D.
As requested, we have been analyzing during your absence,
various comments received on the Board's recent change in reserve
requirements, and related views on some broader aspects of monetary
policy and regulation. These views were expressed by Messrs. Nat
Rogers, Donald Graham, and A. W. Clausen in letters of September 2,
10, and September 21 respectively; and have been considered together
since there is some coincidence of subject matter.
The reservations with respect to the Board's recent actions
revolve essentially around three points:
(1) The belief that the treatment as demand deposits of
less than 30-day holding company paper, and the extension
of Regulations D and Q to term debt in the two to seven
year maturity range unfairly exclude banks from raising
funds in market sectors to which other participants have
access.
(2) The belief that the Board seriously underestimated the
added burden on banks created by shifting from the originally
proposed 10 per cent reserve requirement for all bank-related
commercial paper to the 17-1/2 per cent requirement for that
of less than 30 days maturity.
(3) The belief that the Board should have requested further
public comment on the changed proposal before acting on it.
On the first point, the philosophy underlying the Board's
action was to make the treatment of bank holding company commercial
paper as close as possible to that of large time certificates of deposit.
To accomplish this, the 30-day maturity distinction between time and
demand deposits was extended to commercial paper. We recognized fully
that this action would have the effect of virtually excluding banks with
holding companies from access to the very short term commercial paper
market (an avenue which has been closed all along to banks not affiliated
with holding companies). We also had in mind, however, that commercial
banks could continue to operate in the less-than-30-day sector quite
effectively through the purchase of Federal funds, Euro-dollars, and
the use of short-term Rp's secured by Treasury and Federal agency
securities. Furthermore, from the standpoint of competitive advantage,
these latter means are not universally available to other market
participants.
GERALD FORD LIBRARY
Chairman Burns
-2-
In addition, with the Board's previous suspension of rate
ceilings on large CD's in the 30-89 day maturity range, banks again
have access to this alternative source of funds. And, of course,
bank-related commercial paper in this maturity range carries a 5 per
cent reserve requirement (rather than the previously published 10 per
cent), and has no rate ceiling either.
On the question of subordinated bank debt, the Board's recent
extension (effective June 30, 1970) of the point at which term debt
becomes exempt from Regulations Q and D -- from two to seven years --
was supported by the following logic: Only a few banks were using such
high-yielding notes of two to three years maturity to lure deposit-type
funds away from regular depositary-type claims; but to the extent this
was occurring, the effect was a clear circumvention of the regulations.
The purpose of the new restriction on promissory notes was to ensure
that all banks use the subordinated debt, for bona fide capital purposes
and not as a substitute for regular time and savings deposits as a
source of essentially short-term deposit-type funds. On the general
issue of the application of regulations to banks, it can well be argued
that commercial banks should be free -- along with nonbank borrowers --
to seek funds without restriction as to reserve requirements or interest
rate ceilings, particularly when banks and nonbank borrowers are compet-
ing in similar markets and for the funds of similar investors. But there
are differences among institutions. It is where the functions of institu-
tions tend to overlap that the distinctions become blurred and reasonable
men come to differ as to the appropriate policy approach. It could be
argued, from a highly theoretical point of view, that reserve requirements
are not really necessary. Most would accept, however, from a pragmatic
and institutional viewpoint, that demand deposits should be subject to
such requirements, for monetary control if for no other reason. It then
becomes difficult to argue that time deposits, too, should not be subject
to some reserve requirement since at least a portion of time deposits take
on the characteristics of money in their use and function. But time deposits
issued to businesses compete with such instruments as Treasury bills and
commercial paper issued by nonbank corporations, which do not bear reserve
requirements. Where should the reserve requirement line then be drawn?
A decision must be made at some point. We have attempted to draw our lines
in such a way as to reduce inequities within the banking system, and to
minimize the disparities between banks and other competing institutions to
the extent this is compatible with the overall objectives of public economic
policy. And these disparities can only be viewed within the context of the
whole spectrum of regulation affecting banks and other institutions, recogniz-
ing that banks have advantages in some respects (such as interest-free demand
deposits) that others do not have.
GERALD FORD TIBRARY
Chairman Burns
-3-
In the broadest sense, it might be pointed out that commercial
banks will in the future expand as a group only to the extent that the
Federal Reserve System adds reserves, and to the extent that they can
become more active as financial intermediaries. Once again, suspension
of Regulation Q ceilings helps facilitate this role. But there is a
finer point to make. While the Board may want to encourage financial
intermediation at the expense of direct borrower-lender arrangements
not subject to the discipline of intermediaries, it must also take
account of the effects of flows among different types of financial
institutions.
Turning to the second question of the burden on banks by
applying the 17-1/2 per cent reserve requirement on commercial paper
of less than 30 days maturity, we simply disagree. Our formal survey
in February of this year indicated that less than 20 per cent of out-
standing bank-related commercial paper had initial maturities under
30 days. This proportion increased over the spring and summer as
expectations of declining rates persuaded borrowers to remain short,
and based on informal contacts with major banks, we estimate that the
short maturities accounted for 30-40 per cent of total outstandings
at the time of the Board's announcement.
One banker commented that if the 17-1/2 per cent reserve
requirement were placed against the outstandings of his bank alone at
mid-August, the reserve impact would account for nearly all of that
which we estimated for the entire system. The maturity distribution
at mid-August is not relevant, however, in estimating the reserve impact
at the effective date one month later. What is important is whether the
banks could shift into other sources of funds during the one-month period
provided for adjustment. Another felt that it would not be possible in
most cases to replace the short dated maturities as they mature with 31
day or longer paper, especially when customers have need for the short
dated maturities and other issuers of commercial paper are not penalized
when they issue such short dated paper. Despite this pessimism as to
the banks' ability to shift, very substantial adjustments have been
reflected in deposits and commercial paper and the cost of such adjust-
ment became less costly as rates declined during the period. Latest
preliminary data show that the commercial paper-issuing banks got rid
of all but $300 million of their less than 30 day commercial paper between
August 12 and September 17, and that there was a more than commensurate
increase in time deposits during the same period. The fact that banks
have reduced their offering rates for CD's maturing in the 30-89 day
maturity range indicates that they had no difficulty in finding CD money
during this adjustment period. As a matter of hindsight, we now see
preliminary indications that the combination of Federal Reserve actions
&
FORD
GERALD
LIBRARY
Chairman Burns
-4-
and flows of funds resulted in a net reduction in required reserves of
approximately $500 million (we estimated only $350 million at the time
the Board acted).
On the third point, that we did not invite further public
comment, and that the Board should reconsider its action, we were
motivated by two principal factors: first, the net effect of our
action was designed to reduce required reserves rather than have a
tightening effect; and second, we felt that with the available alter-
natives for securing very short term funds (Federal funds, Euro-dollars,
and Rp's) and the full month adjustment period provided, there-would be
no severe hardship placed on the banks most affected. In retrospect, we
feel that these two results did, in fact, obtain.
FORD i GERALD LIBRARY
THE AMERICAN BANKERS ASSOCIATION 90 PARK AVENUE, NEW YORK, N.Y. 10016
NAT S. ROGERS
PRESIDENT
FIRST CITY NATIONAL BANK
September 2, 1970
HOUSTON, TEXAS 77001
Hon. Arthur F. Burns, Chairman
Board of Governors of the
Federal Reserve System
Washington, D. C. 20250
Dear Mr. Chairman:
Reference is made to the announcement by the Board of Governors
of the Federal Reserve System on August 17, 1970, that action had been
taken to apply a 5 percent reserve requirement on funds obtained by mem-
ber banks through the issuance of commercial paper by their affiliates,
and at the same time to reduce from 6 to 5 percent the reserves that
member banks must hold against time deposits in excess of $5 million.
It is understood that notwithstanding the Board's announce-
ment the actual effect of the Board's action as reflected in its pub-
lished regulation is to set a 5 percent reserve on commercial paper
issued with maturities of more than 30 days and a reserve of 17½ per-
cent for reserve city banks for commercial paper with maturities of
30 days or less.
This result apparently is achieved by amending Regulation D to
include commercial paper issued by bank affiliates under the definition
of "deposits" and treating commercial paper in the same manner as certif-
icates of deposit and time deposits are treated for reserve purposes,
namely, on the basis of maturity dates. However, the regulations are
silent on this point, and it does not necessarily follow that the regu-
lations can be interpreted in this manner in the absence of specific
provisions in Regulation D. The reference to "demand deposit reserve
requirements" accompanying the amendment to Regulation D adds to the
confusion in view of the specific reference to a 5 percent reserve in
the Board's release to the press on August 17, 1970, and the notice
sent to member banks in its district by the Federal Reserve Bank of
New York on August 17, 1970, a copy of which is enclosed.
These rates become effective on deposits and commercial paper
outstanding in the week beginning September 17, for the reserve computa-
tion period beginning October 1. It is stated that changes made in the
regulation proposed originally last January raise no new issues or are
insignificant as a practical matter. In these circumstances, and in
view of the deferral of the effective date until September 17, 1970,
the Board finds that further notice and public procedure with respect
to the announced regulation are unnecessary and would be contrary to
the public interest.
&
FORD
GERALD
LIBRARY
Hon. Arthur F. Burns
Page 2
The action taken by the Board in requiring reserves on funds
obtained through commercial paper issued by bank affiliates has a sig-
nificant impact upon a number of the members of The American Bankers
Association, and in our view represents a considerable departure from
the action proposed initially on January 29, 1970. The initial pro-
posal would have placed a 10 percent reserve on all commercial paper
issued by bank affiliates having a maturity of 1 day or more. The
final regulation which places a 17½ percent reserve for reserve city
banks on commercial paper with maturities of 30 days or less, even
though a reserve of 5 percent is set for paper with maturities over
30 days, places commercial bank affiliates in an untenable competitive
position in the commercial paper market. It will not be possible in
most cases to replace these short dated maturities as they mature with
31 day or longer paper, especially when customers have need for the
short dated maturities and other issuers of commercial paper are not
penalized when they issue such short dated paper.
We are concerned with the effect which the reserves on com-
mercial paper will have on overall reserves of the banking system,
because while we do not have precise statistical information showing
a maturity breakdown of outstanding commercial paper issued by bank
affiliates, informal information obtained from a number of commercial
banks indicates that one-half or more of the paper issued by their af-
filiates has maturities of 30 days or less. Under these circumstances,
the extension of reserve requirements to bank-related commercial paper
which is estimated by the Board, as stated in its announcement, to in-
crease required reserves of the affected member banks by roughly $350
million, may in fact place a much heavier reserve requirement on such
banks, and lessen the reduction of required reserves for the banking
system as a whole. Thus, the amount of net reserves intended to be re-
leased to make funds available in financing housing and State and local
governments will not accomplish the objectives announced by the Board.
It is requested that the Board reconsider its action with
respect to the required reserves set for bank-related commercial paper,
and either reduce such reserves to 5 percent for all such paper having
maturities of one day or more (the maturities originally designated in
the January, 1970, proposal), or defer the effective date of the changes
announced on August 17, 1970, until precise data is developed showing
the amount of outstanding bank-related commercial paper with maturities
of 30 days or less, and the impact on the required reserves of the mem-
ber banks involved. In view of the relatively limited number of member
banks which will be affected directly by the Board's action requiring
reserves on bank-related commercial paper, we believe that further con-
sideration to this matter as we request is justified, and that the
&
FORD
GERALD
LIBRARY
Hon. Arthur F. Burns
Page 3
banks involved are entitled to present their views concerning such
action before it becomes effective, as provided for in Section 553 (b)
of Title 5, United States Code.
Very truly yours,
nats Rogers
Nat S. Rogers
President
Enclosure
FORD & LIBRARY GERALD
FEDERAL RESERVE BANK
OF NEW YORK
Circular No. 6589
August 17, 1970
CHANGES IN RESERVE REQUIREMENTS
- Five Percent Reserve Requirement Established
For Bank-Related Commercial Paper
-Reserve Requirement For Time Deposits Over
$5 Million Reduced From 6 to 5 Percent
To All Member Banks, and Others Concerned,
in the Second Federal Reserve District:
Following is the text of a statement issued today by the Board of Governors of the Fed-
eral Reserve System:
The Board of Governors of the Federal Reserve System today applied a 5 per cent
reserve requirement on funds obtained by member banks through the issuance of com-
mercial paper by their affiliates, and at the same time reduced from 6 to 5 per cent the
reserves that member banks must hold against time deposits in excess of $5 million.
Both actions will become effective in the reserve computation period beginning
October 1 and will be applicable on such deposits and commercial paper outstanding in
the week beginning September 17. This coincides with the beginning of the fall period of
seasonal expansion of deposits and required reserves.
The dual action will result in a reduction of required reserves of about $350 million
for the banking system as a whole. The extension of reserve requirements to bank-
related commercial paper is estimated to increase required reserves of the affected
member banks by roughly $350 million. On the other hand, the reduction in reserve re-
quirements against time deposits over $5 million is expected to lower required reserves
by some $300 million at banks issuing commercial paper, and by about $400 million at
all other member banks.
The greater portion of the net reserves thus released will become available to banks
that in the present circumstances might be expected to use a sizable share of the avail-
able funds in financing housing and state and local governments.
Both actions of the Board were adopted unanimously.
No change was made in the 3 per cent reserve requirement on a member bank's
savings deposits, and time deposits of less than $5 million. Today's action represents
the first change in reserve requirements since April 17, 1969, when the Board increased
reserves on demand deposits by one-half of one per cent for all member banks.
FORD & LIBRARY GERALD
(Over)
Since most commercial paper is issued in denominations of $100,000 or more, the
extension of reserve requirements to bank-related commercial paper will put instru-
ments of this kind on a substantially equal footing, in terms of reserve requirements,
with negotiable certificates of deposit issued by banks.
In imposing reserve requirements on commercial paper issued by bank affiliates,
the Board used for the first time the authority contained in the Act of December 23,
1969, which explicitly authorized such action. The reserve requirement will apply to
funds obtained by member banks through the issuance of commercial paper or similar
obligations by their affiliates.
Presently, about $7.5 billion of bank-related commercial paper is outstanding. Over
the past year, the amount of such paper had risen by $5.5 billion.
At the time the new reserve requirements become effective the permission initially
granted on November 4, 1969, to the Federal Reserve Banks to waive penalties for
reserve deficiencies connected with the application of reserve requirements to sub-
sidiaries' commercial paper will be withdrawn.
In taking this action with respect to bank-related commercial paper, the Board urged
member banks and their holding companies to comply with the spirit and purpose as well
as the letter of the rules regarding member bank reserve requirements.
Copies of the Supplement to Regulation D, revised to reflect the above changes, will be
sent to you shortly. Additional copies of this circular will be furnished upon request.
Alfred Hayes,
President.
FORD & LIBRARY GERALD
October 5, 1970
Mr. A. W. Clausen, President
Bank of America
Bank of America Center
San Francisco, California 94120
Dear Mr. Clausen:
As you know, I was in Copenhagen at the international
meetings when your letter of September 21 arrived at my office.
I find the comments that you made therein to be most useful and
constructive; and their benefit is of the best kind that we can
get from members of the Federal Advisory Council.
I am taking the liberty of enclosing a copy of a memorandum
I asked our staff to prepare while I was out of the country. As you
can see it is addressed primarily to comments received from Messrs.
Nat Rogers and Donald Graham, but your letter is similar in may
respects. I feel that this memorandum gives an accurate picture of
the technical reasoning behind the Board's recent action on reserve
requirements.
May I say to you I do agree that we have at times been
guilty of ad hoc decisions on matters of monetary and regulatory
policy. But having said that, I must defend our actions as reflect-
ing the best judgment of reasonable men at the time and under the
circumstances.
Your comment about disintermediation and the commensurate
rapid growth in commercial paper makes. in my opinion, a very good
point -- one to which we addressed ourselves when Regulation Q ceiling
on CD's of 30-89 days maturity were suspended. There is more thought
to be given in this area, and our study of rate ceilings continues.
I would not agree that our extension of reserve requirements
to commercial paper is a step in the direction of asset reserve require-
ments, to which I assume you would object on selective credit control
grounds. Our objective as explained in the attachment to this letter,
FORD & GERALD LIBRARY
Mr. A. W. Clausen
-2-
was in the interest of equitable treatment among all banks, most of
which do not have holding companies and cannot issue commercial paper,
and must therefore rely on certificates of deposit for funds of this
character.
We appreciate your views on the subject of the Federal
Home Loan Bank Board decision to allow direct payments. We are aware
of the many questions and implications this raises for the entire
monetary and payments system, and the Board is giving a high priority
to a careful and thorough study of the entire matter.
Finally, please be assured that I share your preference for
broad monetary control in preference to the selective approach, and
I am hopeful that we can make further progress in this area as time
and circumstances permit. The conduct of monetary policy is a
challenging and at times frustrating business, but I honestly feel
that recent policy has been appropriate, and so far, the performance
of the economy in the current adjustment has been about as good as
could be achieved given the magnitude of the task.
Thank you once again for sharing with us your important
views.
Sincerely yours,
Arthur F. Burns
Enclosure
EAL:ck
GERALD R. FORD LIBRAPA
BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM
Office Correspondence
Date October 5, 1970
To
Chairman Burns
Subject: Comments on letters received in
connection with Board's recent action
From
The Staff
on Regulation D.
As requested, we have been analyzing during your absence,
various comments received on the Board's recent change in reserve
requirements, and related views on some broader aspects of monetary
policy and regulation. These views were expressed by Messrs. Nat
Rogers, Donald Graham, and A. W. Clausen in letters of September 2,
10, and September 21 respectively; and have been considered together
since there is some coincidence of subject matter.
The reservations with respect to the Board's recent actions
revolve essentially around three points:
(1) The belief that the treatment as demand deposits of
less than 30-day holding company paper, and the extension
of Regulations D and Q to term debt in the two to seven
year maturity range unfairly exclude banks from raising
funds in market sectors to which other participants have
access.
(2) The belief that the Board seriously underestimated the
added burden on banks created by shifting from the originally
proposed 10 per cent reserve requirement for all bank-related
commercial paper to the 17-1/2 per cent requirement for that
of less than 30 days maturity.
(3) The belief that the Board should have requested further
public comment on the changed proposal before acting on it.
On the first point, the philosophy underlying the Board's
action was to make the treatment of bank holding company commercial
paper as close as possible to that of large time certificates of deposit.
To accomplish this, the 30-day maturity distinction between time and
demand deposits was extended to commercial paper. We recognized fully
that this action would have the effect of virtually excluding banks with
holding companies from access to the very short term commercial paper
market (an avenue which has been closed all along to banks not affiliated
with holding companies). We also had in mind, however, that commercial
banks could continue to operate in the less-than-30-day sector quite
effectively through the purchase of Federal funds, Euro-dollars, and
the use of short-term Rp's secured by Treasury and Federal agency
securities. Furthermore, from the standpoint of competitive advantage,
these latter means are not universally available to other market
participants.
FORD
GERALD
LIBRARY
Chairman Burns
-2-
In addition, with the Board's previous suspension of rate
ceilings on large CD's in the 30-89 day maturity range, banks again
have access to this alternative source of funds. And, of course,
bank-related commercial paper in this maturity range carries a 5 per
cent reserve requirement (rather than the previously published 10 per
cent), and has no rate ceiling either.
On the question of subordinated bank debt, the Board's recent
extension (effective June 30, 1970) of the point at which term debt
becomes exempt from Regulations Q and D -- from two to seven years --
was supported by the following logic: Only a few banks were using such
high-yielding notes of two to three years maturity to lure deposit-type
funds away from regular depositary-type claims; but to the extent this
was occurring, the effect was a clear circumvention of the regulations.
The purpose of the new restriction on promissory notes was to ensure
that all banks use the subordinated debt, for bona fide capital purposes
and not as a substitute for regular time and savings deposits as a
source of essentially short-term deposit-type funds. On the general
issue of the application of regulations to banks, it can well be argued
that commercial banks should be free -- along with nonbank borrowers --
to seek funds without restriction as to reserve requirements or interest
rate ceilings, particularly when banks and nonbank borrowers are compet-
ing in similar markets and for the funds of similar investors. But there
are differences among institutions. It is where the functions of institu-
tions tend to overlap that the distinctions become blurred and reasonable
men come to differ as to the appropriate policy approach. It could be
argued, from a highly theoretical point of view, that reserve requirements
are not really necessary. Most would accept, however, from a pragmatic
and institutional viewpoint, that demand deposits should be subject to
such requirements, for monetary control if for no other reason. It then
becomes difficult to argue that time deposits, too, should not be subject
to some reserve requirement since at least a portion of time deposits take
on the characteristics of money in their use and function. But time deposits
issued to businesses compete with such instruments as Treasury bills and
commercial paper issued by nonbank corporations, which do not bear reserve
requirements. Where should the reserve requirement line then be drawn?
A decision must be made at some point. We have attempted to draw our lines
in such a way as to reduce inequities within the banking system, and to
minimize the disparities between banks and other competing institutions to
the extent this is compatible with the overall objectives of public economic
policy. And these disparities can only be viewed within the context of the
whole spectrum of regulation affecting banks and other institutions, recogniz-
ing that banks have advantages in some respects (such as interest-free demand
deposits) that others do not have.
GERALD FORD LIBRARY
Chairman Burns
-3-
In the broadest sense, it might be pointed out that commercial
banks will in the future expand as a group only to the extent that the
Federal Reserve System adds reserves, and to the extent that they can
become more active as financial intermediaries. Once again, suspension
of Regulation Q ceilings helps facilitate this role. But there is a
finer point to make. While the Board may want to encourage financial
intermediation at the expense of direct borrower-lender arrangements
not subject to the discipline of intermediaries, it must also take
account of the effects of flows among different types of financial
institutions.
Turning to the second question of the burden on banks by
applying the 17-1/2 per cent reserve requirement on commercial paper
of less than 30 days maturity, we simply disagree. Our formal survey
in February of this year indicated that less than 20 per cent of out-
standing bank-related commercial paper had initial maturities under
30 days. This proportion increased over the spring and summer as
expectations of declining rates persuaded borrowers to remain short,
and based on informal contacts with major banks, we estimate that the
short maturities accounted for 30-40 per cent of total outstandings
at the time of the Board's announcement.
One banker commented that if the 17-1/2 per cent reserve
requirement were placed against the outstandings of his bank alone at
mid-August, the reserve impact would account for nearly all of that
which we estimated for the entire system. The maturity distribution
at mid-August is not relevant, however, in estimating the reserve impact
at the effective date one month later. What is important is whether the
banks could shift into other sources of funds during the one-month period
provided for adjustment. Another felt that it would not be possible in
most cases to replace the short dated maturities as they mature with 31
day or longer paper, especially when customers have need for the short
dated maturities and other issuers of commercial paper are not penalized
when they issue such short dated paper. Despite this pessimism as to
the banks' ability to shift, very substantial adjustments have been
reflected in deposits and commercial paper and the cost of such adjust-
ment became less costly as rates declined during the period. Latest
preliminary data show that the commercial paper-issuing banks got rid
of all but $300 million of their less than 30 day commercial paper between
August 12 and September 17, and that there was a more than commensurate
increase in time deposits during the same period. The fact that banks
have reduced their offering rates for CD's maturing in the 30-89 day
maturity range indicates that they had no difficulty in finding CD money
during this adjustment period. As a matter of hindsight, we now see
preliminary indications that the combination of Federal Reserve actions
&
FORD
GERALD
LIBRARY
Chairman Burns
-4-
and flows of funds resulted in a net reduction in required reserves of
approximately $500 million (we estimated only $350 million at the time
the Board acted).
On the third point, that we did not invite further public
comment, and that the Board should reconsider its action, we were
motivated by two principal factors: first, the net effect of our
action was designed to reduce required reserves rather than have a
tightening effect; and second, we felt that with the available alter-
natives for securing very short term funds (Federal funds, Euro-dollars,
and Rp's) and the full month adjustment period provided, there-would be
no severe hardship placed on the banks most affected. In retrospect, we
feel that these two results did, in fact, obtain.
FORD is GERALD LIBRARY
BA
BANK OF AMERICA
A.W. CLAUSEN
President
September 21, 1970
The Honorable Arthur F. Burns
Chairman
&
FORD
Board of Governors of the
Federal Reserve System
GERALD
Washington, D. C. 20551
LIBRARY
Dear Mr. Chairman:
Your interest in certain views discussed at length at the last meeting
of the Federal Advisory Council is appreciated, and I am glad to have an opportunity
to comment further. Although we are concerned about some recent policy moves in
particular, we are even more concerned about the implications on a long-term
basis.
The latest Board action in connection with bank related commercial
paper again raises the question of whether we are moving toward a more orderly
and equitable system of monetary control or slipping into a further patchwork of
ad hoc actions which are neither efficient nor offer long-range solutions but
indeed lead instead to more problems in regulation. Traditionally, Federal Reserve
regulation of member banks has been assumed to be a sufficient substitute for
more specific controls over the entire credit mechanism. While in the past a
careful control over this important source of money and credit has efficiently
transmitted general policy objectives to the credit creation process, the reduced
effectiveness of this system has increasingly become evident in the last five
years.
As the need for more restrictive credit regulation in an inflationary
environment caused the Federal Reserve to tighten its grip on member banks it
actually reduced the growth of member bank-provided credit as generated through
traditional deposit creation. The restrictive measures used have encouraged an
increasing flow of funds outside the banking system which to a great extent
offset the decline in the banking system's ability to extend credit. Certainly
the rapid growth in the unregulated commercial paper market and the massive
disintermediation during 1969 and early 1970 frustrated the objectives of monetary
policy and reduced the Fed's credit control base. Hindsight has shown that
commercial paper issued on a nonregulated basis also increases risks in the
financial system and poses a serious threat to the financial fabric of this country.
In an effort to offset loss of control the Federal Reserve is then
forced to work more vigorously on the relatively shrinking banking segment of the
financial system to accomplish its objectives. In short, the end result of
these developments is that the Federal Reserve frustrates its own objectives.
BANK OF AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION
BANK OF AMERICA CENTER
SAN FRANCISCO, CALIFORNIA 94120
The Honorable Arthur F. Burns
-2-
By concentrating its efforts on only one part of the general credit markets, it
forces funds into markets beyond its control.
Specifically, we have in mind three recent developments which work
in this direction:
1. The use of the Credit Control Act of 1969 to impose reserve
requirements on commercial paper is an unprecedented move.
It raises questions about the propriety of applying reserves to
asset sales of an outright, nonrecourse nature. Presumably the
door is now open to the imposition of reserves on assets of any
type.
The primary responsibility of any commercial bank is to meet
deposit withdrawals without impairing the safety of funds left by
other depositors. This obviously transcends even its obligations
to stockholders as a profit-making concern. When faced with
net deposit losses under disruptive conditions in financial markets,
as in 1966 and again in 1969, it still must provide for the deposit
losses in one of two ways: by borrowing or sale of assets. Since
borrowing at the Central Bank for any extended period is
discouraged, banks thus are faced with the sale of assets to
raise the funds necessary. Traditionally bank investment
portfolios are utilized for restoring the necessary balance, but
this has limits. We all recognize that the sale of securities from
bank investment portfolios in an already difficult period would
place added pressure on the bond and money markets. Beyond
reasonable limits of adjustment it produces a serious impact on
the financing of state and local governments. Moreover, it is not
clear how sizable capital losses imposed on the banking system
can assist monetary authorities who have a responsibility for also
maintaining a sound banking system. The outright sale of loans
to other investors, however, does provide an orderly transitional
outlet for making such adjustments, and bank related commercial
paper activities provide this conduit.
In our judgment the key to monetary control lies in the liability side
of the bank statement. We do not quarrel with the necessity for
control of the level of credit in the economy, but this is appropriate
only through control of the volume of funds available. We do not
believe it appropriate for the monetary authorities to attempt to
control the asset side where the adjustments have to be made--
certainly not to the extent of forcing undue capital losses
contributing to disorderly market conditions. The sale of loans
facilitated through commercial paper activities by a bank does not
by itself affect the ability of the commercial banking system to
extend total credit any more than the sale of securities.
FORD & GERALD LIBRARY
BANK OF AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION
The Honorable Arthur F. Burns -3-
This latest move, on bank commercial paper, raises some extremely
serious questions regarding the scope and composition of credit
regulations. Although the aim of this new regulation is to provide
closer control over the credit creation process, its imposition
is clearly inequitable. The application of this regulation discrim-
inates against one class of commercial paper issuer without
justification for such discrimination. If the issuance of one
class of commercial paper can work to frustrate the goal of
monetary policy, then the issuance of all commercial paper can
have the same result. This latest step alters competitive
relationships significantly in favor of nonregulated issuers of
commercial paper while encouraging a further slippage in the
effectiveness of the Federal Reserve's policies. Several more
efficient ways to regulate commercial paper come to mind:
a) require member bank endorsement of all commercial
paper thereby bringing all such paper under existing
Federal Reserve control.
b) by legislation enact appropriate permanent control
of commercial paper issuance giving proper authority
to the Federal Reserve system rather than the reliance on
such emergency measures as the Credit Control Act.
c) enact the appropriate legislation to bring commercial
paper issuers under the Security and Exchange Commission
coordinated with Federal Reserve control of the issue
volume.
2. A second problem which has received much attention in the last five
years is the general use of Regulation Q interest rate ceilings.
These have been used both as protective devices and to restrict
bank deposit growth. As a device to prevent excessive interest
rate competition, their existence in the short-run is necessary.
Sharp across-the-board escalation of rates in the thrift area could
cause severe earnings problems for many institutions and could
lead to imprudent lending and investment practices in order to
justify payment. Such practices may, of course, endanger the
health of the banking system.
The use of Regulation Q as a credit control device, however, has
considerably different implications. We believe it incorrect to
view the time deposit market as one homogeneous market. Holders
of large certificates of deposit are generally sophisticated investors
who are extremely yield conscious. They regard these deposits as
money market instruments and are quick to shift to alternate
investments at the slightest yield differential advantage. These
FORD & GERALD LIBRARY
BANK OF AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION
The Honorable Arthur F. Burns
-4-
market decisions bear little resemblance to the motives and
activities of small savings depositors. Small deposit holders
are customarily more concerned with availability and safety than
yield. Yet both small deposits and large deposit instruments are
currently treated similarly for credit control purposes.
When Regulation Q interest rate ceilings are held below market
rates on competing instruments in an effort to moderate bank
credit expansion, the differences in the two segments of the time
deposit market stand out quite clearly. Funds held in large
deposits immediately flow out of the banking system into
higher yielding investments. Undeniably, this shift of deposit
mix restricts the banking system's ability to create credit and
ultimately the tightness in the banking system makes its effects
on the economy known. But this proves to be an extremely
inefficient and disruptive means to accomplish a modest reduction
in the reserve base. Moreover, it causes a significant
redistribution of deposits between banks. The net result is simply
an increase in velocity which largely offsets the intended tightening
for a painfully long time.
It is inequitable to regulate the rate of interest on one investment
instrument and leave others free to trade at the market rate.
We believe a much better procedure is to recognize that negotiable
Certificates of Deposit in excess of $100 thousand, say, are money
market instruments and treat them as such. We strongly recommend
complete removal of Regulation Q interest rate ceilings on these
large CD's. This would allow the banking system to be competitive
and keep a greater share of credit transactions within the direct
influence of the Federal Reserve System thereby making monetary
policy operate more rapidly, more equitably, and more efficiently.
Over the longer term, the viability of Regulation Q ceilings on even
small deposits must be questioned. If, as we suspect, the future
holds well sustained growth, largely full employment, more capital
shortages rather than surpluses, and intermittent inflationary
pressures, then the competition for loanable funds will be more
and more intense.
Interest rate competition in this sort of an environment would be
quite spirited and would reach out to even the smallest saver,
with the result that smaller and smaller blocks of funds will
become interest sensitive. This implies that the banking system
and the Federal Reserve will be faced with fund outflows complicating
monetary control and jeopardizing the very banks Regulation Q
ceilings were designed to protect.
FORD is LIBRARY 076830
BANK OF AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION
The Honorable Arthur F. Burns -5-
3. The recent Federal Home Loan Bank Board decision to allow third
party payments brings out another aspect of the recurring problem
of equity and efficiency in the regulation of competing financial
institution. This ruling has effectively granted savings and loan
associations the right to pay interest on demand deposits.
The ruling as it stands is clearly discriminatory against the
banking system and threatens even more dramatic undermining
of the Federal Reserve's base of control.
Ultimately under this ruling a very large proportion of the payments
in this country could be handled completely outside the Federal
Reserve's control. This cannot but further intensify the rate of
decline in the control base and lengthen policy lag to the point
where monetary policy would have no significant impact.
The question arises then whether any financial institution should
be permitted to pay interest on demand deposits. What the exact
effects of paying interest on demand deposits would be in the
modern financial system are unknown. It is obvious, however,
that for savings and loan institutions to pay demand deposit
interest and for banks not to pay demand deposit interest would
be clearly inequitable and undesirable from a public policy
point of view. The Federal Reserve's control base would shrink
further and banks would be penalized arbitrarily.
I would hope that you will use your influence to bring about the
withdrawal of these amendments by the Home Loan Bank Board.
I wholeheartedly endorse the ABA position outlined by Nat Rogers
in his letter of September 4. If the Federal Reserve and the
commercial banking system are to continue to play the central
role in the payments system it is vital now not to encourage the
further diversion of payments and transfers into non-reserve channels.
In summary, examples such as those cited serve to underscore the
confusing situations created by patchwork control devices and ad hoc
regulations. It is imperative that a broader and longer range policy
perspective on the part of the Federal Reserve System be adopted. The
current excessive regulatory environment fostered by a helter-skelter
response to emergency situations must be reformed.
Financial policy decisions designed to influence the course of
economic activity can no longer be limited to the context of a banking
system. Since this requires some basic alterations in the structure of
financial institutions and regulations, it is imperative that further delays
in moving in this direction be avoided.
Kindest regards.
Sincerely,
FORD & GERALD LIBRARY
Andausen
CC: Members Federal Advisory Council
BANK OF AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION
October 5, 1970
Mr. Donald M. Graham, Chairman of the Board
Continental Illinois National Bank
and Trust Company of Chicago
Chicago, Illinois 60690
Dear Mr. Graham:
Before I left for the international meetings in Copenhagen,
I asked our staff to prepare an analysis of the issues reised in your
letter of September 10. I an taking the liberty of enclosing a copy
of a memorandum which I think presents an accurate picture of the
techniqal reasons for the Board's August 17 action on Regulation D.
You will notice also, the reference to letters received of Messrs.
Nat Rogers and A. W. Clausen which contained comments similar to
yours.
In general, we appreciate your concern about recent trends
in Federal Reserve policy which you describe as being of a selective
or direct control nature. While we all have the same basic goals in
mind, reasonable men differ on the best means of achieving these ends.
I hope you will recall that shortly after I took this office,
I expressed reservations about Regulation Q. and I asked the Board to
study the subject carefully; and that the Board's most recent action
on Regulation Q was to suspend interest ceilings on large CD's in the
30-89 day maturity range -- surely a start in the direction of which
you would approve. And may I also say, that our August action on
Regulation D was designed, first and foremost, as a reduction in
reserve requirements, in view of the needs of the economy and in view
of the fact that most Regulation D changes in the 1960's were increases
in reserve requirements.
The treatment of bank holding company commercial papers was
done in favor of equitable treatment among all banks and was not meant
to deny access to the very short-term market for funds.
FORD & GERALD LIBRARY
Mr. Donald M. Graham
-2-
Finally, let me say that while we do not regard monetary
policy as perfect, I do feel that we have performed recently to the
best of our knowledge and ability under the circumstances; and the
response of the economy has been somewhat better than in other
post-war periods of adjustment. Please be assured that I share
your preference for a broad, general monetary influence over the
specific regulatory approach, and it is my personal hope that we
can work in that direction as time and circumstances permit.
Thank you once again for sending me your views on these
important matters.
Sincerely yours,
Arthur F. Burns
Enclosure
EAL:ck
FORD & GERALD LIBRARY
BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM
Office Correspondence
Date October 5, 1970
To
Chairman Burns
Subject: Comments on letters received in
connection with Board's recent action
From
The Staff
on Regulation D.
As requested, we have been analyzing during your absence,
various comments received on the Board's recent change in reserve
requirements, and related views on some broader aspects of monetary
policy and regulation. These views were expressed by Messrs. Nat
Rogers, Donald Graham, and A. W. Clausen in letters of September 2,
10, and September 21 respectively; and have been considered together
since there is some coincidence of subject matter.
The reservations with respect to the Board's recent actions
revolve essentially around three points:
(1) The belief that the treatment as demand deposits of
less than 30-day holding company paper, and the extension
of Regulations D and Q to term debt in the two to seven
year maturity range unfairly exclude banks from raising
funds in market sectors to which other participants have
access.
(2) The belief that the Board seriously underestimated the
added burden on banks created by shifting from the originally
proposed 10 per cent reserve requirement for all bank-related
commercial paper to the 17-1/2 per cent requirement for that
of less than 30 days maturity.
(3) The belief that the Board should have requested further
public comment on the changed proposal before acting on it.
On the first point, the philosophy underlying the Board's
action was to make the treatment of bank holding company commercial
paper as close as possible to that of large time certificates of deposit.
To accomplish this, the 30-day maturity distinction between time and
demand deposits was extended to commercial paper. We recognized fully
that this action would have the effect of virtually excluding banks with
holding companies from access to the very short term commercial paper
market (an avenue which has been closed all along to banks not affiliated
with holding companies). We also had in mind, however, that commercial
banks could continue to operate in the less-than-30-day sector quite
effectively through the purchase of Federal funds, Euro-dollars, and
the use of short-term Rp's secured by Treasury and Federal agency
securities. Furthermore, from the standpoint of competitive advantage,
these latter means are not universally available to other market
participants.
FORD & LIBRARY GERALD
Chairman Burns
-2-
In addition, with the Board's previous suspension of rate
ceilings on large CD's in the 30-89 day maturity range, banks again
have access to this alternative source of funds. And, of course,
bank-related commercial paper in this maturity range carries a 5 per
cent reserve requirement (rather than the previously published 10 per
cent), and has no rate ceiling either.
On the question of subordinated bank debt, the Board's recent
extension (effective June 30, 1970) of the point at which term debt
becomes exempt from Regulations Q and D -- from two to seven years --
was supported by the following logic: Only a few banks were using such
high-yielding notes of two to three years maturity to lure deposit-type
funds away from regular depositary-type claims; but to the extent this
was occurring, the effect was a clear circumvention of the regulations.
The purpose of the new restriction on promissory notes was to ensure
that all banks use the subordinated debt, for bona fide capital purposes
and not as a substitute for regular time and savings deposits as a
source of essentially short-term deposit-type funds. On the general
issue of the application of regulations to banks, it can well be argued
that commercial banks should be free - - along with nonbank borrowers --
to seek funds without restriction as to reserve requirements or interest
rate ceilings, particularly when banks and nonbank borrowers are compet-
ing in similar markets and for the funds of similar investors. But there
are differences among institutions. It is where the functions of institu-
tions tend to overlap that the distinctions become blurred and reasonable
men come to differ as to the appropriate policy approach. It could be
argued, from a highly theoretical point of view, that reserve requirements
are not really necessary. Most would accept, however, from a pragmatic
and institutional viewpoint, that demand deposits should be subject to
such requirements, for monetary control if for no other reason. It then
becomes difficult to argue that time deposits, too, should not be subject
to some reserve requirement since at least a portion of time deposits take
on the characteristics of money in their use and function. But time deposits
issued to businesses compete with such instruments as Treasury bills and
commercial paper issued by nonbank corporations, which do not bear reserve
requirements. Where should the reserve requirement line then be drawn?
A decision must be made at some point. We have attempted to draw our lines
in such a way as to reduce inequities within the banking system, and to
minimize the disparities between banks and other competing institutions to
the extent this is compatible with the overall objectives of public economic
policy. And these disparities can only be viewed within the context of the
whole spectrum of regulation affecting banks and other institutions, recogniz-
ing that banks have advantages in some respects (such as interest-free demand
deposits) that others do not have.
GERALD FORD LIBRARY
Chairman Burns
-3-
In the broadest sense, it might be pointed out that commercial
banks will in the future expand as a group only to the extent that the
Federal Reserve System adds reserves, and to the extent that they can
become more active as financial intermediaries. Once again, suspension
of Regulation Q ceilings helps facilitate this role. But there is a
finer point to make. While the Board may want to encourage financial
intermediation at the expense of direct borrower-lender arrangements
not subject to the discipline of intermediaries, it must also take
account of the effects of flows among different types of financial
institutions.
Turning to the second question of the burden on banks by
applying the 17-1/2 per cent reserve requirement on commercial paper
of less than 30 days maturity, we simply disagree. Our formal survey
in February of this year indicated that less than 20 per cent of out-
standing bank-related commercial paper had initial maturities under
30 days. This proportion increased over the spring and summer as
expectations of declining rates persuaded borrowers to remain short,
and based on informal contacts with major banks, we estimate that the
short maturities accounted for 30-40 per cent of total outstandings
at the time of the Board's announcement.
One banker commented that if the 17-1/2 per cent reserve
requirement were placed against the outstandings of his bank alone at
mid-August, the reserve impact would account for nearly all of that
which we estimated for the entire system. The maturity distribution
at mid-August is not relevant, however, in estimating the reserve impact
at the effective date one month later. What is important is whether the
banks could shift into other sources of funds during the one-month period
provided for adjustment. Another felt that it would not be possible in
most cases to replace the short dated maturities as they mature with 31
day or longer paper, especially when customers have need for the short
dated maturities and other issuers of commercial paper are not penalized
when they issue such short dated paper. Despite this pessimism as to
the banks' ability to shift, very substantial adjustments have been
reflected in deposits and commercial paper and the cost of such adjust-
ment became less costly as rates declined during the period. Latest
preliminary data show that the commercial paper-issuing banks got rid
of all but $300 million of their less than 30 day commercial paper between
August 12 and September 17, and that there was a more than commensurate
increase in time deposits during the same period. The fact that banks
have reduced their offering rates for CD's maturing in the 30-89 day
maturity range indicates that they had no difficulty in finding CD money
during this adjustment period. As a matter of hindsight, we now see
preliminary indications that the combination of Federal Reserve actions
FORO
GERALD
LIBRARY
Chairman Burns
-4-
and flows of funds resulted in a net reduction in required reserves of
approximately $500 million (we estimated only $350 million at the time
the Board acted).
On the third point, that we did not invite further public
comment, and that the Board should reconsider its action, we were
motivated by two principal factors: first, the net effect of our
action was designed to reduce required reserves rather than have a
tightening effect; and second, we felt that with the available alter-
natives for securing very short term funds (Federal funds, Euro-dollars,
and Rp's) and the full month adjustment period provided, there-would be
no severe hardship placed on the banks most affected. In retrospect, we
feel that these two results did, in fact, obtain.
FORD i LIBRARY GERALD
CONTINENTAL ILLINOIS NATIONAL BANK
AND TRUST COMPANY OF CHICAGO
CHICAGO, ILLINOIS 60690
DONALD M. GRAHAM
CHAIRMAN OF THE BOARD
September 10, 1970
The Honorable Arthur F. Burns
Chairman, Board of Governors
of the Federal Reserve System
20th and Constitution Avenue, N. W.
Washington, D. C. 20551
Dear Chairman Burns:
Over the past year, we have addressed several formal comments
to the Board concerning various policy moves of a selective or
direct control nature. In addition, several officers of the
Continental Bank have made comments to various Board members
and to a number of Federal Reserve Bank presidents concerning
the trend of Federal Reserve policy. We expressed our deep
concern with the apparent moves of the Board increasingly to
rely upon direct specific controls with consequent lesser
reliance upon general policy prescriptions.
In case you are not aware of these particular points of view,
I am enclosing two memoranda to the Board of Governors that
we submitted in response to requests for comments on the
Board's proposed amendments to both Regulation Q and Regu-
lation D. We feel that the general philosophy spelled out
in these memoranda is still pertinent to the present situa-
tion. In brief, some of these steps in our judgment introduce
harmful discontinuities in the credit markets without in any
way changing the Board's control of the total money supply.
They tend to encourage the flow of short-term credit through
non-bank channels thus penalizing banks unfairly and reducing
the Board's influence on credit markets.
The purpose of this letter and the enclosed prior statements
is to protest the recent action of the Board to place reserve
requirements on the issuance of bank holding company commercial
paper. We find objectionable those elements of the regulation
which classify such paper of under 30 days' maturity as demand
deposits and extend the thrust of the regulation beyond con-
ventional commercial paper maturities to term debt of as much
as seven years' maturity. The initiation of these sweeping
&
FORD
GERALD
LIBRARY
CONTINENTAL ILLINOIS NATIONAL BANK AND TRUST COMPANY OF CHICAGO
CONTINUED
-2-
The Honorable Arthur F. Burns
September 10, 1970
Chairman, Board of Governors
of the Federal Reserve System
Washington, D. C. 20551
policy changes without the benefit of public comment is particularly
startling.
We feel that this recent move represents a major further, and to us
adverse, development of Federal Reserve policy. We are especially
concerned with the abrupt manner in which the significance of these
moves is dismissed in your release to the press. For example, we
would take strong exception to the statement that "expansion of
the categories of affiliates subject to the regulations and shift-
ing from the proposed 10% reserve requirement on obligations with
a maturity of less than 30 days to the usual demand deposit reserve
requirement raises no new issues." The inaccuracy is apparent in
the statements accompanying the press release which estimate the
shifts in reserve requirements involved in the simultaneous reduc-
tion of reserve requirements against time deposits and the application
of reserve requirements to bank-related commercial paper. The
substance of your press release indicates that the member banks
issuing commercial paper would have experienced an increase in
their required reserves -- in total -- of some $50 million. In
looking at our situation alone, you will be interested that if
the new regulation had been applied to our holdings of commercial
paper and time deposits over the most recent 4-week reporting
period ending 8-12-70, the additional required reserves resulting
from the new regulation (including the benefits from the reduction
in time deposit reserve requirements) would have averaged about
$46 million. The new regulation -- even with the reduction in
required reserves on time deposits -- results in higher required
reserves for our bank than if the initial regulation calling for
a 10% reserve had been adopted.
The new regulation represents a major change in money center banks'
method and degree of participation in the short-term money market.
The result of this regulation will be to exclude commercial banks
from the major segment of this market, which is a major source of
funds today for non-financial corporations, the Federal government
and its agencies, and non-bank financial institutions. Thus, our
only access to short-term money will be through Federal funds, the
Eurodollar markets, and repurchase agreements on Treasury and Agency
securities. It has been our experience, especially during the recent
tight money period, that the bulk of corporate funds seeking temporary
employment has resided in the under-30-day area. Many of these funds
FORD i LIBRARY GERALD
CONTINENTAL ILLINOIS NATIONAL BANK AND TRUST COMPANY OF CHICAGO
CONTINUED
-3-
The Honorable Arthur F. Burns
September 10, 1970
Chairman, Board of Governors
of the Federal Reserve System
Washington, D. C. 20551
are earmarked for specific purposes and cannot be shifted out
into longer maturities. Thus, often it is not merely a question
of rate -- it is a question of the transactions' purposes for
which the funds are earmarked. This means that the new regula-
tion effectively excludes only banks from this area of the market.
We do not understand why the Board again chooses to leave this
market to all other corporate and governmental borrowers and
intermediaries, especially the unregulated, uncontrolled non-bank
commercial paper houses and finance companies which are direct
competitors of banks. Our basic protest concerning this parti-
cular approach has been set forth at some length in the accompanying
documents.
The Board's explanation of its recent action goes on to state
that "the increase in the obligations covered as a result of
expanding the maturity element from two to seven years is also
insignificant since few, if any, obligations have a maturity of
two years or more." Again, there is the assumption that this
particular change is of no importance to the banking system.
If commercial banks are to expand in the 1970s and adequately
perform in their role as financial intermediaries, they will of
necessity have to tap many new sources of funds. As you well
know, the demand deposit route, with the possibility of further
conversion of assets, is not likely to offer a net source of
appreciable new funds for commercial banks in the 1970s.
The regulation implies that since banks or bank holding companies
have not used 5-year notes, for example, that they would never
have an interest in tapping this particular intermediate sector
of the funds market. Yet this area might very well offer an
attractive source of funds for commercial banks. In recent
years, many non-bank financial institutions and non-financial
corporations, not to mention the Federal government and its
agencies, have drawn heavily on such medium-term borrowings.
This is understandable in the light of relatively high rates
of inflation and congested long-term bond markets. From a
regulatory agency's point of view, it would seem to be a proper
area in which banks might restructure somewhat the very short-
term maturity nature of their purchased funds portfolios. We
do not see how the public interest is served by requiring banks,
directly or through holding companies, to borrow funds solely at
GERALD FORD LIBRARY
CONTINENTAL ILLINOIS NATIONAL BANK AND TRUST COMPANY OF CHICAGO
CONTINUED
-4-
The Honorable Arthur F. Burns
September 10, 1970
Chairman, Board of Governors
of the Federal Reserve System
Washington, D. C. 20551
the very short or relatively long ends of the maturity spectrum.
The Board's release then goes on to state that "in these circum-
stances, and in view of the defferal of the effective date until
September 17, 1970, the Board finds that further notice and public
procedure with respect to the amendments are unnecessary and would
be contrary to the public interest." This statement implies that
the Board regards the issues here to be of negligible significance
or mistakenly ones in which there is general agreement within the
financial community. In both the short run and the long run, we
feel that the public interest has not been served by these recent
additions to the Federal Reserve's already overburdened set of
selective controls. In view of the above objections, we strongly
urge reconsideration of these moves.
Lonan Sincerely Traham
FORD & LIBRARY GERALD
CONTINENTAL ILLINOIS NATIONAL BANK AND TRUST COMPANY OF CHICAGO
November 24, 1969
Mr. Robert C. Holland
Secretary of the Board of Governors of the
Federal Reserve System
Federal Reserve Building
Washington D. C. 20551
Dear Bob:
Lam pleased to submit a memorandum embodying
our views with respect to the proposed amendment
to Regulation a released by the Board of Governors
of the Federal Reserve System on October 29, 1969.
Sufficient copies of the memorandum are enclosed
so that they will be available to each of the members
of the Board of Governors, as well as the staff.
Sincerely,
Donald M. Graham
FORD & GERALD LIBRARY
COMMENTS OF CONTINENTAL ILLINOIS NATIONAL BANK
AND TRUST COMPANY OF CHICAGO ON PROPOSED
AMENDMENT TO REGULATION Q
The Federal Reserve Board's proposed amendment to Regulation Q to include
within the definition of "deposits" of a member bank the commercial paper issued
by bank holding companies has provoked major objections from our point of view.
We realize that from the Board's point of view the present overall economic
climate is such that monetary and credit policy must function properly -- and
expeditiously -- to slow the inflationary thrust of our economy. We have no
quarrel with the Board's general posture of prolonged, severe restriction. On
the contrary, we feel the present level of restraint must be maintained even at
the risk of precipitating a more than desired dampening of the economy. In our
opinion, the proposed amendment should be viewed as only one of a series of
moves which in sum are discriminatory and not productive of the end results
desired by the monetary authorities. We believe there are alternative approaches
which would achieve better, or at least equal, results without the long-run dangers
that are implicit in the recent series of specific, direct controls which have been
promulgated.
In this memorandum, we will summarize our objections to (1) the proposed
regulation on legal grounds, (2) the specific proposal affecting bank holding company
commercial paper, and (3) the general approach used by the Board to effectuate
its restrictive policy through the commercial banking system. Finally, we will
attempt to suggest some alternative ways that may be used by the Federal Reserve
in dealing with the very difficult problems faced by it and the commercial banking
system.
FORD & LIBRARY GERALD
In offering these comments, we realize that the Board and its staff are already
- 2 -
aware of some of these points of view and have heard some of the objections many
times before. In our view, however, these observations are important and perhaps
crucial to central banking as well as to commercial banking. The arguments bear
repeating, and we would like to add our weight to the similar position put forth
by others.
Definition of "Deposit" - Our concern in the area involving the legal basis for
the Board's proposed action is based on a longer run concern we have over the
Board's use and interpretation of the term "deposit." We expressed reservation
over this tendency in our letter to the Board of July 28, 1969 in which we commented
on the Board's proposed program to implement reserve requirements against bank
liabilities to their own foreign branches. We stated then that "we have some
concern over an apparent change in the Federal Reserve's approach to the use of
reserve requirements as a tool of monetary policy. The application of reserve
requirements in this instance involves the asset rather than deposit side of the
balance sheet. If this change in approach sets a precedent or indicates a trend for
Federal Reserve policy, we feel this approach should be examined carefully before
its adoption."
The most substantial difficulty with the proposed amendment appears to be in the
need to accept the idea that there is a bank "deposit" in a situation where the bank
incurs no liability to anyone else. In the typical transaction which would be covered
by the proposed amendment, the holding company issues short-term paper and the
bank then sells a portion of its assets (in the form of a participation in loans)
without recourse to the holding company. No funds are placed in the bank subject
to withdrawal or repayment on demand or otherwise.
FORD & LIBRARY GERALD
- 3 -
The standard conception of a "deposit" as involving a debtor -creditor relationship
between the bank and a depositor seems to have been carried over into virtually
every legal context in which the term is used. Section 3(e) of the Federal Deposit
Insurance Act, for example, contains an extended definition of the term "deposit"
encompassing many different types of relationships and arrangements, all of which,
however, share the characteristic of entailing the holding of funds by the bank on
someone else's behalf or an immediate or future obligation on the part of the bank
to some other person.
The Federal Reserve Board in its many rulings under Regulations Q and D appears
never before to have contended that a "deposit" has been created in a situation
where the bank incurs no liability. In a 1968 Ruling determining that -called
"dealer's reserves" (which involves certain potential liabilities on the part
of a bank) do not constitute "deposits," the Board stated:
" For the purposes of Section 19 of the Federal Reserve Act and Federal
Reserve Regulation D the Board considers that a deposit liability exists
only when there is an indebtedness on the part of the bank with respect
to either funds received or credit extended by the bank, and that
'indebtedness' for this purpose does not include a contigent liability
of the kind represented by a dealer's reserve or differential account.
A similar contingent liability that does not constitute such an indebtedness
arises in connection with a commitment to make a loan."
1968 Federal Reserve Bulletin 761 (Emphasis added)
Perhaps, the most controversial previous interpretation by the Board of the term
"deposit" has been the amendment of Regulations D and Q in September 1966 to
FORD i LIBRARY GERALD
- 4 -
cover short-term notes issued by a bank. Such notes obviously represent bank
liabilities, and the question was whether the term "deposit" is limited to certain
kinds of liabilities. The Comptroller of the Currency initially took the view
that such notes were not the kind of liabilities deemed to be "deposits" subject
to reserve requirements and interest rate limitations; however, he acceded to the
Federal Reserve Board's contrary views after the Board amended its Regulations.
See Ruling of the Comptroller of the Currency No. 7530 (amended as of June, 1967).
This cannot be regarded as a precedent for the present amendment since a liability
on the part of the bank (although arguably not a "deposit liability") was created.
The only possible basis for saying that the holding company transactions entail a
liability on the part of the bank would seem to be an argument that since the
bank and the holding company are under common control, the loan participations
may at any time be repurchased by the bank, constituting a "withdrawal" of funds
by the holding company. The Board, however, has not stated its proposed amend-
ment in these terms; it has not tried to argue that the arrangement involves
liabilities on the part of the bank, but rather that "deposits" of the bank include
what are concededly liabilities not of the bank but of the holding company. In any
event, the argument lacks validity since the bank has no legal obligation to
repurchase participations, and there is no reason whatsoever to expect that such
repurchases will be made.
In sum, therefore, the proposed amendment of Regulation Q constitutes a
construction of the term "deposit" which is unprecedented and contrary to the
universally accepted conception of the term as entailing an obligation to some
other person on the part of the bank.
FORD i LIBRARY GERALD
- 5 -
In short, it appears that the Board has attempted to extend the term "deposit" beyond
any meaning of the term which has ever before been suggested and, therefore,
beyond any meaning which Congress could have had in mind in adopting Section 19
of the Federal Reserve Act.
Our general concern in this area is the tendency of the Board to interpret the
Federal Reserve Act in such a manner as to move into new areas of control over
the banking system that we feel are questionable. We do not subscribe to the
"ends justify any means" approach that appears to be implicit in recent Board
action. Over the years, the working relationship between the central bank and
commercial banks has been too valuable to the American economy to be undermined
by questionable interpretations responsive to the demands of expediency.
Restriction of Bank Holding Company Commercial Paper - The most obvious
objection to the proposed regulation involves singling out the commercial banks for
control from the huge over -$30 billion commercial paper market. The tremendous
growth of this market in the past year reveals quite clearly the route taken by many
of the funds formerly intermediated by the commercial banks via the C/D route.
The paper route has offered the most economical and efficient mechanism available
to the corporation to continue its expenditure program. Many, turned down at
the bank or appalled by the corporate bond market, turned to this avenue to obtain
funds. Acting just like commercial banks, they have borrowed short-term funds to
place long term - -- some undoubtedly in brick and mortar - -- all this outside the
control of the Federal Reserve System. The commercial banks, seeking a lower
cost for their raw material, appeared in this market through their holding companies
FORD & LIBRARY 639
and began to bid for the same funds. With a given supply, this action served to
- 6 -
drive these rates up closer to other market rates which used to be the way one
would expect such a system to work. These were not new funds; the banks merely
channeled them rather than their corporate customers. It can be argued that this
process came a step closer to Federal Reserve control at this juncture.
It is sometimes urged that the commercial banks provide a more efficient mechanism
to channel a given amount of funds through the economy, and thus the intermediation
process outside the banks with its inefficiencies and frictions acts as more of a
drag on the economy with resultant greater restriction. If this position is accurate
and measurable, it is also probably of marginal significance which could be easily
offset by general Federal Reserve restriction of reserve availability. Certainly,
the portion accounted for by the banks would be more readily measurable and
subject to close Federal Reserve control. The unfettered nature of the
market (beyond Federal Reserve control) has been dramatically illustrated by
company after company, large and small, moving into this market to obtain funds.
In some of these cases, the operation will probably prove efficient enough so that
banks have lost their role as a financial intermediary for a significant portion of
the business of these companies. A related concern is the question of credit
quality. It seems clear that credit extended through this unregulated market has
less -- if any regulation by the monetary authorities. At the same time, it
seems equally clear that banks are better equipped by training and being subject
to examination to extend the credit on a sounder basis.
In terms of achieving the Federal Reserve's goal of restricting the growth of total
credit in the economy, limitation of bank competition in the commercial paper
market does not make sense. The problem of attaining credibility for the
FORD & LIBRARY GERALD
- 7 -
Federal Reserve's program of monetary restraint is attributable in large part
to the availability of an unfettered commercial paper market. Most banks have
finally gotten the message but apparently not the entire business community. Is
this really so surprising if there is an attractive alternative financing route avail-
able to the corporation when its credit requests are declined or scaled down at
its banks? For many corporations, the paper route has proven a very economical
alternative over recent months.
If the Board acts to close the access of the commercial banks to the nation's money
market by foreclosing the use of commercial paper, the action could precipitate
some wide -spread difficulties for the financial community. The change that
would occur in the banking system would be analogous to that occurring when the
Board applied price controls through the use of Regulation Q on bank certificates
of deposit. Given continued Federal Reserve monetary restriction, banks will
seek the needed funds elsewhere. The larger banks, of course, would again turn
to the Eurodollar market, but further reliance upon the cushioning characteristics
of this market at the present time would prove difficult. The effect on Eurodollar
rates caused by the Board's announcement of October 29 is already apparent. If
the Board's proposed amendment should become effective, the Eurodollar borrowings
of banks having access to this market would drive rates up quite rapidly over the
short run, with possible difficulties ensuing for Western European nations.
BERALD FORD TIBRARY
In part, the difficulties might arise because of the very short maturity structure
of presently outstanding bank commercial paper. Based on our average maturities,
and what we know of other large banks' activities, we doubt that average maturities
are much over thirty days. Thus the run-off adjustment process would be more
- 8 -
abrupt than that occurring during the C/D decline. When financial markets are
as close to crisis conditions as they are today, the prospect of sudden shifts of
this character cannot be treated lightly, even though theoretically over time the
funds will merely flow through different channels given no change in the
Federal Reserve's posture.
Thus for the large money center banks with branches in London, an alternative
source of funds would be available but only at very high cost with disruptive effects
on world money markets and a resultant further squeeze on these banks' already
sharply declining profit positions.
For other banks, however -- both large and small - -- even this unattractive
alternative does not exist. For those banks without London branches, the access
to the Eurodollar market is, of course, quite limited. Some funds can be borrowed
from this market through brokers but this is even more expensive and the volume
available is restricted by the individual bank's borrowing limits. In terms of
overall equity then, the banks without London branches would again be back in
the unfortunate position they were in following their C/D runoff experience. Many
medium-sized and even some large banks without London branches were placed
in a very difficult position because they had built up their C/D totals and maturities
in much the same fashion as the money center banks but did not have the Eurodollar
cushion to fall back upon. Now many banks will again be in this position as well
as many smaller banks which have only recently become quite tight but which have
also at the same time come to rely upon commercial paper for funds. Some of
FORD i LIBRARY GERALD
these banks will find it difficult to adjust readily to other sources of funds. It is
not generally appreciated that activity in this market is widespread as opposed to
- 9 -
the concentration of Eurodollar volume in the hands of only a few large banks.
General Observations on Board's Policy Techniques - In examining the possible
responses of the banking system to the latest in a series of direct control devices,
the analysis and terminology used are often put in terms of the banks seeking ways
in which to evade Federal Reserve control. The press in general, and financial
writers in particular, refer to the Federal Reserve's actions as closing "loopholes"
to general credit restraint. Looking at individual banks' actions over the past
year, there is probably some validity in this generalization. Under present
circumstances, however, it is our observation that commercial banks in general
have gotten the Federal Reserve's message of restriction and, consequently, are
not desperately seeking funds in this market or any other market with the aim of
putting new loans on the books. Commercial banks are now simply struggling to
carry their present assets by using the best markets available. A glance at the
growth in total bank credit over recent months or even more particularly at business
loans does not lend credence to the "loophole theory." The money position manager
of a large bank has available several different alternative sources of funds and does
not seize upon availability in any particular market as a way in which to add to
the bank's loans or other assets. Rather, in these times, any availability of
funds at attractive rates in any market is used quite simply and directly to
reduce reliance upon high-cost funds in one of the other markets. A glance at
the cost of funds in any bank today will quickly reveal the necessity of reducing the
marginal cost.
With the Federal Reserve in full overall control of the reserve base and thus
FORD i LIBRARY GERALD
eventually of the total volume of bank credit, a preferable way to look at banks'
- 10-
efforts to obtain funds in new and varied markets is that this is simply the way
that banks as part of a free market system respond to direct price controls. Even
if there were an absolute dollar ceiling on total bank credit, those individual banks
who sought to maximize profits would still seek funds from the most desirable
source. Over the past few months, this would have meant that banks would have
entered the commercial paper market just as they have done without any such
limitations. Looking at the figures in retrospect, the period has worked out
as if they had been operating under such restriction.
What happens in practice then is that if the Board's regulation is aimed at a further
restriction of credit availability, it will not achieve this objective. It will, however,
adversely affect particular banks in other ways. But is this the proper function of
a central bank? For many banks, the major result will be decreased bank
profitability coupled with relatively little impact on the banks' demand or usage
of funds; in the long run, this kind of move could have serious adverse effects on
the banking system.
FORDO i LIBRARY GERALD
The long-run trend is already all too clear and is the familiar situation of any
system of price controls. Each new control breeds an additional control which
is followed by the markets' efforts to seek new sources of funds and new approaches
to obtain funds followed by further control with a resultant unfortunate cumulative
process. These discriminatory aspects appear when commercial banks are
prohibited from competing to seek their share of the available supply of funds.
This kind of situation is all the more disturbing to commercial banks when other
developments in the economy are moving counter to the restriction placed on the
banking system. The most obvious example of this, of course, is the existence
- 11 -
of an inadequate fiscal policy during a period of inflation. More specifically,
however, it is incongruous to see commercial banks squeezed at the same time
that the Federal Home Loan Board announces a reduction in the liquidity require-
ments of saving and loan associations to free some $650 million for their use.
This is another example of the abuses that occur in the resource allocative process
when improper Federal economic policy places an undue burden upon one arm of
that policy - credit and monetary policy.
The result has been that the Federal Reserve has been unwilling to place complete
reliance upon traditional methods of monetary control. As fiscal policy has failed,
and as timing difficulties in monetary policy have appeared, the various afore-
mentioned direct control devices have been made effective. Unfortunately, this
has been a relatively simple accomplishment because the commercial banking system
is so highly susceptible to such control. As the total economy fails to respond
promptly to efforts to curb inflation, more and more pressure is placed on the
banking system. Those institutions, both financial and non-financial, outside of the
central banking-commercial banking sphere play an increasing role in meeting the
nation's financial requirements. In effect, this means that the policy base against
which the Federal Reserve reacts has become relatively smaller and smaller. The
monetary authorities have obviously concluded that this smaller base can be con-
trolled quite simply by directive - -- and this is the path being taken.
Thus it appears in the short run to the Federal Reserve officials that there is ample
justification for direct controls over banks to meet what appears to them to be the
recalcitrance of these institutions as they constantly plumb for new "loopholes"
in GERALD R. FORD LIBRARY
- 12
the Federal Reserve's armor. This is the way in which a free market reacts.
The long-run implications of such a process, however, for the commercial banks
and for central banking and the market system as well are disturbing. There is
the ever present danger that when current pressures cease to exist, there will
not be a return to the relatively free market conditions enjoyed previously and
continued reliance upon general Federal Reserve techniques of control. In short,
we are worried about the long-run interrelationship into which the central bank
and commercial banks seem to be entering.
Alternative Approaches - If credit and monetary policy is to have a desirable
effect upon the economy through the eventual dampening of inflation, it must be
accomplished through changes in total credit availability and in cost. Most of
the furor over Federal Reserve policy in recent months arises from its efforts
which affect individual institutions, distort money markets, and cause a mammoth
reshuffling of the available supply of funds. The entire process may well have
produced a higher pattern of interest rates than otherwise would have prevailed
and has resulted in the current widespread political criticism without the
accompanying rate benefits that have occurred in the past. One overall result is
that the financial adjustment process has been hindered. The monetary authori-
ties should no more expect commercial banks to turn off the lending process and
show immediate results than they can expect the economy to respond immediately
to their policy. (However, in passing it may be noted that the major money center
banks have achieved a remarkable result in rationing of credit - with resultant
leveling off in loan totals.)
FORD & LIBRARY GERALD
13 -
The desirable alternative approach to the various direct control devices attempted
is, in reality, quite simple: more reliance upon the traditional quantitative policy
measures. There is no new or startling course of action available to Federal Reserve
authorities; rather, the sole meaningful alternative is the one which the Federal
Reserve knows best how to administer. The only way to return to increased reliance
upon the traditional methods of control is to remove the ceiling limitations of
Regulation Q. Initially, perhaps the ceiling should be removed only on large
denomination C/Ds - perhaps on denominations of $500, 000 and over. The argument
involving the vulnerability of other savings-type institutions to such changes in
Regulation Q no longer carries the weight of former years since market instruments,
not commercial bank deposits, have become their main competition. This
prescription is one leading toward greater reliance upon the marketplace and upon
general techniques of credit control. It is deceptively simple and will meet
resistance from those who feel that further tinkering with and adjusting of the
economic system must be attempted; but we feel it has a better chance of working
in the long run.
Admittedly, the Federal Reserve would have a difficult problem of credibility if
they removed Regulation Q ceilings. If this is essentially a problem of communi-
cation, it would seem that under present crisis conditions the Federal Reserve
System should abandon its time-honored techniques of having very little to say
about its policy moves. Strong effort would be required to communicate the basis
of such a move to financial markets, to Congress, and to the public at large.
The financial markets could be made believers very quickly through the use of
the Federal Reserve's traditional techniques. Interest rate barometers would
continue to indicate a high degree of restraint as the C/D rate would not just move-
in today's markets--to the 7% area but rather would move rapidly to seek an
FORD i LIBRARY GERALD
- 14
adjustment level along with Federal Funds and Eurodollars in the 9%- - 10% or
higher range. Commercial banks would not suddenly obtain quantities of cheap
money. Enough profit motives are now being affected by such rate levels that
rates again would begin to assume more significance in the plans and projections
of bankers as well as others in the financial community. The implementation
of such a radical departure in Federal Reserve policy could be accompanied by
other techniques such as increases in reserve requirements and the establishment
of various C/D bases at various rate levels, but such changes would probably
clutter up the objectives of such a program. The crux of the matter would be
to free markets--yet to maintain the credibility of Federal Reserve determination
to curb inflation. We believe this can be accomplished.
Donald M. Graham, Chairman of the
Board of Directors
November 24, 1969
FORD & LIBRARY GERALD
WALL STREET JOURNAL 11-3-69
The Paper Problem
The more you consider it, the more it has been at the price of depriving
confusing bank regulation seems. The savers of benefits of the generally
latest example is the Federal Reserve
higher interest rates. In any case, rate
Board's proposal to apply interest rate ceilings have tended to discourage sav-
FORD & GERALD LIBRARY
February 13, 1970
Mr. Robert C. Holland, Secretary
Board of Covernors
of the Federal Reserve System
Federal Reserve Building
Washington, D. C. 20551
Dear Dob:
We are back again with an additional note of protest on
your proposed amoundments that would have. an effect on bank
holding company issuance of commercial paper. The more we
look at this possibility in the light of current developments
both in this market and in the economy, the more we are con-
cerned about your actual application of new regulations. As
time has gone on and this market has grown, the discriminatory
aspects of applying regulations only to cormercial banks in
this huge market seems more and more unfair. Furthermore,
1f the economy is indeed slowing and we are at the threshold
of some easing in Federal Reserve policy, it would seem most
unfortunate to saddle the commercial banks with an additional
expensive regulation at this particular time. It scens to us
that during the past few years you have saddled the commercial
banking system with enough costly restrictions that you should
not have to add further to the burden at this juncture.
You will note that the accompanying memorandum repeats much of
what we have said to you before both in writing and verbally
and we would refer again to our memorandum of Fovember 24, 1959
which sets forth more fully our objections to the Federal
Reserve's general approach to such problems.
If we can provide any additional information or be of further
aid on this subject, ve would be hoppy to work with you.
Sincerely
/s/ D. M. Graham
FORD & LIBRARY GERALD
COMMENTS OF CONTINENTAL ILLINOIS NATIONAL BANK
AND TRUST COMPANY OF CHICAGO ON PROPOSED
AMENDMENT TO REGULATION D
We are taking this opportunity to comment again on the Board's proposed amendment
to its Regulation D, "Reserves of Member Banks," applying reserve requirements to
bank-related commercial paper. We realize the Board is aware of some of our views
expressed hereafter and has heard some of the objections before. Many of the same
points were made by us in a memorandum to the Board dated November 24, 1969. We
feel they are still valid, however, and bear repeating.
Our main objections to the proposed amendment are (1) it singles out commercial
banks for control from the large and growing commercial paper market, and (2) it
appears as another in a series of moves by the Board to use direct controls over
commercial banks. This approach to control overall credit growth and to channel
funds into various sectors of the economy is a disturbing development to us. We
feel such steps in the past have not had the desired effect in reducing credit
growth and at the same time have reduced the competitive ability of commercial
banks.
Applying a 10% reserve requirement on funds obtained by member banks through the
issuance of commercial paper would not in itself mean any reduction in the use
of this technique as a source of funds. As long as the cost of commercial paper,
including required reserves, is less than alternative sources of available funds,
the issuance of commercial paper will continue in order for commercial banks to
accommodate the needs of customers based on long-standing relationships. To the
extent that 10% of the funds obtained through commercial paper issuance is required
as reserves, a case can be made that bank holding company paper outstanding would
have to be increased in order to maintain the same level of loanable funds. What
will happen is that the cost of these funds to commercial banks will be higher
LIBRARY GERALD R. FORD
- 2 -
than for a non-bank issuer of similar paper.
Even if this action were to cause banks to reduce the issuance of commercial paper,
it would not necessarily mean any reduction in total credit provided in the economy.
The rapid growth of the commercial paper market in the past year reveals quite
clearly the route taken by many of the funds usually intermediated by the commer-
cial banks. Issuance of commercial paper has offered the most economical and
efficient mechanism available for corporations to obtain funds, particularly since
they have not been able to meet their needs by obtaining loans from commercial
banks. To the extent commercial banks are forced to cut back further on bank
credit growth due to the higher cost of funds obtained through commercial paper
issuance, non-financial corporations will be forced to turn to a greater degree
to issuing their own commercial paper if they intend to carry out spending
programs.. This has been the trend throughout 1969. As the commercial banks
lost funds because of interest rate limitations, the rise in commercial paper
by non-financial corporations accelerated. It is often argued that commercial
banking affords a more effective mechanism of intermediation. The record in
1969 indicates little hesitation on the part of corporations to obtain needed
funds via non-banking sources such as the commercial paper market.
The action by the Board in this proposed amendment in our view reflects another
in a series of moves either to use direct control over banks or increase the cost
of funds to banks over what other businesses are required to pay. These actions
imply the banks in general are seeking ways to evade Federal Reserve control.
Under the present system, however, it is our observation that commercial banks
in general have responded to the Federal Reserve's policy of restraint. Con-
sequently, banks are not seeking funds in the commercial paper market or in any
GERALD FORD LIBRARY
- 3 -
other market with the aim of putting new loans on the books. Commercial banks
are simply struggling to carry their present assets by obtaining funds in
available markets at the lowest cost. The record of bank credit growth in 1969
demonstrates this posture. On the other hand, total credit growth in the economy
shows the ability of other sources and markets to carry an inflating economy.
The efforts by commercial banks to obtain funds in new and varied markets is
simply the way that banks as part of a free market system respond to direct
price controls. This has meant that banks have entered the commercial paper
market just as they had previously attempted to cushion the effect of declining
time and savings deposits by entering the Eurodollar market. Despite these shifts
to new markets, total bank credit in the last year has shown very little growth
as would be expected in response to the Federal Reserve policy of tight restraint.
What has happened, however, is that an increasing amount of financing is now being
done outside the commercial banking system and, therefore, outside of the direct
influence of the Federal Reserve System.
The long-term trend of these types of actions is disturbing. As banks attempted
to cushion the impact of large and discrete losses caused by unrealistic interest
rate limitations on deposits, the Board has felt the need to apply additional
controls. This leads to the question of what will happen in the future. If the
move is taken to apply reserve requirements to commercial paper, will the next
step be to make these funds subject to Regulation Q and effectively restrict
their issuance under current money market conditions? Increasing controls,
through effectively stopping banks from attracting funds in some markets or
increasing the cost $0 as to reduce profitability, could have serious adverse
effects on the banking system's long-run future.
is
FORD
GERALD
LIBRARY
- 4
We also feel another aspect of the Federal Reserve's action is to attempt to
control the flow of funds. One stated motive for the maintenance of interest
rate limitations on time and savings deposits was to protect savings banks and
savings and loan institutions from losing funds and thus reducing the avail-
ability of funds for mortgages. (Bank entrance into commercial paper has not
provided an additional means of disintermediation because of minimum denomination
requirements.) This, of course, has not been successful and is reflected in the
recent increases in interest rate limits which have probably had only a minimal
effect in allowing banks to hold funds. It is our feeling that not only does
the Federal Reserve not have the techniques with which to allocate funds to
various markets, but it is doubtful whether techniques could be developed without
changing the Federal Reserve's traditional role in the Nation's financial
structure.
We recognize the possibility that the Board's recent liberalization of
Regulation Q may mesh nicely with a declining pattern of interest rates which
will gradually and flexibly allow the reentrance of commercial banks into money
market areas now effectively excluded. If such projections of lower interest
rate trends are wrong, however, (which is not beyond the realm of possibility)
then banks could be saddled with sharply higher interest costs of savings and
time deposits and on marginal Eurodollars as well as the higher costs resulting
from the proposed reserves on bank commercial paper. In the short run, banks
would still seek to finance their current needs through utilization of the most
desirable fund alternatives. This would mean little change in their demands but
would mean a further reduction in profits. In the long run, of course, the theory
of the firm would suggest the disappearance of some banks through the working of
the competitive process as stylized by the posture of the central bank. We cannot
FORD & LIBRARY GERALD
- 5 -
believe this to be the goal of the Federal Reserve System, but it is a
disturbingly logical conclusion to the direct control techniques recently
introduced and furthered by the suggested application of Regulation D.
It should be emphasized that we are not objecting to the Board's general
posture of restrictive monetary policy. We agree that the strong inflationary
pressures have required the present level of restraint. Recent trends in
economic conditions suggest the possibility for some move toward ease within
the near future, but the inherent inflationary problem requires the risk of
causing more than a desired dampening of the economy. We do not quarrel with
the intent of monetary restraint, but rather with the methods used which in
our view are discriminatory and nonproductive of the end results desired by
the Board.
February 13, 1970
FORD is LIBRARY GERALD
November 6, 1970
TO:
Board of Governors
SUBJECT: Relationship of Federal
Reserve System to ABA and
FROM: Division of Federal Reserve
other Banking Associations
Bank Operations & Office of
the Secretary
Recommendation
In view of the fact that membership in the American Bankers
Association exposes the Federal Reserve System to charges of possible
conflict of interest, participation in political activity, and an
improper expenditure of public funds, it is believed the Reserve Banks
should consider discontinuing their "membership" relation in favor of
the status of the "subscriber to services" if the so-called advantages
of the ABA relationship can be maintained. S-1647 dated February 7,
1958, and S-1791 dated May 11, 1961 contain the latest Board policy
statements on the general subject of banking association membership
dues and contributions. In addition, Mr. Scanlon's letter of May 2,
1969 to the Presidents of the Reserve Banks gives the background out
of which Mr. Kimbrel's current assignment grew. (Copy attached.)
Membership by the Federal Reserve Banks in the various state
associations is a longer run issue but one which should be considered
further. The President's Conference is currently discussing state
bankers association relationships, in keeping with the Conference dis-
cussion of June 22, 1970. (Copy attached.) Perhaps the entire matter
can be discussed with the Reserve Bank Presidents at the afternoon
meeting on November 17. Associations such as the AIB, BAI, and Robert
Morris Associates are sufficiently different in organization and purpose
FORD i LIBRARY GERALD
-2-
that we see no need to consider withdrawal from membership status in
those groups.
Discussion
The following summary shows by district for the year 1969 the
total contributions to banking organizations and attached is a detailed
listing of organizations by district.
ABA
State BA's
AIB
Other
Boston
$2,200
$2,305
$2,495
$ 920
New York
2,235
5,240
5,336
678
Philadelphia
2,200
1,960
298
960
Cleveland
2,270
1,627
1,530
932
Richmond
2,270
2,435
3,584
1,118
Atlanta
2,460
2,245
5,628
1,223
Chicago
2,235
950
-
470
St. Louis
2,305
1,898
2,873
1,134
Minneapolis
2,229
1,220
5,876
1,097
Kansas City
2,305
1,425
4,180
945
Dallas
2,305
1,900
3,282
1,205
San Francisco
2,340
1,480
4,888
1,409
$27,354
$24,685
$39,970
$12,091
The services which the Federal Reserve would presumably want
to continue on a pay-as-you-go basis can be broadly categorized as
follows:
Educational. Educational facilities of the ABA, such
as listed below, have been used extensively and successfully
for personnel and management development by the Federal
Reserve Banks:
American Institute of Banking
Stonier Graduate School of Banking
National Trust School
National Mortgage School
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National Automation School
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Publications. Access to and the use of ABA publications
is a means of keeping abreast of developments in commercial
banking.
Cooperation. The Federal Reserve and the ABA have a
similar objective in aiming their efforts toward strengthing
the commercial banking system. Cooperations has contributed
materially to the success of the following programs:
Emergency Preparedness
Check Mechanization (MICR)
Discount Mechanism Study
Uniform Designation of Securities
(CUSIP)
Business Loan Surveys
Joint responsibility. In addition to mutual cooperation,
there is also an area related to the check collection system
where there is joint responsibility; assignment of the check rout-
ing symbol is the responsibility of the Federal Reserve and
the transit number is the responsibility of the ABA.
Economic intelligence. Attendance at national, State,
and local meetings permit regional soundings and blending of
views that constitute one of the important strengths of the
Federal Reserve System.
We believe the ABA leadership is amenable to the recommended
change in status, and President Kimbrel feels that the Reserve Bank
Presidents will be receptive also. It appears that the benefits described
above could continue to accrue to the Federal Reserve System under an
alternative arrangement whereby we would pay our share of the cost of
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these benefits but would not be considered "members" or even associate
members.
The undesirable political consequences of involvement with the
ABA do seem, with one exception, to be of a nature that would disappear
or could be more successfully "played down" if actual "membership" were
terminated. That one exception has to do with the expenditure of public
money. It can be argued that one cannot effectively "trace dollars"
and any financial support of the ABA could be construed as an expendi-
ture of the taxpayer's money in support of activities, lobbying or
otherwise, with which the Federal Reserve would not wish to be associated.
This does not, however, change our recommendations.
Attachments
FORD i LIBRARY GERALD
FEDERAL RESERVE BANK OF CHICAGO
OFFICE OF THE PRESIDENT
G 1914
May 2, 1969
To:
MEMBERS OF THE CONFERENCE
OF PRESIDENTS
You have most likely received a notice indicating
that the American Bankers Association' dues for Federal
Reserve Banks and others will be substantially increased
effective September 1, 1969. In the circumstances,
President Clay has suggested that it would be entirely
appropriate for the Presidents' Conference to review the
benefits and appropriateness of membership and develop
a System posture with respect to such expenditure.
While he believes the Federal Reserve Banks should be
members of the American Bankers Association, he feels we
would be wise to establish the justifications. His pur-
pose in calling attention to consideration of some
special rate is prompted by his understanding that the
new dues schedule finances the entire program of the ABA
and includes a number of items which previously had been
handled by special assessments, some of which we have
felt were not proper items for Federal Reserve expenditure.
The purpose of this memorandum is to inform you.
that the matter is being referred to the Committee on
Bank Coordination and Special Topics for consideration at
the June meeting of the Conference. It would be desirable
for each of us to defer payment of the ABA dues on the
new basis until after the June meeting.
Sincerely,
Charlie
Charles J. Scanlon
Chairman, Conference of
Presidents
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from minutes of Conference of
President meeting - June 22, 1970
Membership in State Banking Associations
Mr. Kimbrel reported that on May 6 the Conference Chairman
referred to the Committee on Bank Coordination and Special Topics
for its consideration, a question raised by the Federal Reserve
Bank of Kansas City regarding Reserve Bank memberships in state
banking associations. He reported that the Committee had conducted
a survey of the Reserve Banks and noted from the returns that a
wide disparity exists in the membership dues paid by the various
Federal Reserve offices. The Committee, Mr. Kimbrel said, intended
to discuss this matter with American Bankers Association staff members
who were acquainted with this problem and with officials of the
national state banking association managers group with a view to
developing a membership arrangement for the Reserve Banks similar
to the arrangement made with the ABA. This would be a non-voting
membership; it would be a System membership so that where two Banks
service parts of a State there would be a single membership between
the two Banks; and, membership would be established on a permanent
basis, not subject to renegotiation when the individual associations
raised their dues schedules.
Several Presidents were of the opinion that membership in the
state banking associations had value as a means of communicating
and working with banks in their Districts. However, the value of
these memberships had to be weighed against the costs involved.
Mr. Kimbrel noted that in 1969 the Federal Reserve Banks paid $23,778
for membership in state banking associations.
FORD i LIBRARY GERALD
The Amount and Breakdown by District of the
Total Amount of Dues Paid by the Federal Reserve System to the
American Bankers Association, State Bankers Associations, Regional
Banking Organizations, Banking Institutes, etc. for the Year 1969
Boston
American Bankers Association
$2,200
Connecticut Bankers Association
750
Maine Bankers Association
200
Massachusetts Bankers Association, Inc.
1,000
New Hampshire Bankers Association
200
Rhode Island Bankers Association
5
Vermont Bankers Association, Inc.
150
American Institute of Banking, Boston
Chapter
2,495
Bank Administration Institute
420
Robert Morris Associates
500
New York
American Bankers Association
2,235
American Institute of Banking
5,336
Bank Administration Institute
560
Bank Credit Associates of New York
18
Bank Operations Conference of New York
City
75
Connecticut Bankers Association
375
Erie Niagara Counties Bankers Association
-
National Association of Bank Women
25
New Jersey Bankers Association
1,440
New York State Bankers Association
3,300
New York State Bankers Association -
Group I
125
Philadelphia
American Bankers Association
2,200
New Jersey Bankers Association
560
Pennsylvania Bankers Association
1,400
American Institute of Banking
298
Bank Administration Institute
National
400
Philadelphia Chapter
35
Robert Morris Association
&
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National
460
Philadelphia Chapter
30
Bank Methods - (local organization)
35
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Cleveland
American Bankers Association
$2,270
Ohio Bankers Association
152
American Institute of Banking
1,530
Robert Morris Association
441
Bank Administration Institute
491
Kentucky Bankers Association
500
Pennsylvania Bankers Association
900
West Virginia Bankers Association
75
Richmond
American Bankers Association
2,270
North Carolina Bankers Association
200
North Carolina Bankers Association-Group 9
12
South Carolina Bankers Association
500
Virginia Bankers Association
750
Virginia Bankers Association-Group 2
25
Virginia Bankers Association-Group 3
25
West Virginia Bankers Association
575
Maryland Bankers Association
338
Maryland Bankers Association-Group 7
10
American Institute of Banking
3,584
Association of Agricultural Bankers
15
Bank Administration Institute
595
Bank Administration Institute-Piedmont Chapter
3
Robert Morris Associates
450
Robert Morris Associates-Carolina, Virginias Chapter
55
Atlanta
American Bankers Association
2,460
State Bankers Association
2,245
Bank Administration Institute
655
National Association of Bank Women
75
Robert Morris Associates
493
American Institute of Banking
5,628
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Chicago
American Bankers Association
$2,235
Illinois Bankers Association
100
Illinois Bankers Association-Chicago Chapter
430
Indiana Bankers Association
100
Iowa Bankers Association
100
Michigan Bankers Association
Chicago
100
Detroit
60
Wisconsin Bankers Association
60
Bank Administration Institute
430
Bank Administration Institute
Chicago Chapter
25
Detroit Conference
15
St. Louis
Missouri Bankers Association
$500
Mortgage Bankers Association of St. Louis
40
Illinois Bankers Association
100
Junior Section Arkansas Bankers Association
10
Arkansas Bankers Association
500
Indiana Bankers Association
100
Bankers Transit Club of Kentuckiana
60
Kentucky Banking Association
500
Tennessee Bankers Association
88
National Association of Bank Women -
St. Louis
25
Louisville
25
Memphis
25
Robert Morris Associates -
National (all offices)
445
Southern Chapter (Little Rock)
8
Ohio Valley Chapter (Louisville)
8
Southeast Chapter (Memphis)
8
Bank Administrative Institute -
St. Louis
410
Little Rock
45
Louisville
80
Memphis
55
American Bankers Association -
St. Louis
2,200
Little Rock
35
Louisville
35
Memphis
35
American Institute of Banking -
St. Louis
2,005
Little Rock
575
Memphis
293
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Minneapolis
American Bankers Association -
Minneapolis
$2,200
Helena
29
Independent Bankers Association
75
Michigan Bankers Association
100
Minnesota Bankers Association
750
South Dakota Bankers Association
50
North Dakota Bankers Association
50
Wisconsin Bankers Association
60
Montana Bankers Association
210
Bank Administration Institute -
Minneapolis
550
Helena
42
American Institute of Banking -
Minneapolis Chapter
5,876
Robert Morris Associates
400
Robert Morris Associates -
Minnesota Chapter
30
Kansas City
American Bankers Association
2,305
Missouri Bankers Association
500
Kansas Bankers Association
375
Colorado Bankers Association
100
Nebraska Bankers Association
50
Wyoming Bankers Association
100
New Mexico Bankers Association
100
Oklahoma Bankers Association
200
American Institute of Banking
4,180
Bank Administration Institute
500
Robert Morris Associates
445
Dallas
American Bankers Association -
Dallas
2,200
E1 Paso
35
Houston
35
San Antonio
35
*Texas Bankers Association -
Dallas
1,000
El Paso
200
Houston
100
San Antonio
200
*Due to receipt of billings, the annual dues for the years 1969 and
1970 were both paid in 1969.
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Dallas (continued)
Arizona Bankers Association -
Dallas
$50
E1 Paso
50
Louisiana Bankers Association (Dallas)
100
New Mexico Bankers Association -
Dallas
50
E1 Paso
50
Oklahoma Bankers Association (Dallas)
100
Robert Morris Associates-National
415
Robert Morris Associates -
Texas Chapter (Dallas)
15
E1 Paso
20
Houston
20
San Antonio
20
Bank Administration Institute -
Dallas
610
E1 Paso
37
Houston - Gulf Coast Chapter
30
San Antonio
38
American Institute of Banking -
Dallas
2,500
E1 Paso
210
Houston
349
San Antonio
223
San Francisco
Alaska Bankers Association
50
American Bankers Association
2,340
Arizona Bankers Association
100
Bank Administration Institute
610
California Bankers Association
985
Credit Managers Association of Northern
& Central California-Bankers Chapter
175
Idaho Bankers Association
-
Los Angeles Credit Mens Association
8-
Nevada Bankers Association
75
Oregon Bankers Association
150
Robert Morris Associates
556
Salt Lake City Bank Officers Association
60
Utah Bankers Association
50
Washington Bankers Association
70
American Institute of Banking
4,888
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