Chairman ST GERMAIN. Thank you, Mr. Connell. Now we will hear from Governor Partee, member of the Board of Governors of the Federal Reserve System. STATEMENT OF HON. J. CHARLES PARTEE, MEMBER, BOARD OF GOVERNORS, FEDERAL RESERVE SYSTEM; ACCOMPANIED BY EDWARD F. MCKELVEY Governor PARTEE. Thank you, Mr. Chairman, members of the subcommittee: I am happy to appear today on behalf of the Federal Reserve Board to discuss the new savings instruments proposed last month by our agencies. I have also attached a supplement commenting on the questions contained in the chairman's letter of May 1, but these are not covered directly in my statement. Chairman ST GERMAIN. Without objection, they will be placed in the record. Governor PARTEE. At the outset, let me emphasize that the agencies' recent proposals were constrained by our responsibilities to consider and balance three conflicting needs; namely: to provide more equitable rates of return to depositors, particularly small savers; to insure an adequate flow of funds to the savings institutions and, hence, to mortgage markets; and to protect the viability of the thrift industry. The last two of these objectives were mandated by the Congress when it expanded the scope of deposit rate control authority in 1966, and they have been reaffirmed repeatedly in subsequent renewals of that legislation. The objective of providing equitable returns to small savers, while never specifically incorporated into legislation, has nonetheless emerged as an important factor. In view of the sharp increase in market interest rates and in the price levels that have occurred over the past year or two, it is no wonder that small savers have become increasingly vocal about the disparities between market yields and the maximum rates available on deposits at thrift institutions and commercial banks. Despite these developments, fundamental conflicts among the three regulatory goals persist and must be reckoned with in any responsible regulatory action. For example, policies designed to augment mortgage flows during periods of high market interest rates necessarily place pressure on the earnings of thrifts and may cause severe problems for some of the weaker institutions. Similarly, actions intended primarily to benefit small savers also squeeze the profitability of thrifts and may not generate any significant additional flow of funds for housing. These conflicts, and the agencies' attempts to resolve them, are reflected in the three new account categories proposed for public comment last month. Consider, for example, the bonus savings account plan, which would authorize the payment of an extra onehalf percentage point in interest on the minimum balance held in a savings account for 1 year or more. This plan is designed to provide some additional income to savers who prefer to keep their funds in very liquid deposits but nevertheless end up holding these deposits for a substantial period of time. Though the bonus increase in yield proposed is modest, it would raise costs significantly for depository institutions and, at present rates of interest, produce little or no new funds for investment in mortgages. It would be our hope, however, that the minimum maturity restriction would encourage depositors to maintain funds in their savings accounts for longer periods of time and therefore add stability to deposit flows, particularly for thrifts. Creating an incentive to maintain funds on deposit was also an important consideration in developing the rising rate certificate proposal. This plan would provide depositors with an instrument whose yield increases gradually with the passage of time. Specifically, commercial banks could pay interest according to a schedule which starts at 6 percent for the first year and rises in increments of one-half percent, reaching 8 percent for the sixth through the eighth year-the maximum specified maturity. Thrifts could pay one-fourth percent more throughout. Three months' forfeiture of interest would be required for withdrawals during the first year, after which no penalty would apply. The main attraction of this instrument to depositors would not be a higher return, since the yield for most given holding periods is at or somewhat below that available on fixed-term certificates of the same maturity. But by eliminating the early withdrawal penalty after 1 year, the rising rate certificate offers passbook-type liquidity and the prospect of increasing returns to those savers who believe that they will keep their funds on deposit for at least 1 year. Under the proposed rate schedule, this instrument should not affect thrift earnings materially, nor would we expect it to augment mortgage flows significantly. Instead, the proposed instrument would be intended to serve a particular need for those whose plans are not sufficiently certain to warrant investment in fixedmaturity deposit instruments. Of the three new account categories, we think that the 5-year, floating-ceiling certificate probably has the greatest cost potential in the short run. It is certainly the most likely, in the Board's view, to augment deposit flows and mortgage credit availability. Patterned after the money-market certificate, the instrument would provide a market-oriented rate of return to savers who are willing to commit as little as $500 for 5 years; moreover, depositors withdrawing funds prematurely after a year or so would face a penalty less severe than the existing requirement. Maximum rates of interest would be changed once every month and would be 1 percentage point below the yield on 5-year U.S. Treasury securities for thrifts and 14 percentage points below for commercial banks. In advancing this proposal, the agencies have recognized the desirability of permitting a deposit instrument offering a marketdetermined yield to small savers. We believe that the proposed 5year certificate meets this need without endangering the short-run viability of the thrift industry. The relatively large discount from market yields serves to reduce the cost to depository institutions, and is warranted by the simplicity and convenience of dealing with local institutions rather than going into the market for the placement of small savings balances. During the interagency deliberations leading to this proposal, careful consideration was given to the much simpler steps of either reducing the minimum denomination of the existing 6-month money market certificates or creating a new short term market certificate with a lower rate ceiling and a lower minimum denomination. However, these alternatives were rejected because of their potential for inducing substantial transfers of funds from low-cost passbook and short term time deposits and the resultant institutional cost implications. The relatively long maturity of the proposed instrument, coupled with the still significant penalty for premature withdrawals, should reduce these risks considerably. Individually the proposed instruments strike a balance among conflicting objectives in different ways. Taken as a group, we hope that they would provide for greater liquidity and moderately higher returns to small savers and lead to a somewhat larger flow of funds to mortgage markets, all at a cost to the depository institutions that is manageable. Although the considerations motivating each element of the package seem diverse, at least two features are common to all components. First, the differential between the maximum rates payable by thrifts and commercial banks that characterizes each new instrument continues the competitive advantage for thrifts that has clearly been the intent of Congress in its legislative decisions on deposit rate ceilings. Second, all of the proposals, including the suggested reduction of the existing $1,000 minimum denominations on fixed-rate certificates to $500, enlarge the savings opportunities for depositors with moderate sums to invest. It is too early to provide this subcommittee and the public with a detailed evaluation of the comments that have been received on the proposals. The 30-day comment period ended just last Friday and we are still receiving letters that were transmitted to our regional Reserve banks. I understand, however, that very few of the 400-or-so letters reviewed to date are receptive to the proposals. This is, of course, an inevitable consequence of the need to compromise between opposing interests. Depositors would be offered better rates of return, but these rates are still well below current market yields. The depository institutions would find their costs to be appreciably higher, but their savings inflows would likely be somewhat better than without the new instrument alternatives. Mortgage credit should be a little more plentiful as a result of the larger deposit inflows, but those interested in obtaining such credit would still be disappointed by the relatively small impact. And, finally, deposit rate ceiling regulations which are already complicated would become even more complex, adding to public confusion. Such complexity, I am afraid, is the heritage of congressional and regulatory efforts to compromise among competing objectives. The Board urges that this congressional mandate be given prompt review and reconsideration with a view to facilitating simplification and/or decontrol of the ceiling rate structure before it collapses of its own weight. Thank you. [The supplement referred to by Governor Partee in the opening of his statement follows:] SUPPLEMENT TO GOVERNOR PARTEE'S STATEMENT IN HIS LETTER OF MAY 1, 1979 The issues raised in Chairman St. Germain's letter of May 1 are important ones which the regulatory agencies and the Congress have grappled with for some time. Unfortunately, the lack of data in many instances prevents precise and detailed answers to these questions. Nevertheless, I hope the following comments will be of some help in the further deliberations of the Subcommittee. Let me emphasize at the outset that the Board does not endorse the concept that increases in deposit rate ceilings necessarily lead to higher mortgage interest rates. Such a view implies that thrift institutions possess sufficient power in mortgage markets to pass on increases in their deposit costs to their borrowers. Although the thrift industry as a whole is the principal supplier of residential mortgage credit, individual savings and loan associations and mutual savings banks generally face intense competitive pressures in local markets from other lenders, including mortgage companies which may resell to nondepository institutions such as insurance companies, pension funds and the Government-sponsored agency sources. Thus, on the whole, it seems more reasonable to assume that mortgage rates will be influenced primarily by the relative supply and demand for funds. Under this assumption, an increase in deposit rates, by augmenting the flow of funds to thrift institutions, should tend over time to reduce interest rates on home mortgages. Of course, other factors such as movements in yields on alternative long-term securities also will have an important bearing on mortgage rates and might at times obscure the effects of changes in deposit rate ceilings. |