Sunday, March 9, 1952, is as follows:)

[The New York Times, Sunday, March 9, 1952]

"OPEN MOUTH" RULE ENDS IN UNITED STATES BONDS

MARTIN TELLS CONGRESS GROUP LAPSE OF PEGGING PUT DEALS ON IMPERSONAL BASIS

By Paul Heffernan

It is now becoming clear that when the Treasury's outstanding bords first sold below par last year the decline in prices to discount levels in the market did not represent only the termination of fixed-price support by the Federal Reserve System.

It meant too, the end of the central bank's so-called open-mouth operationsthat is, attempts of Federal Reserve officials and employees to influence the sales, purchases, or the market standing of Treasury securities through significantly worded public statements or through "words to the wise" communications through dealers to institutions with heavy holdings of Government bonds.

Moreover, it meant also the end of the Federal's relating its sales and purchases of Treasury securities-the system's traditional tool for influencing business by swelling or shrinking the available quantity of credit-with "selective" or "qualitative" considerations; that is, with considerations bearing on the identity of the other parties to the System's operations, on investors' reasons for buying or selling, and on the use to which they might want to put the money.

As part of its reply to the Patman (House of Representatives) subcommittee's questionnaire on monetary policy, the Federal Reserve Board has just revealed to Congress how "moral suasion" and lack of "impersonality" came to creep into the System's open-market operations while the System was coping with probleins posed by the pegged market in the inflationary postwar period.

MARTIN OUTLINES POLICY

However, the Reserve Board's statement, as presented to the congressional subcommittee by Board Chairman William McC. Martin, Jr., clearly disavows any intention to deviate in the future from the straight and narrow path of impersonality. The Martin statement suggests, too, that the deviations during the period of the pegged market may not have been effective at all times, and may even have boomeranged in a direction opposite to what was intended. Here is the Federal Reserve's pledge to the Patman committee:

"Now that the Federal Open Market Committee is not following a policy of pegging prices of Government securities, it is general policy and practice of the System to conduct open-market operations solely on an impersonal or objective basis without attempting to influence through personal contact or other methods of moral suasion market decisions of investors in Government securities." The Martin pledge follows upon a discussion of a related question-why the Open Market Committee confines its dealings in Treasury securities to a small number of "recognized" security dealers.

There is nothing in the Federal's reply to this question to indicate that the present recognized dealer set-up, which, like the moral suasion and lack of impersonality, grew out of the central bank's abandoned war-finance commitments, is in for any change. Congressional promotion of small business may be all right to spread defense contracts; and the concentration of big business may be a proper occupational concern for the Department of Justice. But when it comes to maintaining markets in Government bonds it is clear that the central bank doesn't want many customers, and doesn't want any small business at all. As a result the commissions generated each week by changes in the System's $22,500,000,000 Government securities portfolio are shared by only 10 investment houses, 5 of them investment banking or discount specialists and the rest major commercial banks with dealer departments.

QUALIFICATIONS OF DEALERS

Of five qualifying conditions within the control of recognized dealers, two are related to financial resources, namely: (1) The volume and scope of business and the contacts such business provides; and (2) financial condition and capital at risk.

The others are related to such consideration as integrity, knowledge, capacity and experience, and willingness to make markets under ordinary conditions.

A sixth and final condition hedges significantly the Board's assertion that its aims are to conduct its operations so as to promote the effective functioning of the market mechanism, not to replace that mechanism. This sixth qualification is as follows:

"The reliance that can be placed on such person to cooperate with the bank and the Federal Open Market Committee in maintaining an orderly market for Government securities; to refrain from making any recommendations or statements or engaging in any activity which would encourage or stimulate undue activity in the market for Government securities; and to refrain from disclosing any confidential information which he obtains from the bank or through his transactions with the bank."

If this qualifier is to hold over as indicated, the much-touted free market for Government bonds, so far as the market-making activities of dealers are con cerned, can be only as free as the central bank will permit. Extraordinary market conditions, undue activity, and orderly market are things no recognized dealer would dare define himself.

GOVERNMENT DEALERS LIMITED

Of the thousands of investment houses and banks that transact business in Government securities, only about 20 are Government dealers that is, enterprises willing to keep bonds in inventory. During the war period the Reserve System sponsored the formation of a dealers' group, whose members shared in the System's open-market operations. In recent years, however, the dealers of smaller financial resources and of limited market-making capacity were dropped, regardless of their experience in the business or reputation in the trade. The Federal Reserve has never formally made known the names of the qualified dealers out of a professed wish to avoid any public act which might be interpreted as disadvantageous to or a reflection upon the dealers who were not qualified.

The recognized dealers at present are:

New York:

Bankers Trust Co.

Chemical Bank & Trust Co.

C. F. Childs & Co.

C. J. Devine & Co.

Discount Corp.

First Boston Corp.

Guaranty Trust Co.

Salomon Bros. & Hutzler.

Chicago:

Continental Illinois National Bank & Trust Co.

First National Bank of Chicago.

Unrecognized dealers, who maintain markets of varying extent, and who compete more or less regularly in the public sealed bidding for the weekly issues of Treasury discount bills, are as follows:

James S. Baker & Co.

Bartow, Leeds & Co.

Blair, Rollins & Co., Inc.

Briggs, Schaedle & Co., Inc.

Harvey, Fisk & Sons.

Aubrey G. Lanston & Co., Inc.

New York Hanseatic Corp.

William E. Pollock & Co., Inc.
R. W. Pressprich & Co.

Charles E. Quincey & Co.
D. W. Rich & Co.

J. B. Roll & Co., Inc.

Schroder, Rockefeller & Co.

J. G. White & Co., Inc.

Mr. LANSTON. The terms under which the Federal Reserve Bank of New York recognizes dealers more or less prevent public statements by any recognized dealer as to practices that involve (a) elements of selectivity in security transactions, (b) identification to the

New York Federal Reserve Bank of the customers who wish to see or buy, and (c) information why the sale or purchase was desired.

The resulting personalization of Federal open-market transactions was acknowledged in the response of the Chairman and Vice Chairman of the Open Market Committee. The reactions of Treasury security holders to these practices ranged from tacit acceptance, to annoyance, to considerable resentment, and stimulated more selling of Treasury securities than it discouraged.

The response of the Chairman and the Vice Chairman states it is the desire of the Federal Open Market Committee to conduct all of its transactions on a completely impersonal basis, and now that the policy of pegging Government securities is not being followed this is the general policy and practice of the system.

The statements, made jointly by the two senior officials of the Federal Open Market Committee are and must be considered as definitive. Since the private market is the instrument through which Federal Reserve transactions in Treasury securities are to be maintained on an impersonal basis, and since an increased reliance on the primary markets made by dealers followed from the cessation of fixed or minimum price support by the Federal Reserve, a review by the Federal Reserve (a) of the degree of encouragement it offers to such dealers, (b) of its organization for the conduct of open-market operations when these are necessary, and (c) of its relationship to Government securities dealers, in general, might have some constructive results.

Finally, may I illustrate by examples the type of Treasury securities that I believe would attract a maximum demand from the public, and which are consistent with the points of view I have expressed. First-the savings bonds.

I believe they should more closely approximate, in design and terms, a savings deposit, something the mass of savers is familiar with and which might eliminate the need to explain "scales of redemption prices," "yields to maturity," and the like.

It is necessary to withhold from the rest of the money supply that portion of the world war deficit that was financed by savings bonds. It becomes necessary, therefore, to aim at two seemingly incompatible goals, namely, to compete for private savings and at the same time to protect the private savings institutions.

Finally, it seems necessary to provide for flexibility in the rates of interest to be paid so that these may be made consistent with changes in the objectives of debt and credit management.

Therefore, I would offer, in substitution for the series E bond, a savings certificate that is issuable and redeemable at par, on suitable notice. The rate of interest would be adjusted semiannually by public notice.

If such a security were to be offered now, the rate of interest would be attuned to current economic conditions but whatever the rate, it would apply to only the first 6 months' interest period. The rate of interest to be paid in succeeding interest periods would be determined in the light of the economic conditions then prevailing. For example, the rate of interest to be paid for the 6 months beginning January 1. 1953, might be unchanged, or be decreased or increased by one-fourth percent or by one-half percent or by whatever seems the most appropriate.

Holders of the outstanding series E bonds should be permitted to convert these into the new savings certificate.

New purchases for cash should be limited so as to assure protection to private savings institutions against large withdrawals of deposits. The idea of seeking to preempt the funds of nonbank investors during periods such as these holds a lot of appeal. I would offer in the very near future two issues of long-term unrestricted bonds. One might be a 25-year bond, callable in 20 years, bearing a 3 percent interest rate and the other really long-term bond maturing perhaps in 50 years, callable in 40 years, and bearing an interest rate of 34 percent. The combination would enable the Treasury to test the preferences of investors (1) for the lower rate issue of shorter term and (2) for the higher rate issue of quite long term.

Primarily, the offering would be for the purpose of encouraging maximum purchases from nonbank institutions. To that end, the Treasury should accept subscriptions for immediate delivery and subscriptions for forward delivery with the latter timed to coincide with periods when the Treasury's balance otherwise would be at a low level, such as August 1 and November 1, 1952.

The prospects for a favorable result would be vastly improved if it became public knowledge that in periods of boom and inflation the Treasury would seek to sell the maximum of high-rate securities and during periods of depression it would be basic policy to concentrate new issues in the short-term area.

With the combination of a new savings certificate and of the marketable bonds, I believe the Treasury would be able to raise substantial sums from the public with a corresponding reduction in the necessity of bank financing and the resultant increase in the money supply.

In summation, it seems to me that: (1) For debt management to be able to counter strong inflationary or deflationary forces it should provide securities that are suited to the economic needs of the period. (2) Purchases or sales of Treasury securities by the Federal Reserve for the purpose of maintaining orderly market conditions should be confined to a minimum.

(3) The cost of interest on the public debt represents payments made largely to a cross section of the American people, and if an increase in the costs follows from debt management that aims to counter strong inflationary forces effectively, this is to be preferred to the alternative costs of a larger increase in the cost of Government and a decrease in the purchasing power of everyone's dollars.

(4) The increased reliance on the primary markets of Government security dealers that followed the cessation of fixed-price support for Treasury securities, suggests that a review by the Federal Reserve of the conduct of Federal open-market operations and of its relationship to the dealers in general might have some constructive results.

(5) Properly designed Treasury securities, offered for immediate and future delivery, which will aggressively seek the savings of individuals and the funds of nonbank institutions, would substantially reduce the necessity for bank financing, which increases the money supply.

Most important of all, if money is to remain our servant and not our master, Federal Reserve officials must be encouraged to discharge their responsibilities with consideration only for the economy as a whole.

Representative PATMAN. Do you have any questions, Congressman Bolling?

Representative BOLLING. No questions.

Representative PATMAN. You realize, of course, Mr. Lanston, the importance of a very close working relationship between the Treasury and the Federal Reserve Board?

Mr. LANSTON. Very close, sir.

Representative PATMAN. How would you do that, and at the same time not make one entirely subservient to the other?

Mr. LANSTON. I think the matter of subservience, Mr. Chairman, is a kind of a trick phrase that we have fallen into. Certainly, the Treasury has the responsibility for debt management, but when it comes to the question of whether the terms set on new Treasury issues would impinge upon the responsibilities of the Federal with respect to credit policy, then I think we more or less, you might say, have the chips down on the table. I do not think it is necessary, in the first place, for the Treasury to exercise its responsibility to this extent. I do believe it is necessary that the Secretary be able to obtain at first hand the thinking of the individual members of the Open Market Committee, something that heretofore has not been available to the Secretary, and that it is desirable for each member of that committee to become more familiar at first hand with the thoughts of the Treasury with respect to the needs of debt management. It was for that reason that I suggested in my response that the Secretary become a member of the Open Market Committee.

Representative PATMAN. Which would mean, of course, for all practical purposes a member of the Board.

Mr. LANSTON. Well, not necessarily. I have read the responses of the council and recall that they noted that although the division of powers between the Board and the committee was somewhat illogical they recommended no change in it. It is odd to have such powers. divided, but my idea was that the Secretary would be a member of the Federal Open Market Committee.

Representative PATMAN. Really, do you not believe that the Board should be composed of the members constituting the Open Market Committee? In other words, put them in on the whole show, and not just part of it?

Mr. LANSTON. The members of the Board are members of the Open Market Committee.

Representative PATMAN. I know the seven members of the Board are, but five members of the Open Market Committee are not members of the Board.

Mr. LANSTON. Are you asking me whether I think the Open Market Committee should consist only of the Board?

Representative PATMAN. NO; whether or not they should be members of the Board. In other words, have a Board of 12 members instead of a Board of 7.

Mr. LANSTON. If you mean, sir, that we would have a Board of 12 members instead of the Committee, that is, we would eliminate the bank presidents who have the closer contact with the public, I do not.

I lived in Washington for a long time, and during the 6 months I was in the Treasury a chap came in from Riggs Bank and he said, "You have not changed."

I said, "What would make me change?"