Explanation

The very controversial issue of reserve requirements, particularly as they might apply to thrift institutions, is being dealt with in a number of other bills. We would hope that, in the interest of furthering the objectives of Titles I and III of this measure, the reserve question could be considered apart from this bill.

Amendment to Section 301

Strike Section 301 and add the following:

"Sec. 301. Section 5(c) (4) of the Home Owners' Loan Act of 1933 is amended by adding at the end thereof the following:

'(E) CONSUMER LOANS - An association may make secured or unsecured loans for personal, family, or household purposes, but the aggregate amount of such loans at any time may not exceed 10 per centum of the assets of the association.'"

Explanation

This amendment would allow Federals to make secured consumer loans as well as the unsecured loans currently provided for in the bill. As a practical matter, the ability to insist on a security interest in the good to be bought is vital for any lender extending credit on purchases of automobiles and other major consumer durables. While we do not believe that S&Ls would be a major factor in such lending, we believe that it is important that they at least have the ability to offer this type of financial service as part of a complete package of family finance powers. As an argument for this, the National Commission on Consumer Finance has documented imperfections in the consumer credit market and recommended that S&Ls have broad consumer credit powers in order to promote greater competition in this credit market.

The amendment also deletes the language giving authority to Federals to invest in commercial paper, corporate debt securities, and bankers acceptances. The Bank Board does not believe such investments fit into the family finance approach to S&L portfolio powers, and sees no reason why they should be included in a 10 percent "basket" with consumer loan authority. Nevertheless, the Bank Board is proposing, infra, that investments in commercial paper and corporate debt security be permitted under $5A (b) of the Federal Home Loan Bank Act, as investments in bankers' acceptances currently are, in order to broaden the range of items which S&Ls may use to satisfy liquidity requirements. Such investments probably would be restricted regulatorily to short-term, high-quality instruments for which there is a secondary market substantial enough to ensure that they have a sufficiently "liquid" character.

counseling, pension planning, financial managment or similar services."

Explanation

This amendment would allow associations to provide their customers with financial counseling services related to family financial management. Services could range from tax return preparation to investment advice.

Amendments to Section 303

1. In paragraph (1), after the last word, add the following:

", or any creditor as defined in section 1602(f) of Title 15."

Explanation

This amendment clearly would extend the coverage of the usury exemption to real estate loans made by such important lenders as mortgage bankers. It would be unfair to leave these entities subject to usury restrictions not applicable to their main competitors.

2. Strike subsection (b), renumbering the other parts accordingly.

Explanation

Usury laws serve only to distort the mortgage market and divert funds from strict usury locales during periods of high interest rates. The real estate loan market and those wishing to enter it will be better served if the archaic inefficiencies of the usury statutes are eliminated. Amendment to Title III

Add a new section 304, as follows:

"Sec. 304. The first sentence of section 5A (b) of the Federal Home Loan Bank Act (12 U.S.C. 1425a (b)) is amended to read as follows:

"(b) Any institution which is a member or which is an insured institution as defined in section 1724 (a) of this title shall maintain the aggregate amount of its assets of the following types at not less than such amount as, in the opinion of the Board, is appropriate: (1) cash, (2) to such extent as the Board may approve for the purposes of this section, time and savings deposits in Federal Home Loan Banks and commercial banks, and (3) to such extent as the Board may so approve, such obligations, including such special obligations, of the United States, a State, any territory or possession of the United States, or a political subdivision, agency, or instrumentality of any one or more of the foregoing, and bankers acceptances, commercial paper and corporate debt securities, as the Board may approve.

Technical Changes

In defining insured institution, §401(a), rather than $408, of the National Housing Act should be referenced in SS101(c)(6), 103, 104(a), and 106(c) (1(E).

In addition, $106(c)(1)(D), in defining depository institution refers to "any member as defined in this section," rather than "any member as defined in section 2 of the Federal Home Loan Bank Act, in conformance with language used elsewhere in the bill.

J. CHARLES PARTEE, GOVERNOR, BOARD OF GOVERNORS, FEDERAL RESERVE BOARD

Mr. PARTEE. I am Charles Partee, member of the Federal Reserve Board.

SUPPORTS S. 1347

I am pleased to appear today on behalf of the Federal Reserve Board to discuss S. 1347, the Depository Institutions Deregulation Act of 1979. The Board supports strongly the principles underlying each of the major provisions of the bill. Indeed, we believe that S. 1347 provides a workable framework for accomplishing desired, gradual changes in the structure of our financial system, although we would propose several minor amendments to help ensure achievement of the bill's objectives. Before turning to our specific concerns, however, I would like to review briefly the reasons for the Board's support of the broad thrust of S. 1347; these arguments have been developed in greater detail in my testimony of May 15, 1979, before the Subcommittee on Financial Institutions of the House Banking Committee.

Our endorsement of the principle of interest payments on transactions balances at all depository institutions is based on considerations of equity and economic efficiency. Many well informed larger depositors already earn something approaching market rates of return on their transactions balances, either through implicit returns in the form of banking services provided below cost or by placing some of their funds in interest-bearing short-term investments that can be mobilized quickly for transactions purposes. As a matter of equity, it is only proper that smaller, less sophisticated depositors have similar opportunities. Moreover, authorization of the payment of interest on transactions accounts would enable financial institutions to compete directly for funds and to charge for services on the basis of costs incurred. This environment should promote a more efficient use of resources by both consumers and producers of financial services.

Although the Board thus favors the principle of permitting interest on all transactions accounts, we believe that progress toward such an environment should be gradual. Orderly change might best be achieved by extending an activity with which experience has already been gained; thus, nationwide NOW accounts would be a logical extension of existing programs in New England and New York. Moreover, our concern with transitional problems in the move to interest on transactions accounts suggests that NOW's be subject to a deposit rate ceiling in the short run. Staff analysis at the Board suggests that, without deposit rate ceilings set by coordinated action of the regulatory agencies, the actual cost of NOW account funds to financial institutions might rise temporarily by several percentage points above the long run sustainable rate in those States gaining NOW powers for the first time. While resulting earnings reductions would not pose major problems for most commercial banks, they would be serious for some individual institutions. The impact could be especially marked for thrift institutions, which could be expected to compete vigorously with banks for the new interest-bearing transactions account business. The

Board therefore supports the interest rate ceiling on NOW's contained in S. 1347-a ceiling that would be phased out gradually in concert with all deposit rate ceilings.

The Board has long advocated the gradual removal of deposit interest rate ceilings. Most economists believe that these ceilings are anti-competitive-and that they have a particularly inequitable impact on the small saver. Moreover, by reducing depository institutions' ability to compete for funds, ceilings subject such institutions to significant periods of disintermediation whenever market interest rates are cyclically high. However, while the elimination of deposit rate ceilings is by itself highly desirable, this process must be a gradual one. Many of the factors that caused Congress to establish the framework for coordinated rate ceilings in 1966 are still at work. Thrift institutions, because of constraints on the kinds of assets they hold, still are unable to pay market-oriented rates of return on all deposit liabilities when those rates are high. Before the thrifts can compete in such an environment-without jeopardizing the financial solvency and stability of individual institutions-reform of thrift asset powers is necessary.

In light of these considerations, the Board agrees that the plan for phasing out deposit rate ceilings should proceed in tandem with expansion of the asset powers of thrift institutions. We support those provisions of S. 1347 that would accomplish this, including the temporary Federal preemption of existing State usury ceilings on mortgage rates, which would oblige the States to reconsider such ceilings in light of existing economic realities. We also endorse the recent regulatory move authorizing federally chartered savings and loans to issue variable rate mortgages, and thereby achieve a more flexible return on part of their loan portfolios. And, allowing thrifts to hold up to 10 percent of assets in consumer loans and various money market instruments, as provided in S. 1347, would help thrifts to shorten the effective maturity structure of their assets, so that portfolio returns could rise and fall more nearly in unison with market rates. At the same time, this limited expansion in portfolio possibilities would not likely have a significantly adverse impact on mortgage flows, given the expanding range of sources of mortgage credit and the increasing experience of thrifts in the packaging of mortgages for sale through such devices as pass-through securities.

Let me turn now to the board's strong endorsement of the provisions of S. 1347 requiring NOW accounts at all financial institutions to be subject to Federal Reserve reserve requirements. The setting of reserve ratios on transactions balances is an important tool of monetary policy and, as such, needs to be controlled by the Nation's central bank. Further, it is essential that required reserves on all transactions balances be held in the form of vault cash or in balances held at, or passed through to, Federal Reserve banks; otherwise, the system's ability to control reserve availability is compromised. Finally, in order to exercise control over transactions balances, the central bank must have reasonable control over the total amount of reserves supporting these balances. In our view, universal reserve requirements on NOW's are a step in the right direction toward universal reserve requirements on all transactions balances. However, passage of S. 1347 would leave unre

solved serious problems-both in terms of monetary control and institutional equity-which I will note later in my testimony.

I turn now to some particular difficulties we have with S. 1347. I will note only our major concerns and have asked Board staff to communicate other minor, technical suggestions to the committee's

staff.

First, while the Board strongly supports the phasing out of deposit rate ceilings, we believe that the regulatory agencies should be able to respond flexibly to circumstances created by the transition to a ceiling-free environment. For example, it is conceivable that, even with the broadened asset powers, portfolio returns at thrifts might not rise as rapidly as deposit costs-leading to serious earnings squeezes at a sizable number of individual institutions. Prudence could suggest delaying an increase in ceiling rates at one or more points in the transition period to give portfolio returns a chance to catch up to deposit costs. Under our interpretation of the bill, however, any delay in implementing the scheduled phaseout would have to be fully madeup within 12 months. Thus, following such a delay, the bill would seem to require ceiling rates to jump 50 basis points, possibly at a time when the viability of thrift institutions might be particularly strained. For this reason, the Board prefers that the "catchup" provision of the bill be deleted so as to allow more flexibility in dealing with the problems of transition. As an alternative, we recommend that the Board, after consultation with other regulatory agencies, the Board be permitted to waive scheduled half-yearly rate increases up to three times during the 8-year phaseout without need to reinstate the scheduled increases. This added flexibility to the phaseout schedule would, we believe, reduce the chances that earnings problems during the transition period might become crippling to financial institutions. And, even if the scheduled 25 basis point increases need to be foregone for the maximum number of times, ceiling rates at the conclusion of the phaseout still would be 325 basis points above current rates.

A second concern we have is that the scheduled increases in ceiling rates appear to apply to money market certificates and to the new savings certificate with a variable rate ceiling tied to the yield on 4-year Government securities. These instruments are broadly designed to key permissible deposit rates of return to the market and the Board sees no reason for including them under the proposed legislation. Indeed, under the scheduled phaseout, ceilings on MMC's would quickly rise above the rates on corresponding Treasury instruments-which is tantamount to removing ceilings on these deposits and ignoring the problems of the transition period which otherwise have been so carefully addressed in the bill. The Board recommends instead that the existing variable rate instruments be exempted from the scheduled phaseout; of course, ceilings on such instruments should be eliminated, along with those on other deposit categories, by 1990.

Finally, the Board believes that the range for the reserve ratio on NOW accounts as proposed in the bill-3 to 22 percent-is much wider than is necessary. It seems highly unlikely that anything like a 22-percent reserve ratio would be needed for the effective