Speech

For release on delivery 10:00 AM, E.D.T. Statement by Paul A. Volcker Chairman, Board of Governors of the Federal Reserve System before the Committee on Banking, Housing, and Urban Affairs United States Senate August 5, 1980 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis I am pleased to be here this morning on behalf of the Depository Institutions Deregulation Committee (DIDC) to discuss the actions taken by that Committee in the months since its creation by the Depository Institutions Deregulation and Monetary Control Act of 1980. At the outset, I would like to emphasize my personal view that the Committee has worked effectively, with good coordination and cooperation among the constituent agencies that make up its membership. As might be expected, differences of opinion or emphasis on some issues have been expressed, but I have been much more impressed with the degree of consensus that has developed as we have attempted to solve common problems. The Committee staff, drawing on the expertise of each agency, has provided a balanced analysis of the issues, so that dis- cussion among the DIDC members has had a common base as well as drawing on the special insights of the individual members. Our discussions have focused — I believe in a balanced way — on the needs of savers and borrowers, the relationship between DIDC decisions and the pattern of economic growth, the needs of financial institutions within the context of a changing competitive environment, and the charge of Congress to the Committee to look toward the eventual elimination of deposit rate ceilings. As this listing suggests, we see our central responsibility under the law as one of managing interest rate ceilings in a manner that supports the nation's economic goals and prepares the way for ultimate deregulation; the controversial matter of the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -2- differential on various types of deposit instruments created after December 1975 should be evaluated in that larger context. The first major issue before the Committee was that of premiums and finders'fees for new deposits. The issue had been under study by the various agencies and had already been scheduled for discussion by the Interagency Coordinating Committee when the DIDC was created. While the; question of permitting or eliminating premiums or finders1 fees is sometimes posed as an issue of further regulation rather than deregulation, that view seems to me oversimplified. The fact is that premiums and finders' fees have been regulated in large part as a means of enforcing deposit rate ceilings, but DIDC members have found that current industry practices involving the use of premiums and finders1 fees are making it increasingly difficult to administer such ceilings fairly and effectively during the phase-out period. Regulatory limits on the value of gifts have been difficult to enforce, and it is evident those limitations are being widely exceeded in some instances. The effect is to increase yields above deposit rate ceilings and divert valuable examiner time that clearly could better be spent evaluating the safety and soundness of institutions. Offers of cash by some institutions to those that bring a "friend" to make a deposit have recently increased deposit yields by 1-1/2 or more percent- age points above ceiling rates in some markets; it is apparent that such finders' fees are often shared, directly or indirectly, with the depositor, contrary to the intent of present regulation. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -3- An extended comment period on DIDC proposals to ban both premiums and finders1 fees for any deposit subject to rate ceilings has resulted in widespread comment. These comments, along with other relevant material, are now being analyzed by our staff. Our present schedule calls for the DIDC to make its decision on September 9. In order to provide planning time for the industry, the Committee has already announced that, should it take action on these proposals to eliminate or significantly reduce premiums or finders' fees, its decision would not be effective until December 31. In its most significant decision, the DIDC at the end of May adjusted the ceiling rates payable on both 6- and 30-month floating ceiling deposits — those deposits whose ceiling rates are tied to interest rates on comparable maturity Treasury securities. (Attachment I displays those ceilings before and after the recent action; floating rate deposit ceilings are relatively recent, first being introduced in mid-1978.) The adjustments made increased the ceilings by changing their relationship to the corresponding Treasury securities yields and established minimum ceilings for each of the deposit categories, Several factors led us to take these actions. With respect to increasing the ceilings relative to Treasury securities, the primary objective was to improve the competitive position of all depository institutions, in order to attract funds at a time when the extreme pressures on institutions1 earnings seemed to be subsiding. Savings and loan associations, mutual savings Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -4- banks, and smaller commercial banks -- all of which had been under liquidity pressure — are a primary source of credit for housing, agriculture and small business* These institutions had been finding it increasingly difficult to compete with alternative market instruments for funds, particularly money market mutual funds and Treasury securities, (Attachment II shows these rate relation- ships.) In that connection, I should note that yields on Treasury securities to which the deposit ceilings are related are typically significantly below other interest rates available in the market. I believe all of the DIDC members are sensitive to the reality of an environment in which the cutting edge of competition faced by depository institutions has been increasingly not among themselves, but with non-deposit instruments — and especially with new vehicles such as money market mutual funds. Funds diverted to the market or to money market funds do not directly find their way into important credit markets — especially for housing, agriculture, and small business — emphasized by the institutions. By allowing depository institutions the flexibility to offer higher returns, the changes made by the Committee should facilitate a larger increase in their deposits and, consequently, the flow of funds to the credit markets they serve. Moreover, the overall decline in interest rates occurring at the time the actions were taken, by easing the earnings pressures faced by many of these institutions, made them better able to offer the more competitive rates. In short, from the point of view of both economic recovery and concern with the long-run financial strength and competitive posture of depository instittuions, it seemed to the Committee a desirable time for banks and thrifts Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -5- to be placed in a stronger position to increase flows of small time deposits with floating ceilings. The concept of minimum ceilings (which, ait the time the decision was made, were at levels near or below those prevailing) was adopted in part in recognition of the fact that Treasury security yields are not only generally below other market rates but generally lead declines in other rates available to savers. Thus, floating deposit rate ceilings related to such instruments would decline more rapidly than yields on other available instru- ments, such as money market mutual funds. As a consequence, the competitive position of depository institutions might, at least temporarily, suffer should Treasury security yields, to which floating ceilings are tied, dip to relatively low levels. In an environment of declining interest rates, in which pressures on institutional earnings would in any event be reduced, the best approach seemed to be to permit the thrifts and small banks to compete more effectively. In the past, declines in interest rates have been associated with an acceleration of deposit inflows to thrifts and small banks because their fixed rate ceiling deposits became increasingly more attractive relative to competitive instruments. Today, those fixed rate deposits are well below market rates. But establishment of a minimum ceiling rate on the popular 6- and 30-month floating ceiling certificates potentially enables depository institutions to enhance their competitive performance in a relatively low rate environment. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -6- In addition, the Congressional mandate to the DIDC to look toward ultimate removal of deposit rate ceilings suggested that it would be desirable for the depository institutions, when consistent with other goals, to gain experience with greater competitive freedom in rate setting. DIDC members are aware that there has been a tendency for institutions generally to pay the ceiling rate, and that consequently, institutions may be reluctant to follow open market rates down, should they drop appreciably. In the short-run, at the minimum levels of the ceiling, the result should be higher inflows of deposits than would otherwise take place. Should rates in the open market persist at lower levels, institutions should in time respond; indeed, any other result would cast in doubt the concept of deregulation. The question of a differential in deposit rates between thrifts and banks has, of course, been highly controversial. The DIDC left the 1/4 percent differential intact for 3 0-month savings certificates. Those longer-term deposits are considered particularly appropriate to the longer-term nature of thrift institutions 3 asset distribution, and provide a more solid base and incentive for mortgage lending. The DIDC, in establishing the new rate ceilings, also faced the prospect that the decline in interest rates would, under pre- existing arrangements, reintroduce a differential on 6-month money market certificates after more than a year during which commercial banks and thrifts had competed on equal terms. Small Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -7- commercial banks, which are significant lenders not only in the mortgage market, but also to agriculture and small businesses, could thus have faced substantial deposit attrition and significant pressure on their ability to extend credit to vulnerable sectors of the economy• In the light of that potential problem, the Committee, while permitting the differential to reappear generally at levels of rates prevailing in recent months, also permitted commercial banks temporarily to reissue maturing MMC deposits to the same holder at a rate equal to the thrift ceiling. Moreover, the minimum deposit ceiling established made no allowance for a differential, mainly on the basis that should those minimums be effective, all institutions would be in a relatively favorable position to attract deposits. In evaluating the potential impact of the late May deposit rate ceiling adjustments, DIDC members were apprehensive that lenders may not be willing to commit additional deposit inflows to mortgage and other credit markets because of their concern that those deposits would be rapidly withdrawn if market rates subsequently rose. In the environment of rising interest rates in late 1979 and early 1980, the volume of withdrawals prior to maturity for the purpose of acquiring higher yielding deposits — often at the same institution — rose sharply because the early withdrawal penalty in the early months of a deposit's life was not sufficient to offset the gain from reinvestment. Technically, this reflected the provision that the minimum required penalty was imposed only on accrued interest and did not require a reduction Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis —8 — in the amount of the original deposit; in the early months of a deposit's life there is insufficient accrued interest to act as a deterrent to early withdrawal when interest rates are rising appreciably. In those circumstances, the original maturity of the deposit lost significance. Hence, in late May, the DIDC modified the early withdrawal rule to increase the early withdrawal penalty in the early months of a deposit's life, while leaving the penalty in subsequent months virtually unchanged; in the first months of the life of the deposit, the penalty will exceed accrued interest. While the Committee is aware that the depositor who breaks his deposit contract by withdrawing the deposit prior to maturity may be concerned upon finding his principal reduced by early withdrawal penalties, a similiar situation would also occur if an investor were to liquidate a market security prior to maturity in a rising rate environment. A depositor provided a market-oriented rate of return on a term deposit is, in effect, asked to share more of the interest rate risk formerly borne by the depository institution, a risk that appeared to be limiting the willingness of the institutions to commit funds to credit markets. Attachment III reviews actual experience since the DIDC acted in late May. On a seasonally adjusted basis over the last two months, small time deposits (mostly MMC's and small saver certificates) at all institutions have shown only modest growth, but thrifts appear to have performed somewhat better Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -9- than commercial banks. Both banks and thrifts have experienced outflows of MMC balances, as the ceiling rate on such deposits generally remained below those available on alternative invest- ments , despite the ceiling rate adjustment (see Attachment II). Both kinds of institutions have attracted larger inflows of 2-1/2 year-or-longer small saver certificates, but thrifts, which have had the advantage of a 25 basis point differential, have done relatively better* Presumably, growth in total small denomination time deposits at both sets of institutions would have been slower, and even negative, without the DIDC actions of late May. The biggest surprise has been the behavior of savings accounts, which rose substantially at all types of institutions in spite of ceiling rates well below market rates. Undoubtedly, economic uncertainty -— including questions in depositors1 minds about the interest rate outlook — has increased the public's desire to hold highly liquid assets. Although the increase in total time and savings deposits has not as yet been reflected in expanded mortgage holdings at the various institutions, both outstanding and new commitments by savings and loan associations registered increases in June. Questions have arisen about the effects of the DIDC actions on mortgage rates. As a general principle, the effect of the ceilings on mortgage rates must be viewed in the context of the entire capital market, of which the mortgage market is just one part. Mortgage rates are unlikely for long to diverge substantially Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -10- from other capital market rates because many potential mortgage buyers can shift freely from bonds to mortgages, or the reverse. However, to the extent that higher ceilings increase the ability of depository institutions to compete for deposit funds, the flow of mortgage credit should be enhanced, tending to bring downward pressure on mortgage rates relative to the bond market. Deposit costs can at times play some role in that process, but the current spread between mortgage rates and deposit costs appears wide enough to induce profitable mortgage lending should deposit inflows materialize in size, and that factor appears to have contributed to the recent tendency for mortgage rates to fall. Finally, I would like to comment on S. 2927, a bill which would require a full 25 basis point differential on all deposit categories established after December 10, 197 5 for 12 months, and then reduce the differential 5 basis points per year for the subsequent five years. The DIDC presently has the authority to institute a schedule such as that proposed in the bill for all such deposit categories and to create new deposit categories with or without the differential. However, my own feeling —- reinforced by my actual experience in working with the Committee — is that the public interest in the face of shifting and uncertain markets is likely to be enhanced by retaining flexibility within the overall context of working toward deregulation. I understand some other members of the Committee may have a different view of the matter; the bill has not been discussed at a Committee meeting. -k * -k * Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Attachment I Ceiling Rates on 1/ 6-Month Money Market Certificates ~ and 30-Month Small Saver Certificates — 6-Month MMCs Before May 28 After May 28 When the 6-month Commercial Banks When the 6-month Commercial Banks bill rate is: May Pay Thrifts May Pay bill rate is: May Pay Thrifts May Pay Above 9.00 percent Bill rate Bill rate 8.75 percent 6c above Bill rate plus Bill rate plus 25 basis points 25 basis points 8.75 to 9.00 percent Bill rate 9.00 8.50 to 8.75 Bill rate plus 9.00 25 basis points Below 8.75 percent Bill rate Bill rate plus 7.50 to 8.50 Bill rate plus Bill rate plus 25 basis 25 basis points 50 basis points points 7.25 to 7.50 7.75 Bill rate plus 50 basis points Below 7.25 7,75 7.75 30-Month SSCs Before May 28 After May 28 When the 2-1/2 year When the 2-1/2 Treasury security Commercial Banks year Treasury Commercial Banks yield is• May Pay Thrifts security yield is: May Pay Thrifts May Pay Above 12.50 11.75 12.00 Above 12.00 11.75 12.00 12.50 and below 2-1/2 year bond 2-1/2 year 9.50 to 12.00 2-1/2 year bond 2-1/2 year bond rate minus 75 bond rate rate minus 25 rate basis points minus 50 basis points basis points Below 9.50 9.25 9.50 1/ $10,000 minimum deposit. 27 No regulatory minimum deposit. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Attachment II Rates of Return on MMCs and Alternative Investments (percent) 6-month Treasury 1/ Bill Rate MMMF 6-month Commercial Bank MMCRates rrhrift MMC Rates Average 7'-day Invest- Newt Rule j Old Rule New Rule ^ Old Rule_ net _v_ielel Auction ment Nomi- Nomi- Effecr Nomi- Effec- Nomi- Effec- . First 1980 Rate Yield nal nal tive- nal tive-7 nal tive — Generation Clones Week Ending r3ora*>oraKMiOMB' 15.70 18.04 __ 15.70 16.55 15.75 16.55 15.04 -- 9 14.80 16.88 -- 14.80 15.57 14.80 15.57 15.56 15,80 16 14.23 16.15 -- 14.23 14.95 14.23 14.95 16.03 17.00 23 13.55 15.29 __ 13.55 14.21 -- 13.55 14.21 16.32 15.46 30 11.89 13.24 __ -- 11.89 12.42 -- -- 11.89 12.42 16.03 13.90 May 7 10.79 11.91 _ _ 10.79 11.24 - _ - - 10.79 11.24 15.52 11.89 14 9.50 10.37 -- 9.50 9.82 9.50 9.86 13.61 9.93 21 8.78 9.54 -- 8.78 9.10 9.00 9.33 12.72 10.06 28 8.92 9.70 -- -- 8.92 9.25 — -- 9.00 9.33 11.99 8.76 June 4 7.75 8.35 _«. - - 7.75 8.02 « - 8.00 8.28 10.73 8.16 11 8.17 8.82 8.42 8.81 8.17 8.45 8.67 8.98 8.42 8.71 10.63 8.16 18 6.94 7.42 7.75 8.01 6.94 7.16 1.15 8.01 7.17 7.42 9.79 7.76 25 6.66 7.11 7.75» 8.01 6.66 6.87 1.15 8.01 6.91 7.13 9.19 7.53 July 2 7.11 7.62 7.75 8.01 7.11 7.34 7.75 8.01 7.36 7.56 8.66 7.50 9 8.10 8.74 8.35> 8.64 8.10 8.38 8.60 8.91 8.35 8.64 8.82 7.83 16 8.11 8.76 8.36 8.66 8.11 8.40 8.61 8.93 8.36 8.66 8.57 7.71 23 8.11 8.76 8.36 8.66 8.11 8.39 8.61 8.92 8.36 8.66 8.43 7.50 30 7.91 8.52 8.16 8.44 7.91 8.18 8.41 8.71 8.16 8.44 8.13 7.76 Aug. 8.28 8.95 8.53 8.83 8.28 8.57 8.78 9.10 8.53 8.83 n.a. n.a. " Footnotes on page 11. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Attachment II (Cont'd) Rates of Return on 2-1/2 year-or-Longer Small Saver Certificates (percent) Constant Maturity Commercial Banks | Thrifts 2-1/2 Year New Rules i' S7 Old Rules z/ 5/ New Rules 1/ 57 Old Rules 4/ 5/ Treasury Bond Nominal [j!ffe c t i ve" jjfomi^^Effective | NominalIneffective \NominalJ Effective" January 10.90 10.15 10.84 10.40 11.12 February 11.15 10.40 11.12 10.65 11.40 March 14.00 11.75 12.65 12.00 12.94 April 14.65 11.75 12.65 12.00 12.94 11.25 10.50 11.23 10.75 11.51 2 Weeks Ending June 11 9.05 9.25 9.83 8.30 8.78 9.50 10.11 8.55 9.06 25 9.00 9.25 9.83 8.30 8.78 9.50 10.11 8.55 9.06 July 9 8.60 9.25 9.83 7.85 8.28 9.50 10.11 8.10 8.56 23 9.05 9.25 9.83 7.85 8.28 9.50 10.11 8.10 8.56 u> Aug. 9.05 9.25 9.83 8.30 8.78 9.50 10.11 8.55 9.06 I \J Includes any eapital gains or losses. 2/ The effective rate assumes reinvestment of principal and interest at the same rate for another six months. 3_/ Minimum ceiling rates of 9-1/2 percent at thrifts and 9-1/4 percent at banks are established. Maximum rates set in March will continue* Between the minimum and maximum rates payable, thrifts may pay the 2-1/2 year Treasury securities rate and banks may pay this rate less 1/4 of a percentage point, The rate will change bi-weekly beginning Monday, June 2, based on average daily yields for the five business days ending every other Monday, and will be effective the following Thursday. The temporary cap of 12 percent at thrifts and 11-3/4 percent at banks which was set in February 1980 remains in effect. 4_/ Rate ceiling changed on first calendar day of each month, based on average 2-1/2 year yield on Treasury securities. This yield VBS announced three business days prior to the first day of the month, and TSBS based on the average daily yields for the preceding five business days.. Nominal ceilings at banks and thrifts were 3/4 and 1/2 of a percentage point, respectively, below the 2-1/2 year Treasury securities yield, 5/ The effective rate assumes continuous compounding on a 365/360 day basis. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Attachment III Composition of Deposit Flows (Seasonally adjusted, percentage annual rate of growth) 1/ All Depository Institutions Commercial Banks Thrifts Small Total Small Total Small Total Denomination Savings Denomination Savings Denomination Savings Savings Time 6c Small Savings Time 6c Small Savings Time 6c Small Deposits Deposits Time Deposits Deposits Time Deposits Deposits Time 1980--Jan. -14.1 9.5 0.3 -12.4 22.3 6.6 -15.2 2.3 -3.8 Feb. -25.1 17.4 1.1 -22.5 25.5 4.7 -27.7 12.5 -6.4 March -33.6 29.0 5.5 -35.6 42.7 9.0 -31.7 20.8 3.1 April -44.4 36.1 6.9 -43.3 54.5 14.1 -45.5 24.9 1.8 May -14.9 17.1 6.0 -7.5 14.0 5.6 -21.3 19.0 6.3 June £,/ 25.8 2.3 10.3 32.9 -2.8 10.9 19.2 5.6 9.8 July (est.) 28.7 -0.5 9.6 38.0 -2.8 13.5 20.4 0.9 6.9 Memo: Flows in billion of dollars, not seasonally adjusted 6-month MMCs 30-month SSCs Sum of MMCs and SSCs Commercial Banks Thrifts Commercial Banks Thrifts Commercial Banks Thrifts 1980--April 19..3 17.,0 2.8 7.,2 22,,1 24.2 May -2..7 -5.6 4.6 9,,1 1..9 3..5 June -3.,4 -5.,2 4.2 6,.3 0..8 1.,1 July (1st 20 days) n.a. -4.9 2/ n.a. 4.7 2/ n.a. -0.2 2/ 1/ Commercial bank data are daily average and thrift data are average of month end. 2/ First 20 days for insured S&Ls only. £/ Preliminary. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Paul A. Volcker (1980, August 4). Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/speech_19800805_volcker

@misc{wtfs_speech_19800805_volcker,
  author = {Paul A. Volcker},
  title = {Speech},
  year = {1980},
  month = {Aug},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/speech_19800805_volcker},
  note = {Retrieved via When the Fed Speaks corpus}
}