Using the Credit Tools

During four days of insistent questioning in Washington last week, Texas Congressman Wright Patman, chairman of the House Small Business Committee, tried his hardest to discover what every U.S. businessman would dearly like to know: What will the Federal Reserve Board do next to ease credit and implement its reduction in rediscount rates?

Easy-money Patman prodded FRB Chairman William McChesney Martin Jr.: "I'm sure you will follow through on an easy-money policy." But Martin, as carefully noncommittal as ever, answered: "We are going to look at business conditions at all times and adjust in a way we consider most satisfactory for the economy." FRB's reduction from 3 1/2% to 3% in the rediscount rate, said Martin, was merely a "signal that we saw some change in the business situation. But this doesn't mean that inflation won't occur, or that deflation is the order of the day. I don't think we've licked either one."

President Alfred Hayes of the New York Federal Reserve Bank was a little more helpful. He hinted broadly that "other actions are on the fire." Two days later it became apparent what some of those actions are. The Fed, which has kept heavy pressure on member banks, eased the pressure. It did not counteract an increase in the "float," i.e., uncollected checks in transit between commercial banks, for which bankers get an automatic Fed credit. This was used by mem ber banks to cut their debt to the Fed by $158 million and made possible further borrowings from the Fed, thus could give banks more cash to lend.

Markets & Minims. The Federal Reserve's credit-easing last week was only the mildest and most cautious of the many devices at its disposal. Aside from such private lenders as savings banks, insurance companies and pension funds, the vast bulk of the commercial credit in the U.S. is based on commercial bank deposits, 85% of which are controlled by the Fed through its 6,462 member banks.

To reduce credit, i.e., lending ability, as the Fed has been doing under its tight-money policy, it digs into its $23.3 billion portfolio of Government securities and sells them on the open market, to either the general public or anyone else (banks, dealers, insurance companies) that wants to buy. To pay for them, the buyers draw down their bank accounts, cutting the amount of money banks can lend. To increase credit, the Fed merely has to buy securities. Its checks, deposited in banks, increase the banks' reserves and make more money available for loans. Moreover, since banks can lend $6 for each $1 held in reserves, any increase in reserves rapidly multiplies the available credit.

Still another important credit tool is the Federal Reserve's control of its member banks' "reserve requirement." Under the law, every member bank must keep a certain percentage of its total deposits in cash at the twelve central Federal Reserve banks, cannot lend this cash under any circumstances. By raising or lowering reserve requirements within the limits set by law, the Fed can expand or contract the amount of money members can lend. As of last week, member banks had some $18.5 billion, or an average 16.5% of total demand (checking account) deposits, plus 5% of all time (savings account) deposits salted away as required reserves. The percentages are well above the legal minimums--from 13% for central city reserve banks to 7% for country banks on demand deposits, only 3% on savings deposits for all banks. Thus the Fed could lower required reserves by as little as 1% across the board, as it did in the 1954 business slump, and overnight expand the funds available for loans by $1.5 billion.

Short-Term & Long-Term. How soon FRB Chairman Martin puts such other credit tools to work depends on the overall course of the U.S. economy (see The 1957 Recession). One thing he will watch sharply is the effect the recent 1/2% cut in member banks' discount rate has on business and the businessman's sentiment about business. In the bond market at least, the cut produced a brisk rally, as well as plans for new issues for industrial expansion. As interest rates turned down, dealers in short-.term commercial paper cut their rates twice in five days to 3 7/8% for prime four-to-six month loans.

On the New York Stock Exchange, bonds gained up to two points in one day. Giant A. T. & T., which sold the last of a $250 million 5% issue only a fortnight ago, announced a new one last week, the biggest in corporate history. A. T. & T. plans to float $720 million worth of convertible bonds. Subject to stockholders' approval, A. T. & T. will give shareholders the right to buy $100 worth of bonds for each nine shares of stock, will announce the terms early next year.

As for the U.S. Treasury, which has been having trouble refunding the debt into long-term bonds, it too got a healthy boost from the prospect of lower interest rates. Treasury Secretary Robert B. Anderson was able to exchange $9.97 billion worth of four-month certificates bearing 3 5/8% interest for one-year certificates. In the past six years the Treasury has had to boost the rate as much as 3/4 of a point to shift into longer-term securities. But last week Anderson had to raise it only 1/8 to a 3 3/4% coupon. He also raised $1.5 billion in new cash with a pair of money-saving bonds: a seventeen-year 3 7/8% bond and a five-year 3 3/4% note, both below the 4% interest the U.S. paid on similar issues earlier this year. On the first day alone, the seventeen-year bond drew so many buyers that the price jumped 1 3/4 points above the subscription price, and the five-year bond climbed almost a point.

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