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Some observations can be made, however, which would probably pertain to any system of asset classes reserve requirements if imposed at the present time. It may be assumed that loan assets would carry heavier reserve requirements than Government securities since one of the principal objectives at this time would be to keep banks from liquidating Government securities in order to expand loans.

Substantially increased reserve requirements would probably result for two kinds of banks. (a) Banks with relatively large loan assets would experience relatively heavier reserve requirements. (b) Banks with relatively large time deposits would also find themselves facing a substantial increase in required reserves because time deposits on the present basis carry relatively light reserve requirements. (Perhaps this difficulty could be avoided by a formula permitting time deposits, at least temporarily, to be allowed as a credit against loans in calculating reserve requirements.)

(4) It might be more difficult to provide the desired amount of seasonal flexibility for various local areas. For the banking system generally, the heavy demand for loans tends to occur in the latter part of the year. For a bank in an agricultural area, for example, bank loans tend to change in relation to crop movements. If loan assets were to carry relatively large reserve requirements, such a bank would find itself subjected to a seasonably strained reserve position quite apart from what was happening to its total deposits. While such a bank could presumably get adequate accommodation by borrowing from a Federal Reserve Bank, it would have to borrow more under the asset classes reserve plan than it would under the present system.

(5) To be effective and equitable, nonmember banks ought also to be subjected to similar requirements. The asset classes reserve approach could not resolve this difficulty by excluding small banks (as might be possible under the secondary reserve plan) without considerable confusion, since the old system would presumably still be in effect for the smaller member banks. Yet it seems likely that the adoption of an asset classes reserve plan for banks generally would tend to hit the small banks harder than the large ones under present circumstances. This tendency would occur because small banks have relatively large time deposits and loans. Thus, an asset classes reserve plan which would leave aggregate reserve requirements for the country unchanged would tend to reduce reserve requirements of the larger banks and to increase reserve requirements of the smaller banks. This has implications which would certainly require careful study if such a plan were to be seriously considered, inasmuch as the small member banks, who are already most acutely aware of nonmember competition, would be most severely penalized.

(6) There is also a competitive problem posed by nonbank financial institutions who compete actively with banks in the lending business. Would a similar system of reserves against asset classes be needed to control credit extended by such institutions?

It seems clear from this brief listing of advantages and disadvantages that the asset classes reserve plan has severe practical difficulties. Obviously, these practical difficulties would have to be weighed very carefully, for we are dealing with an operating system of banking which has developed over the years.

3. The Loan Expansion Reserve Plan

The brief statement just concluded applies to the general principle of the asset classes reserve plan. As noted earlier, there are many variations possible and the advantages and disadvantages will presumably vary also for different versions of the central idea. The principal hurdle for these plans is the great variation in the asset composition of banks, making it extremely difficult to shift from the present system of reserve requirements against deposits to reserve requirements against classes of assets with heavier requirements against loans in the circumstances of today-than against Government securities.

A compromise plan has been discussed which would help meet this problem. This is the so-called loan-expansion reserve plan. This would keep the present system of reserve requirements, but would superimpose a requirement levied against increases in loans over a base period. There are many variations of this idea, but the central theme is to slow up expansion in bank loans under present circumstances by increasing the reserve requirements of any bank which is expanding loans.

The idea is subject to many of the advantages and disadvantages cited above. It would have the particular advantage of hitting at credit expansion on a specific basis without requiring any elaborate changes in our system of reserve requirements. Furthermore, this plan would not involve the serious transition problems which are raised by the asset classes reserve plan. It needs a great deal of study, with regard to the effects on individual banks and localities however, to insure that it would not work out unfairly or in ways which would hinder our national production. In any event, the loan expansion reserve plan should be considered as more of a stopgap measure than some of the other reserve plans, since it would become progressively less appropriate as the base date receded further into the past.

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The three plans discussed in this answer all utilize the principle of reserve requirements to provide additional direct restraint against bank loan expansion. Many versions of these plans may be proposed and undoubtedly new plans will appear from time to time.

There are also proposals to limit the volume of bank loans by imposing direct controls of one kind or another. These plans are discussed in the answer to Question 39.

37. Discuss the advantages and disadvantages of marketable and nonmarketable securities (a) under present conditions; (b) in the event of the necessity for substantial net Government borrowing. Over a period of time, the Treasury has issued securities with a wide variety of terms and conditions. The securities now outstanding, when classified with respect to their marketability characteristics, may be grouped into five main categories:

(1) Securities which are fully marketable, such as issues of bills, certificates, notes, and certain bonds.

(2) Securities which are marketable, but are restricted as to ownership by commercial banks for a designated period of time. The Victory Loan 22 percent bonds are an example of this category.

(3) Securities which are not marketable, but are redeemable in cash over a period of time before maturity according to a specified schedule of values. Savings bonds and savings notes are issues of this type.

(4) Securities which are not marketable and not redeemable in cash before maturity, but are convertible before maturity into a special note issue which is in turn marketable in character. The 234 percent Investment Series bond issued in 1951 is the only issue of this type outstanding.

(5) Securities which are not marketable and are issued only to Government investment accounts. The terms and conditions of some of these issues are provided for by statute. Special securities issued to the Federal old-age and survivors insurance trust fund are an example of this type of issue.

The table which follows classifies the interest-bearing debt as of December 31, 1951, into the above five categories:

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As shown in the table, fully marketable issues are the largest single category of these five groups. Percentagewise, however, this category represents only 41 percent of the debt, a much smaller percentage than existed twenty years ago, for example, when fully marketable securities comprised 98 percent of the debt. This is shown in the following table:

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As the debt grew during the past 20 years, the objective of the Treasury was to design securities which met the needs of the various investor classes as closely as possible, while at the same time satifying the needs of the Government and the economy as a whole. This is discussed in the answer to Question 38. The main result of this policy has been to provide a wider variety of issues than had heretofore existed and a greater proportion of nonmarketable securities.

The Treasury does not have any predisposition toward a particular type of issue either marketable or nonmarketable. If a marketable security suits the needs of a particular investor class and at the same time satisfies the needs of both the Government and the economy as a whole, we may issue it. If, on the other hand, a nonmarketable instrument would do the job better, we would prefer to issue that. On some occasions, we have issued both types of securities simultaneously

to satisfy the differing needs of a particular investor class. An example of such action is the regular issuance of both savings notes and fully marketable short-term obligations to meet the requirements of corporate investors throughout the war and postwar periods.

The advantages and disadvantages of marketable and nonmarketable securities are taken up in the paragraphs that follow. Before starting this discussion, I might note that the present question asks that each of these types of securities be considered separately: (a) under present conditions, and (b) in the event of the necessity for substantial net Government borrowing. The Government is borrowing substantial amounts this fiscal year, and expects to do so again next year. Thus (a) and (b) both appear to be cases related to a budget deficit. The question may, however, aim at distinguishing between the cases of a budget surplus and a budget deficit. In any event, it is my opinion that, as far as the matter of marketable versus nonmarketable securities is concerned, the budget position is not the major factor, as long as the objective is to provide securities best suited to the needs of the various investor classes in harmony with economic conditions and with the other Treasury objectives as outlined in the answer to Question 2. 1. Marketable Issues

(a) Advantages.-Marketable issues of Government securities have certain advantages from the standpoint of the Government and from that of the investor:

(1) They are flexible in their use. They can be bought and sold for immediate delivery or delayed delivery, borrowed and lent, pledged as collateral, deposited as security for fulfillment of a contract, sold under repurchase option, and can be used to satisfy numerous particular situations. They have legal advantages, also-such as advantages with respect to ownership, title, etc.-because they are issued typically in bearer form. Transactions in marketable securities are, therefore, typically covered by the anonymity of the market place. No one (except the dealer involved) knows who is buying or who is selling. Many investors consider this an important advantage of marketable securities because of the confidential nature of their transactions in them.

(2) They permit a greater degree of fluidity in the capital markets. The position of a particular investor frequently varies from that of the investor class as a whole. Some insurance companies, for example, may be selling securities at the same time that other insurance companies are buying securities. The marketability feature of Government bonds allows these intra-investor group adjustments to be made with a minimum of friction. The market serves an important function in this respect, which is prized highly by managers of security portfolios. The redemption provision attached to nonmarketable securities could, of course, accomplish in theory most of the necessary adjustments of this type. Such adjustments would have to be carried out by the Treasury redeeming the securities offered by the sellers and issuing new securities to new buyers. The Treasury, in effect, would be performing the market function. This could be done; but it is a cumbersome procedure for the public, especially for shortterm shifts in funds.

(3) Marketable issues are similar in form to most issues put out by corporations and State and local governments. Purchasers of large

amounts of securities and managers of large investment portfolios are accustomed generally to obligations of this type. Accordingly, other things being equal, many large purchasers of securities may prefer marketable obligations to nonmarketable obligations, and may be willing to pay a better price for them. This would be particularly true in cases where constant speculative adjustments are made in portfolios. (4) The very existence of an adequate volume of marketable Government securities in all maturity areas gives the Federal Reserve a certain amount of flexibility in expanding or contracting the credit base whenever such action seems desirable. The Treasury has flexibility, too. Under conditions of increasing interest rates, it can sell new securities with higher coupons without concerning itself at once with redeeming outstanding obligations. This can be a problem with nonmarketables when rates move so far that it pays holders of such issues to cash them in.

(b) Disadvantages. In recent years, marketable issues of Government securities have come to have some disadvantages.

(1) The first of these disadvantages arises because the Government debt of more than $250 billion has been created so quickly and has become such a predominant factor in the high-grade securities market. If all of this debt were marketable, it might float around loosely and there might be wide movements and swings in prices and yields arising from temporary or special situations. This might have far-reaching repercussions on the prices and yields of other securities, such as municipals and corporates. The capital resources of banks, insurance companies, and other savings institutions, viewed from the standpoint of market values, could either be increased materially or cut drastically in a short period by such developments.

(2) There are now important groups of investors who want to own Government securities, but for whom the price fluctuations of the marketable issues are a drawback. These, primarily, investors want safety of principal. They consider their investment in Government securities as an alternative to a deposit in a bank. And they want the certainty, as in the case of bank deposits, of getting 100 percent of their money returned to them upon demand. This group of investors includes particularly the small individual investor who buys savings bonds. It also may include the treasurers of large corporations and the managers of State and local investment and operating funds. Many of these have preferred nonmarketable Treasury savings notes, on many occasions, to marketable short-term Treasury securities because of the absence of fluctuations in market prices.

(3) Marketable obligations have certain unsatisfactory attributes for the investment of Government trust fund accumulations. On a single day, for example, the Federal old-age and survivors insurance trust fund may have $100 million to invest in long-term bonds. Obviously, these could not be acquired in the market without sharp price effects. This would be a temporary disturbance to the market and would be entirely apart from normal market supply and demand forces. Special provisions involving the issuance of nonmarketable securities by the Treasury for the investment of these funds as they become available have been found to be an appropriate solution to this problem.

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