FRB and Treasury Face a New Problem

AS the Federal Reserve Board alowed a few more steps last week to tighten credit (see State of Business), more and more Wall Streeters wondered whether the FRB can control a new inflationary upsurge as well as it did during the 1955-57 boom. How widespread these doubts are was reflected in the stock market, where stock prices during the week rose to a new high for the year. Wall Street was highly skeptical about the power of the FRB because, in trying to control the new inflation it fears, the FRB is up against a big problem it did not have before. The FRB will have to keep credit easy enough so that the Treasury can raise $10 billion to $12 billion to finance the biggest postwar deficit, and do that at a time when the Government bond market is the weakest in years.

The bond market is still in the throes of a shake-out that Wall Streeters compare to the '29 crash in stocks. With the benefit of hindsight, bond experts lay the blame on Treasury Secretary Robert Anderson. Eager to stretch out the public debt, i.e., lengthen the maturing period of Government bonds, Anderson brought out medium and long-term bond issues in June, a poor time because the market was at the top of a speculative binge that had boosted the price of U.S. bonds (TIME, June 30). Many, gambling on a continued rise, bought the new bonds with nothing down. But in June it also became plain that the recession had hit bottom and the FRB might have to tighten credit. Bond buyers saw the promise of higher interest ahead and dumped their holdings. The speculative bubble burst. As prices fell, the yields reached as high as 3! on Government bonds. The Government bond market turned so weak that when the Treasury floated a $16.3 billion issue of one-year certificates, the FRB had to support the market by buying $1.2 billion of it, thus adding to the credit supply. Then it tried to tighten credit by sopping up the extra funds and permitting its banks to boost their discount rates. For the debacle in bonds, whether brought on by fumbles by the Treasury or the surprisingly quick turnabout in the economy, the Treasury is being bitterly blamed. Said Armand Erpf of Carl M. Loeb, Rhoades & Co.: "I suppose the loss of several billions of dollars in bond values is the price we have to pay to break in a new-Secretary of the Treasury."

Now the FRB and Anderson have to find their way out of the debris of the bond break. Within the next month, the Treasury must raise $3.5 billion in new money, the first of a series of huge financing operations over the next ten months by which Anderson must raise new cash, and refinance some $46 billion in maturing securities. With private investors scared out of the bond market, the Treasury is counting heavily on commercial banks to buy its future issues. Since the banks can turn right around and borrow from the FRB on the bonds, this will also add to the credit supply, forcing the FRB to increase its efforts to check credit.

Washington officials hope that the bond market has hit bottom and that prices will strengthen. But few Wall Street experts are willing to take a chance and advise the purchase of bonds. Said one banker: "I don't know what the bond market will do next, but I'm certainly not going to add any more bonds to my portfolio." Says Girard Spencer of Salomon Bros. & Hutzler, a top dealer in Government securities: "We are in a long term trend to higher interest rates." In fact, some experts predict that Congress will have to raise the 4 1/4% interest ceiling on Government bonds to permit the Treasury to sell long term issues, even though it will drive down further the prices of present issues and raise a political storm.

To solve the Treasury's problems, many an expert feels that it must drastically revise its whole approach to the management of the debt. To start, it should recruit more staffers with practical experience in the money market. Too many Treasury decisions, say critics, are made on the basis of advice from its unwieldy financial advisory committees, which, as one bond trader says, "usually tell the Treasury to issue long-term bonds--for the other guy to buy." A more sweeping suggestion, being pushed by some bondmen, is that the Treasury should consider a "grandiose" refunding of all its older issues. In effect, it should lump individual securities together into fewer issues, stretch out the duration of the bonds and stagger their maturity dates. Treasury financing is now so bunched that the FRB may not be able to apply credit brakes when it wants for fear of upsetting the Government market. To overcome this will take considerable doing, but until the Treasury learns to manage the debt more astutely Wall Streeters fear that the Federal Reserve Board will lack most of the flexibility it has had in the past to ease--or tighten--the money supply and stabilize the economy.

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