The Rush to Repay

Ordinarily, bankers keep their charges for borrowing in lockstep with those of rival lenders. But when the Chase Manhattan Bank initiated the latest round of interest-rate reductions two weeks ago, other bankers grumbled that it was too much too soon. The Chase sliced its prime rate by a fat 1/2%, from 5 3/4% to 5 1/4%. It was the tenth drop in the prime since June 1969, when it was at an alltime high of 8 1/2%, and the eighth reduction in the past four months. Instead of going along as usual, other bankers reluctantly lowered their prime rates by only half as much, to 5 1/2%. Last week, however, the rate cutters triumphed: major banks in New York, Chicago and San Francisco posted a 5 1/4% prime rate.

Most moneymen are betting that rates will fall a bit farther. "The prime rate will probably go to 5%," predicts John Bunting, president of First Pennsylvania Banking & Trust Co. One reason is that other short-term interest rates have fallen even more sharply. The yield on three-month Treasury bills has dropped from a peak of about 8% a year ago to just above 3%; commercial paper is down from nearly 9% in January 1970 to less than 3 1/2%.

Several commercial banks on the West Coast and elsewhere have also reduced the interest that they pay on passbook savings accounts from the legal limit of 4 1/2% to 4%. Those reductions could increase bank profits by 10% or 12% a year. Still, the trend may be slow to spread. In many cities, including New York, competing mutual savings banks and savings and loan associations show no sign of reducing their 5% rate on passbook savings.

Block That Squeeze. The phenomenal decline of loan interest rates shows that the price of money remains highly sensitive to supply and demand. Banks are flooded with funds because the Federal Reserve Board has been expanding the money supply, but few companies want to borrow while business remains slow. Instead, corporations are floating long-term bond issues in order to raise funds to repay short-term loans that carry last year's steep rates. This month's offerings are expected to set a new record of $4.6 billion, topping the previous peak of $3 billion last May. Company treasurers are eager to stretch out the maturity of their debts so that they will not risk financial trouble if there is another sudden cash squeeze like the one that followed last year's Penn Central bankruptcy. "Too many corporations had close calls," explains Salomon Bros. Economist Henry Kaufman. "They want more flexibility."

One consequence of the rush into bonds is that rates on long-term corporate issues have rebounded from a January low of 6.8% to about 7 1/2%. The extra cost deters few companies. "They borrow when they need it, and not because the rates are down," says Economist Tilford Gaines, of New York's Manufacturers Hanover Trust Bank.

Dilemma for Policymakers. Tumbling short-term rates in the U.S. are promoting a new flow of "hot money" into Britain and especially West Germany, where interest levels are considerably higher. Central banks in both countries may be forced to fight the unwanted influx of dollars by reducing interest rates, even though that would aggravate inflation. The transatlantic money tide also creates a dilemma for the Federal Reserve. The board might logically lower its discount rate to keep it in line with falling prime rates, but that step would only increase the dangerous deficit in the U.S. balance of payments by encouraging more dollars to go abroad. If the board takes no action, that will be a signal that the long slide in U.S. interest rates has about reached its end.

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