Bankers in the Woodshed

All last week, U.S. financial markets staggered through a period of startling turbulence. On Wall Street, stock prices nosedived. The Dow Jones industrial average fell 40 points to 923, down 12% from the record high of 1052 in mid-January. Stock traders clearly shared the national anxiety about resurging inflation (see THE NATION). But investors had another major worry: rising interest rates, pointed up by an unusually sharp jump in the bank prime rate that even the redoubtable Arthur Burns, chairman of the Federal Reserve Board, could not immediately reverse.

Early in the week, seven big banks raised the prime by half a percentage point, to 6 3/4%. That meant a jump in the charge on loans to the most creditworthy companies. Burns, acting as chairman of the Phase III Committee on Interest and Dividends, wasted no time summoning the bank chiefs to Washington. Like a stern father herding errant sons into the woodshed, he called them into his office one by one and told them that so large a boost was "not justified." Chicago's Continental Illinois National Bank & Trust Co., Boston's First National Bank, and New York's Marine Midland Bank obligingly shaved their increases to a more reasonable quarter-point. But three others said they would not budge--and by week's end New York's Chemical Bank joined the jump to 6 3/4%. So did Chase Manhattan, on loans to its biggest customers.

Slow Growth. Even if Washington eventually gets the increase rolled back, it will be a hollow victory. As Interest Committee Chairman Burns well knows, most other interest rates are rising anyway--partly because of decisions by Federal Reserve Chairman Burns. To keep the fast U.S. economic expansion from turning into a runaway inflationary boom, the Federal Reserve lately has been slowing the growth of the nation's money supply. In addition, individuals and corporations took several billion dollars out of the U.S. during the recent monetary crisis and exchanged the greenbacks for other currencies that they rightly guessed would rise in value against the dollar. Though much of this money may eventually return, its absence now further restricts the supply of lendable funds. Interest rates have been going up on bonds and Treasury bills. Banks, for example, are paying higher interest on the certificates of deposit that they sell to investors than they are getting back when they lend the same money at the prime rate.

Bankers complain that the result is a scramble by corporations to take advantage of a bargain prime rate. "We are being inundated with business loans," says John R. Bunting, chairman of Philadelphia's First Pennsylvania Banking & Trust Co., one of the prime-rate raisers. "Too much of our money is going to our prime-rate customers, restricting the flow to our other customers," such as small businesses and individuals seeking personal loans. There are even stories about corporations borrowing as much as they can at the prime rate and then lending some of the money back to the banks at higher rates.

Burns himself is not totally opposed to a prime-rate boost, at least something in the range of a quarter-point. Last week his staff at the Federal Reserve worked out another ploy that some of his banker antagonists found intriguing: setting up two prime rates. One would be for loans to smaller business borrowers, and would be held relatively stable; the other would apply to loans to giant companies, and would be free to move up and down according to market conditions. At present, it would undoubtedly go up--resulting in a man-bites-dog oddity of General Motors and IBM paying higher interest rates than smaller concerns. Banks also have other ways of getting more money out of customers if they are jawboned out of raising the prime; they can, for example, simply grant the prime rate to fewer borrowers. Since the prime rate is the lowest of all short-term business-loan charges, a borrower who cannot qualify for it automatically has to pay more. Thus business-loan charges seem sure to rise along with other interest rates, probably eventually including those on consumer and mortgage loans.

Wall Streeters have good reason to be dismayed by that prospect. Rising interest rates tend to siphon into bank deposits or bond purchases money that would otherwise go into stocks. But many economists doubt that much damage will be done to the rest of the economy. The rising rates will of course raise costs. But they may also help promote a needed slowdown in the pace of business growth later this year, by discouraging companies from overborrowing to overexpand.

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