The Economy: Bankers' Brakes

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Tight money got tighter last week. Led by Manhattan's First National City Bank, the nation's third largest, banks raised their prime rate—the minimum interest charge on short-term loans to top-quality borrowers—from 5¾% to 6%. That was the fourth increase in the prime rate in the nine months since the Federal Reserve Board started the trend by raising its discount rate—the interest charge for loans to member banks—to 4½% last December. Though the Federal Reserve has since stood pat on its basic yardstick of money costs, swelling demand for loans has prompted banks to increase their prime rate to 5% Dec. 6, to 5½% March 10 and to 5¾% June 29. At 6%, minimum borrowing costs across the U.S. have risen by 33% since November, now stand at their highest level since rates shot up to 7% in the recession of 1920-21 and touched 6% in 1929-30.

The Better Way. In their move to raise rates, banks ignored an appeal for restraint from Treasury Secretary Henry Fowler. "Surely," he begged, "there is a better way to limit credit than by simply raising its price." There is certainly. The Government itself could cut spending, thereby allowing the Treasury to curb its own borrowing; this not only accounts for a big share of the credit demand that worries Fowler but also tends to expand banks' ability to inflate credit. Reason: the Federal Reserve Board must often pump money into the economy to ensure that the Government can sell its bonds.

After the banks raised their prime interest rates, the Federal Reserve Board, for the second time in two months, acted to cut the supply of bank funds available for lending. It increased the amount that banks must set aside as reserves on certain types of time deposits from 5% to the statutory limit of 6%, starting next month. This will take approximately $450 million out of lendable circulation. Credit-starved housing starts dropped to the lowest level since the bottom of the 1960 recession, an annual rate of 1,064,000 units. Mortgage lenders gloomily forecast that the new prime rate would increase the cost and scarcity of money for home loans still further. The cost of personal and auto loans will also feel pressure, bankers agreed.

Stock-market investors are not notoriously favorable to tight-money policies. Last week the Dow-Jones average of New York Stock Exchange industrials went down five days in a row. The Dow closed out at 804.62, lowest since June 9, 1964. In all some 700 of the 1,250 Big-Board stocks hit 1966 lows. Previously high-flying glamour stocks followed slumping blue chips. Xerox fell off 37 points to 193¼. Optics specialist Itek, a newcomer to the Big Board, sank 15⅛, Polaroid 15, Fairchild Camera 12½.

Still, since the Johnson Administration is clearly unwilling to fight inflation either by cutting Government spending or by raising taxes in an election year, the prospects are that money will get still tighter. Says M.I.T. Economist Paul Samuelson, one of John F. Kennedy's chief counselors: "Since we're not using a tax fiscal policy to keep down inflation, the Federal Reserve will have to make more moves—higher interest rates and less credit." Across the U.S., businessmen were predicting that the Fed would soon reraise the discount rate.