The Economy: The Year of Tight Money And Where It Will Lead

(4 of 9)

Crisis loomed over one big segment of the money market: the savings and loan associations. Tempted by higher yields elsewhere, depositors withdrew $1.5 billion from the S & Ls in July. Government money managers were so worried that dangerously nonliquid S & Ls would go under that the Federal Home Loan Bank Board, which regulates the associations, arranged a $4 billion stand-by loan with the Treasury and hoped to get $5 billion more from the Federal Reserve — if needed. Says one high U.S. Treasury official: "The withdrawals scared the hell out of us. The savings and loan people were hysterical."

To the Precipice. August saw the worst banking squeeze since Franklin Roosevelt's bank holiday of 1933. Though the supply of available money had fallen about $2 billion from the end of June to the end of July, a record high $3.7 billion in new issues of bonds and stocks hit the money market in August. Meanwhile, the U.S. Treasury was corning to the banks for billions more to finance the budget deficit. Under longstanding moral and legal commitments that they could not ignore, the banks were also shelling out corporate loans faster than they were taking in deposits. In New York City banks, the ratio of loans climbed to well over 70% of deposits, a 45-year peak.

Moreover, many banks had lent long but had borrowed short — a classic formula for financial woe. Altogether $18.6 billion of their $194.4 billion total deposits were in the form of short-term certificates of deposit, and many holders of "C.D.s" were cashing them in to draw fatter interest elsewhere. The dismal prospect was that deposits would continue to decline, while in mid-September the banks would be hit by corporations for more loans to finance quarterly tax payments. If the banks turned them down, the corporations would start a run on their deposits.

Though they could scarcely believe that the Fed would let any such disaster occur, bankers could not be certain. To raise money, they sold off billions of dollars in municipal bonds from their portfolios at great loss. Bond prices crashed and bond yields soared. A year before, long-term municipal bonds had been selling at $1,000 and paying $40 in annual interest; in late 1966, the same bonds were down to $800 but still paying $40 — in effect, yields rose from 4% to 5%. New York State had to pay 5.7% to float one tax-free issue; Baltimore, Louisville, Tulsa and Arlington, Va., canceled others. So queasy and depressed was the bond market that several corporations called off bond issues. Moneymen tossed in their sleep, worrying that if companies could get money no other way, they would begin wholesale withdrawals from banks. Says Chase Manhattan President David Rockefeller, 51: "This was certainly the most difficult period of my career."