THE EFFECT OF FHLB BOND OPERATIONS ON SAVINGS INFLOWS AT SAVINGS AND LOAN ASSOCIATIONS: COMMENT

IN THE JUNE 1971 ISSUE, Kwon and Thornton attempt to demonstrate that Federal Home Loan Bank obligations "sold in the open market" compete with savings and loan associations for the same funds and "thus partially deprive them of their deposits," which they consider to be contradictory to the original purpose of the FHLB System.' Their findings, relating to the 1965-1969 period, rest mainly on a regression analysis of a stock adjustment model for selected financial assets using quarterly data. The model explains net new savings at FSLIC-insured S & L associations principally as a function of yield differentials between S & L deposits and other financial assets. Among the latter, FHLB securities emerge as stronger competitors for S & L deposits than do either Treasury Bills or AAA Corporate bonds. That savings flows at S & L associations as well as other deposit institutions were adversely affected by the competition of high-yield credit market instruments during some periods of the 5 years investigated, notably 1966 and 1969, is not a matter of dispute. But the specific results obtained by Kwon and Thornton, which indicate an especially close nexus between S & L deposits and FHLB obligations, warrant close re-examination. First, it should be made clear that the regression analysis merely infers yieldinduced shifts of funds from savings deposits to selected debt securities. It does not show the destination or the magnitude of funds diverted from the savings deposit market. Indeed, the authors make no such claim. It would have been helpful, however, if their cautionary statements on technical aspects of the analysis, such as simultaneous equation bias and intercorrelation of interest rates, had been matched with cautionary statements on substantive interpretation. Second, the analysis is marred by faulty specification of net new savings at S & L associations as the dependent variable. There is no reason in theory or empirical observation to assume that the behavior of S & L depositors varies significantly from that of household savers2 in mutual savings banks or commercial banks when they face alternative investment opportunities at yields substantially exceeding deposit rates. In all three types of institutions, the bulk of funds comes from relatively large accounts whose holders are presumably sensitive to the rate of return, as the authors show in their Table 1 for S & L depositors. Hence, to the extent that FHLB security issues were in competition with savings deposits, the appropriate dependent variable