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SPECULATIVE CAPITAL TRANSACTIONS IN CDRi-cmOE STOCKS
AM; IK IJKBAN AKL FAPJ.;" REAL ESTATE
Progress Report
Pursuant to the request of the Director of Economic Stabilization,
preliminary discussions have been held with several agencies directly
concerned in preventing inflation in the urban and farm real estate
markets and the stock market. The following progress report summarizes
the current situation and outlook in each of these areas, together v;ith
the major proposals for further action advanced by these agencies and by
the Interdepartmental Tax Committee, Because of numerous gaps ±n the
evidence, as well as the need for clarification of the viewpoints of
certain agencies, the findings are tentative. For the same reasons,
appraisal of the proposals and recommendations will bo submitted in a
later report*
Summary
(1) Farm real estate. In terms of probable long-run values, prices
of farm land are alreacy dangerously high and are likely to rise further.
The Department of Agriculture has for some time supported enactjnent of a
drastic tax on grains from resale of farm land* As additional measures,
adoption of more effective credit controls and establishment of a Public
Farm Appraisal System are suggested for consideration
(2) Urban real estate. Present values of urban residential real
estate also on the average exceed probable postwar costs of replacement
As the most practical and immediate measure to ease the continuing
pressure on the housing market, OPA favors adoption of more stringent
controls over evictions. Neither NHA nor OPA believe that a resale gains
tax of the type proposed by Mr o Eccles ?/ould have much effect on the
urban real estate market,, NHA proposes enactment of a stiff capital gains
tax not limited to resales of property purchased since January 1, 194-5©
Both NHA and OPA recognize the desirability of minimizing shoestring
financing, but are pessimistic about the administrative feasibility of
using credit devices as a major mechanism of controlo The Price
Administrator has testified tliat direct price control would be difficult,
but not impossibleo
(3) Stock marketo Common stock prices are still low in terms of
current earningsj justification for further advances depends upon the
probable postwar levels of national income and corporate tax policieso
To halt or reverse the increasing speculative participation, the SEC and
the Chairman of the Federal Reserve Board favor enactjnent of a drastic
resale gains tax; the Interdepartmental Tax Committee suggests lengthening
the minimum holding period for long-term capital gains. The SEC and the
Interdepartmental Committee propose iurther restrictions on stock market
credit, but the Board of Governors believes such action is not warranted
at the present time.
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(1) yarn Real Estate
Current Situation
Farm l«nd values in March 19^5 VJ®re 5 2 percent above the 1935-39
sverrwse; much l,?jrger increases hove occurred inrarmyindividual states
and in area* 'dtfcin states. Trilnc?. rose "by 11 percent in 1 $ & , ^oraevh
lees than in 19*3. Volume of sales in 19^44 was virtually equal to
but sales in the quarter ending Hareh 1, 19^5* tr®rQ 20 percent under
19^3, Transfers of 7^roperty held two years or loss rose to 13 percent
of r.ll sales in the last six months.
Over half of all sales currently are cash sales. About 20 percent
of all purchases, however, are financed by mortgages amounting to 75
percent or more of the purchase price; in such cases, they usually carry
a debt greater than the full narket value four years &{*o. Individual
lenders or sellers provided U5 percent of all Io&n3 on recently trans«
ferred properties, a considerable relative increase since 19**1.
Outlook
Because of the Government8s commitment to maintain farm prices at
90 percent of parity for two years after iho war, no substantial decline
in "the present high level of farm income i s expected during this period©
With shortages of mrupov/er and machinery relieved, araole liquid funds
available and Increased demand for farms fron raturning veterans and
war v;orkers, lnjid values v i l l pro"ba"bly continue rising for a year or tv.-o
after the Japanese war ends*
Unless present levels of farm income are maintained indefinitely
after the war, "both current and future land values !-;ill profccbly prove
unduly higii. Sven with a successftil full employmont program, sone re«
duction in fans prices or output, or "both, seems likely, particularly in
major export crops like cotton and wheat* Failure to achieve full success in maintaining stability in the industrial economy uould further
depress farm income. In terms of long-run values, therefore, farm land
values have already gone through the yellow light*
Present end Possible Controls
Since the fall of 19^1, the Department of Agriculture has carried
on a vigorous educational program designed to put hoth "buyers p»nd lenders
on notice concerning the dangers in mounting farm values* Under i t s
sponsorship, a National Agricultural Credit Committee was formed, con=»
sisting of representatives of the major institutional'lenders, 'faich
as a cleerinsi house for information on land value developments*
In the fall of 19^3, the Department bncked the Gillette bill providing for a drastic tax on sains from resale of farm land, and still
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supports the princir^ls of this "bill. Iha Inter&eprrtmozitrl Tnn CJonoittse
in i t s recent report to the director of Kconoffiio Stabilization likewioe
recognised "that e. special situation nay exist in respect to farm real
estate and th?.t if p o l i t i c a l l y feasible, the penalty \nx t/ould on
be desirable in this field.«
Departnent also suggests for consideration ?vdoption of moro
affective credit controls. Since p&& credit control syctom baaed on
appraiuals t'otxld be difficult to administer, a blanket rQ^uirament of
say ^K) or 50 percent cash doim )x\yn^nt3 i s perhe^a the most nry.cticr.l
niethod* In view of the questionable legality of controlling individual
lenders nnd sellers by rm executive order issued under the WAT Powers
Act, new legislation ml£ht be necessary,
Establishment of a Public 3farn Appraisal System i s also suggented
for diecussion. Uoe of such a system vrould be entirely voluntary, but
buyers on payment of a feo could obtain an inrpartirl opr.rnisal of
particular properties T.#iich would j>ut them on notice of ej:ce9slve
prices.
The Department haa not p.nd does not pronose direct controls over
sale prices; technical staff, however, have diiscuseed a "reoele ceiling"
x*liicli '.*oultt U n i t prices received on resale of property to the price
paid in the f i r s t sale after enactment of the lav. Such a proposal
irould prevent rather thcJi tex speculative profits and would avoid the
administrative problems involved in the appraisals required for other
types of direct controls*
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(2) Urban Residential Real Estate
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Current Situ^on
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Residential r e a l e s t a t e values i n t h e larger urban a^eas have i n creased by an average of about 30 to 40 percent between 1940 end l a t e
1944.
In sooo isar industry c e n t e r s , r i s e s of 75 t o 100 percent have
occurredo Property i n the lower-price brackets has had greater p r i c e
increases than higher-potdced property. The volume of s a l e s has a l s o i n creased, but no q u a n t i t a t i v e data are a v a i l a b l e ,
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With local'exceptions, speculative buying (purchases ibr resale)
has been very minor, the major impetus ha3 come j^otn'purchalees for
owner-occupancy, With rent controls and limitations • on new construction^
acute housing shortages in many communities have forced many tenants to
buy in order to have a satisfactory place to l i v e , OPA certificates of
eviction (required •whenever a house i s sold over the tenant's head to a
new owner-occupant) were 30 percent more numerous in the l a s t six months
of 1944 than in the corresponding period in 1943 •
Cash purchases have accounted for an unknown, but probably increasing s
share of t o t a l transfers. The volume of new loans to finance home pur*
chases, however, i s running very high and the average size of mortgages
i s increasing. Despite the low levels of new construction, mortgage
recordings in 1944- were almost equal to the peak year of 1941; the i n crease from 1943 to 1944 was 20 percent. Mortgages recorded in the name
of individuals, In particular, have increased from 16 percent of the total
volume in 1940 to over 24 percent in 1944; meanwhile the average size of
such mortgages has risen from $1,886 to $2,537, a rise of 35 percent.
Outlook
In the early months of 1945, upward pressure on housing values has
apparently continued, OPA staff forecasts a "period of hesitation and
inactivity" between V-E Day and V-J Day, during which sales may drop
temporarily, bit prices will not fall significantly. Following this interval, however, the large housing backlog and the hi#i prospective levels
of consumer income are expected to cause TIa continued inflation in housing
values for some time after the war," NHA has nade no forecast on the
probable extent of further price increases; resumption of new building,
even in moderate volume, it is argued, however, "would act as a powerful
antidote against inflation,Jt
"Dhile forecasts of developments after V-E Day and in the immediate
postwar periods are indefinite, both OPA and NHA believe that present
prices of urban residential real e state exceed the probable postwar cost
of replacement. Since housing values will ultimately tend to correspond
with levels of construction costs, any further rise will merely increase
the ultimate downward adjustment required. The timing and extent of this
adjustment rdll depend upon the level and stability of postwar national
incomeo
- 5Present and Possible Controls
Through its constituent units, the NHA exercises direct or indirect
supervision over more than half the total volume of •urban home mortgage
loans. Since 1941, the Federal Housing Administration has required its
underwriting staff to refuse recognition to "temporary or unstabilized
cost increases" in appraising properties for Title II insured mortgage
loans. The Federal Home Loan Bank System, through supervision and advice, has endeavored to persuade member savings and loan associations to
appraise properties on the basis of "long-term stabilized values" and to
reduce the percentage of loans to current appraisals as local real estate
prices rose. The Federal Public Housing Authority has adopted a policy
of avoiding inflated prices in the disposition of permanent war housing0
Incident to its rent control operations, the OPA requires a 20 percent
down payment and a 90-day stay of eviction in «11 cases of sales of
rented property for owner-occupancy.
Because of the extremely limited volume of speculative activity
in urban real estate, neither EIHA nor OPA believes that a resale gains
tax of the type proposed by Mr« Eccles would have much effect* NHA
thinks that a broader capital gains tax not limited to resales of
property purchased since January 1, 1945, would be effective in curbing
the urban real estate boom. Some exemptions, however, would be necessary in order not to discourage responsible builders or subdividers from
purchasing and improving land for purposes of neighborhood developmento
Neither NHA nor OPA are optimistic that credit controls (i o e.,
higher down payments and shorter amortization periods) can do the whole
job required. Besides the considerable volume of cash purchases, NHA
cites the increasing proportion of new mortgage loans Toy individuals and
other uncontrolled lenders, the need for uniform appraisal standards applicable to all types of lenders, and the danger that stringent restriction on first mortgages might cause evasion by revival of unsound junior
financing^ OPA staff also express concern with the policing problem, as
well as with the possible discrimination against purchasers unafcie to meet
doivn payments. Both agencies agree upon the desirability of minimizing
shoestring financing of the housing boom in order to reduce the handover
of excessive debts latero
As the most immediate and practical measure, OPA favers further action
against evictions, by lengthening the period of notice and possibly increasing down payments. This proposal has been discussed with (XMt, 'SMU
and 'tgLB, since sales of housing at inflated prices not only involve evasion of rent controls, but also lead to absenteeism and higher living
costs for war workers„ OPA has the power to act under its present law,
bat will probably defer any step until after extension of its authority
fcy Congresso
Both OPA and NHA have discussed the feasibility of direct price controls. NHA suggests three methods, all of which involve serious administrative problemso OPA staff propose that price ceilings be based upon prewar
- 6 appraisals plus a generous allowance for increases in construction costs.
The Price /dministrator testified thst price control would be a "tremendous
administrative job," but not impossible«
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-7(3) Stock Market
Current Situation
Common stock prices (Standard and Poor*3 index) have increased by
about 80 percent since the low of 1942, The recent rise, however, has
been from a relatively depressed base; at the peak in March 1945, the
index was only 15 percent above the 1935-39 average. Prices of low grade
securities have shown even sharper increases.
Despite a decline in turnover during recent weeks, the number of
shares traded on the New Tork Stock Exchange in the first three months of
1945 was the highest in any first quarter since 1937. Margin trading has
been on the rise. Customers' debit balances, although small in comparison
to 1929 levels, are more than twice as high as the low in August 1942.
Purchases through margin accounts have exceeded sales in nearly every
month since January 1943*
Outlook
Although some decline in the market after V-E Day is possible, if not
probable, SEC staff expect that stock prices will sooner or later resume
their rise and that the volume of trading will also expand; tremendous
potentialities exist for a very pronounced advance, possibly an explosion*
In terms of present earnings, stock prices are relatively low. If
a reasonably high level of national income is maintained after the war,
profits before taxes will probably be lower than at present, but profits
after taxes may be kept at or near present levels. If corporate income
taxes were abolished, profits after taxes could easily be doubled. At
any rate, sooner or later upward adjustment of stock prices will take
place. Vihen confidence in the maintenance of the present low levels of
long-term interest rates becomes general, a further impulse to higher
stock prices will result <> This will be reinforced by the large and
increasing pool of liquid fbnds in the hands of savers seeking investment
outlet and the limitations on the supply of existing securities resulting
from corporate debt retirement and the increasing volume of liquid
corporate funds available for internal financing of future capital expansion*
'Khile these and other fundamental economic factors would justify a consideratee
rise in stocks, widespread speculative participation would cause it to
overshoot.
In the event of failure to maintain a high postwar level of national
income present stock prices may not prove to be low. Until uncertainties
over the possible recurrence of depression or deflation are resolved, until
tax policies and other prospective developments, national and international2
are clarified, pessimism over the postwar outlook may serve as a brake on
tendencies toward a runaway marketo If adverse prospects become actual,
increases above the present level of stock prices may prove short-lived at
best, and any speculative advances may be followed by sharp reactions.
-8 Present and Possible Controls
The SEC to date has confined its activities largely to publicity on
unsound market developments (e.g., trading in Imperial Russian bonds) and
to investigations of operations in so-called "cats and dogs," In addition,,
the Trading and Exchange Division has recently recommended the adoption of
a rale to prohibit floor trading,, 3h February, the Board of Governors
raised margin requirements from 40 to 50 percent on additions to margin
accounts, and the New York Stock Exchange ordered elimination of all
margin trading in stocks selling below £10,
In view of the uncertain character of market developments immediately
after V-fc Day, SEC staff favor temporary postponement of further controlso
Both the SEC and the Chairman of the Board of Governors, however, support
the adoption of a penalty tax on resale gains as the most effective method
of preventing an excessive stock market boom* Since short-term trading to
realize speculative profits is a major element in the stock market, a
resale gains tax of the type proposed by Mr. Eccles would produce a much
thinner market and would tend to forestall speculative participation in, or
exaggeration of price rises * Certain exemptions for issues of new enterprises, or issues of old enterprises designed to finance plant expansion
would be desirableo
The Interdepartmental Tax Committee, however, is of the opinion that
"the situation as now foreseen does not justify the general imposition
of so drastic a measureOM Instead, the milder1 step of lengthening the
minimum holding period of long-term capital gains is proposed, which
"merely reestablishes the law in force for many years prior to 1942o?l
The immediate effect of the proposed change, according to the SEC staff,
is problematical, since it may serve to retard selling in the early
months more than it discourages buyingo
In vievv of the relatively large share of trading handled through
margin accounts, the Interdepartmental Tax Committee recommends further
restriction of stock market credit, through increases in margin requirements on both new and existing accounts * The SEC staff propose that the
market be pat on a completely cash basis» The Board of Governors, however,
on March 21, decided that the drastic action of eliminating all margin
trading could not be justified "against the prevailing background"; th<3
Board cited, in particular, the "substantial recession in the stock
market" and the absence of any increase in the volume of credit used to
purchase or carry securities„ "The Board will continue to match the
situation closely and is prepared to take appropriate action, should it
be warranted by subsequent developmentso"
@FedFRASER