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A review by the Federal Reserve Bank of Chicago

1958 J u l y

The up and down in consumer
spending — durables


Financing small business— a review


The Trend of Business


Federal Reserve Bank of Chicago



E ln o u g h statistical markers of a promising
nature now have been cast in the wake of
economic activity to suggest that a change
of direction occurred in the second quarter.
This development was not unheralded. There
was evidence earlier that the momentum of
the decline had slowed. The transition from
small declines to small increases in business
measures can be accomplished as easily as a
retardation in the speed of a downswing.
The months ahead, of course, may bring
further bad news. But if recent developments
do not presage a sustained generalized up­
turn, the 1957-58 recession probably will be
characterized as having had a “double bot­
tom.” Documentation of a “turn” is found in
the performance of a number of broad mea­
sures of activity:
1. Employment, after allowances for
seasonal trends, rose in May and un­
employment declined.
2. Personal income rose in May for the
third straight month.
3. Retail sales improved markedly in
April and apparently maintained that
pace in May.
4. Construction activity continued down
in April and May, but increased hir­
ing of construction workers and the up­
turn in contract awards and housing
starts suggest that this decline will
soon be reversed.
5. Total industrial production increased
slightly in May after a steady eightmonth decline.


6 . Steel production rose substantially in
May and June from the April lows. This
suggests that inventory liquidation in
one major area, at least, was ending or
slowing down.
7. Although data is not yet available,
it is probable that national security
outlays, which had been declining since
the second quarter of 1957, started up
in recent months.
It is now widely believed that the AprilJune period produced a larger volume of total
spending (the gross national product) than
did the first quarter of the year. Previously in
the postwar period, the reversals of declines
have always been sustained in subsequent
Em ploym ent. Wage and salary employ­
ment declined by an average of 300,000 per
month, seasonally adjusted, between August
of 1957 and last March. In April, the decline
was only 135,000, and preliminary reports
indicate a gain of 115,000 for May. This rise,
however, leaves the total 2 million or about
4 per cent below last year.
The seasonally adjusted rate of unem­
ployment dropped from 7.5 to 7.2 per cent
of the labor force between April and May.
This change represents a significant better­
ment, although at 4.9 million, unemployment
was 2.2 million more than last year when
the rate was 4.1 per cent. Unemployment
may rise more than seasonally in June when
graduates looking for permanent work and
students and others seeking summer jobs

Business Conditions, July 1958

enter the labor force. The easing of labor
markets almost everywhere has made sum­
mer jobs much scarcer than in previous years.
As a result, those seeking summer work may
swell the ranks of the unemployed for a
month or two until they obtain positions or
withdraw from the labor market.
In the Midwest, all District states appear
to be enjoying some slight improvement in
job conditions, at least of seasonal propor­
tions. New claims for unemployment com­
pensation were still running well above last
year in May in all these states except Iowa.
In Indiana and Michigan, May claims re­
mained substantially in excess of the national
trend; whereas in Illinois and Wisconsin they
were about the same. But in all of these states
and in the U. S. as a whole, the rise over last
year was much smaller than in March.
P e rso n a l incom e. Between February and
May, personal income rose by 2.6 billion
dollars on an annual rate basis, thereby
making up about half of the loss from last
August. Significantly, wage and salary re­
ceipts shared in the rise in May for the first
time since the recovery began. Of course, the
improvement was aided by the rise in em­
ployment. Also, the average factory work
week rose in May, and wage and salary in­
c re a se s are s till co m m o n p la c e d e sp ite
attempts of management to reduce costs.
Retail trade. Over the past year consumer
buying, as evidenced by retail trade estimates,
has been volatile. Last spring, retail sales
moved up strongly to a seasonally adjusted
record high of 17 billion dollars in July and
August. After a slowdown in the fall these
outlays rebounded in December only to drop
again to a rate of 16.1 billion in February
and March. April and May witnessed a re­
covery to 16.5 billion.
Automobile deliveries rose to a daily rate
of 15,200 in May. This is the best pace since

Broad measures of activity
"bottomed out” in second quarter

last December and compares with 14,000 in
March and April. Towards the end of May
the selling rate was close to 17,000— still
far below last year, but sufficiently high to
relieve some of the gloom in the industry.
The only useful retail trade data available
currently on a regional basis is for depart­
ment stores. Midwest results except for Iowa
have been markedly poorer than the nation
as a whole. In May, department store sales
had performed better than in earlier months,
both in this region and in the nation. In
June, however, cold and wet weather damp­
ened consumer buying vigor, and some weeks
saw department store sales sharply below
last year in virtually all of the nation’s
northern and eastern centers.
The hope that the higher level of retail
trade can be maintained or improved in sub­
sequent months is based on a number of fac­
tors. Personal income, as noted above, is on
the rise. In addition, consumers are adding
less to liquid savings funds than was the case
earlier in the year, and greater confidence in
the outlook doubtless is partly responsible


Federal Reserve Bank of Chicago

for this trend. Finally, the decline in con­
sumer debt has put many individuals in a
position to resume credit buying if they are
so inclined.
Construction. The construction industry
has played an important part in the recent
improvement in over-all business prospects.
For an example, between February and May,
contractors’ employment increased by 300
thousand or 10 per cent, after allowance for
usual seasonal factors. The February total
was depressed by severe weather, but those
conditions had been responsible for deepen­
ing the general drop in activity as well. In
May, the number of production workers in
factories making building materials also rose
slightly despite declines in most manufac­
turing lines.
In the first quarter of the year, construc­
tion contract awards, according to F. W.
Dodge, lagged last year by a wide margin.
April, however, showed a 4 per cent gain
for the nation, and a slight increase was

Steel output rises sharply,
suggesting end of inventory
per cent, 1956=100


Production curtailed by strike.

also reported for May. The type of awards
which have been strongest include commer­
cial buildings, large residential structures,
schools, hospitals and public works. More
recently, there has been evidence of a pick­
up in home-building activity.
Housing starts exceeded last year national­
ly in May for the first time in 1958. Easier
money is playing a large role in stimulating
the construction industry. Requests for FHA
and VA mortgages have increased very
sharply because these obligations have be­
come attractive to lenders once again. In the
Midwest, conventional home mortgages now
can be obtained at rates a full one-half per
cent below the levels of last fall.
Inventories. More and more firms are re­
porting inventories to be well in line with
current sales, and the rate of inventory liq­
uidation probably is moderating at the pres­
ent time. One important piece of evidence
pointing in this direction is the uptrend in
steel production which had been running far
below usage by fabricators.
Nationally, steel production in early June
was 34 per cent above the level of April. A
similar gain occurred in Chicago and an even
sharper rise in Detroit. In June, steel pour­
ings were above 60 per cent of capacity in the
U. S. and Detroit, and over 70 per cent in
the Chicago area. The low point in utilization
relative to potential in April was 47 per cent
for the U. S., 12 per cent for Detroit and 54
per cent for Chicago.
Some of the improvement in steel produc­
tion doubtless represented a desire to beat the
price increases which some expected at the
end of June. However, the fact that the up­
trend became noticeable early in May, and
the knowledge that holdings of many steel
users are rather short indicate that specula­
tion on price is only part of the reason for
larger orders.

Business Conditions, July 1958

The up and down in consumer
spending— durables
T L volatility of consumer hard goods ex­
penditures is dramatically illustrated in the
most recent rise and subsequent decline in
business activity. Spending for consumer
durables increased just under 8 billion dol­
lars or about 26 per cent between the third
quarter of 1954 and the same quarter of
1955. This largely reflected a whopping 6
billion dollar or 48 per cent increase in sales
of automobiles and parts. Total personal
consumption expenditures of all kinds, how­
ever, rose only a little more than 8 per cent.
Since the peak reached in the summer of
1957, total consumer spending has decreased
less than 1 per cent, but outlays for hard
goods have dropped 10 per cent. Again, it
has been the automobile segment that has
accounted for most of the movement in du­
rables. Since 1957’s peak, there has been
only a small decline in “soft” goods— in both
dollar and percentage terms— and a further
rise in expenditures for services. These con­
trasts are characteristic of the general pattern
traced by consumer expenditures during past
business fluctuations.
S h a r p ups a n d d o w n s

A host of factors, not typically present in
spending for most nondurables and services,
permit or induce marked shifts in the pace
of consumer hard goods buying. These are
related to such factors as the nature of the
goods, that is, their “durability,” the relative­
ly large initial outlays required for most pur­
chases and the impacts of changing costs of
living and swings in money income upon con­

sumer resources available for durables buy­
ing. The changing rate of introduction of
new products and the widespread rise of
credit financing also account in part for the
variability in spending for durables.
The long lasting nature of durables pro­
vides consumers considerable leeway in tim­
ing their purchases of them. Usually, the car,
the appliance or the furniture piece on hand
can be made to do for a while longer if there
is any significant uncertainty about income
or job prospects or if the available new mod­
els show no obvious advantages over the old.
The role played by credit in the course of
wide fluctuations in consumer spending is
undoubtedly an important one. About threefifths of all new and used cars are financed in
part by credit, while a substantial though
somewhat smaller fraction of household du­
rables are bought on the instalment plan.
Variations in the ability and willingness of
borrowers to utilize credit and of lenders to
extend it have resulted in wide swings in the
volume of credit-financed sales. During 1955,
instalment credit outstanding rose by almost
5 Vi billion dollars, while durables expendi­
tures increased roughly 6 billion. Helping to
attract consumers into the market and to
boost their capacity to buy in 1955 was a
significant easing in credit terms.
In retrospect, the easing that occurred dur­
ing 1955 was largely “structural” in char­
acter in that it marked the acceptance on a
broad front of 30- and 36-month financing
for automobiles. Significantly, these terms
continued to prevail through the ensuing


Federal Reserve Bank of Chicago


263 million in this year’s first quarter. A rise
period of reduced durables expenditure and
in new instalment borrowing usually supple­
tightening of credit. In the present business
ments current income; a decline in credit ex­
setback, the progressive outward extension
of average contract maturities, within the
tensions means some subtraction from in­
context of essentially unchanged lender
come. This is because the volume of repay­
ments changes only slightly over the short
standards on terms, suggests that instalment
credit has somewhat mitigated the severity of
the decline. This it has done by enabling
A u to o u tla y s d o m in a te
hard-pressed buyers to acquire new cars and
In the current business downturn, autos
other durables to replace old ones, even
though they have had only nominal trade-ins
and parts expenditures declined an estimated
to offer.
19 per cent from the third quarter of 1957
Credit extensions are a reflection of con­
through the first quarter of this year, com­
sumers’ current ability and willingness to
pared with only a 4 per cent drop in house­
take on more debt, whereas repayments large­
hold durables and a still smaller decrease in
ly reflect past decisions concerning instalment
outlays for other consumer hard goods. This
purchases. Therefore,
as extensions contract,
Purchases of consumer durable goods
repayments follow suit
record marked rise in past three decades . . .
only sluggishly. The
resulting decline in to­
tal instalment credit
outstanding, thus, is
achieved by a contrac­
tion in spending for
current purchases. For
example, 9.9 billion
dollars of instalment
credit (seasonally ad­
justed) was extended
in the first quarter of
1958, 783 million less
than in the previous
quarter. At the same
time, repayments de­
although hard goods spending shows relatively
clined only 55 million.
large declines during business downturns
T he d iffe re n c e b e ­
per cent change from pre-recession quarter
tween extensions and
" 1948, 3rd quarter to
1953, 2nd quarter to
1957, 3rd quarter to
1949, 1st quarter
1953,4th quarter
1958, 1st quarter
repayments added 465
million dollars to con­
sumer income during
the last quarter of
1957 but subtracted

Business Conditions, July 1958

roughly approximates
Bigger share of consumer dollar
the pattern traced by
goes to autos in postwar period
consumer spending for
durables in the 1953billion dollars
30 r
54 recession. In the
first postwar downturn
(1 9 4 8 -4 9 ), though
furniture and appli­
ances were hard hit,
the automotive indus­
try appeared unaffect­
ed by the general busi­
ness lag because of the
huge backlog of de­
Prior to the current
decline in auto expen­
d itu re s , c o n su m e rs
were allocating a sub­
stantially greater pro­
portion of their spend­
ing for autos than in
the T h irtie s . T o ta l
a u to m o tiv e -re la te d
'3 0
'4 0
‘5 0
o u tla y s , in c lu d in g
autos and parts, serv­
ice, and gas and oil
household durables as a group have not been
have accounted for over lO per cent of per­
garnering a substantially larger proportion
sonal consumption expenditures during the
of consumer expenditures than before the
past few years, whereas the 1935-39 average
war. Nevertheless, there has been a significant
was IV 2 per cent (see chart).
change in the kind of household hard goods
A ll th e co m forts o f h om e
attracting the most consumer interest. New
products have spelled the difference. Both
Most consumer spending for nonautomoappliances and radio-TV have increased in
tive durables is for products used in and
importance within the durables group since
around the home— furniture, floor coverings,
prewar, while furniture and other household
dinnerware, appliances, lawn mowers and
items have not gained as rapidly.
radios-TV. The remainder, approximately
The past decade has witnessed a remark­
25 per cent by dollar volume, is composed
able surge in the popularity of new products.
of smaller and more heterogeneous items,
Television sets in January 1958 were in 86
which include jewelry, books, durable toys
per cent of the 49 million U.S. homes wired
and sports equipment.
for electric service, according to Electrical
Unlike automobiles and allied products,

Federal Reserve Bank of Chicago

Merchandising. Ten years ago fewer than 3
per cent of the 33 million wired homes had
TV. Other household durables which have
risen from relative obscurity include room
air conditioners, gas and electric clothes
dryers, dishwashers, food waste disposers
and food blenders. It has been estimated that
during the past two years, 50 to 60 per cent
of manufacturers’ sales of household appli­
ances, radios and TV came from products
that were almost unknown at the end of
World War II. The emergence of these new
products has been an important factor be­
hind the relative stability of total spending
on durables in the nonautomotive category.
But the more familiar household appli­
ances, too, have served to stimulate consumer
hard goods outlays. Refrigerators and auto­
matic clothes washers in particular have re­
corded marked gains over the past ten years.
A p p lia n c e prices " s o f t ”

Consumer durables prices as a group have
increased 15 per cent since 1947. This is
slightly less than the 18 per cent advance in
prices of nondurables and much less than
the 38 per cent rise in prices of services.
What’s more, the durables increase was
almost solely the result of a 30 per cent
gain in prices of autos and parts. Prices paid
for durables other than automobiles as a
group have gained only slightly over the past
decade. Changes reported by the Bureau of
Labor Statistics for selected durables of
“comparable quality” are listed below:

vacuum cleaners
washing machines
cook stoves
furnitu re


*s in c e 1951

Per cent change
from 1947 to 1957
— 29
— 22*
— 11
+ 4
+ 7

In some instances, although the price for
a comparable product declined, consumers
upgraded their purchases and actually spent
more per unit. This was true, for example,
in the case of vacuum cleaners and refrigera­
tors. The average refrigerator sold in 1947
for an estimated $225 at retail, while ten
years later the average price paid was $320
for a larger, more deluxe unit.
The stable-to-downward price trend in
household durables has been due in part to
the reductions typically encountered after a
new product gains widespread acceptance.
But much of the price softness appears to
have stemmed from the intense competition
in both the distributing and manufacturing
ends of the business. In appliance distribu­
tion, a new form of retailer arose to spur
competition— the discount house. For many
of these distributors, operating expense ratios
were reportedly not much more than half as
high as for traditional outlets. On the pro­
duction front, the number of appliance mak­
ers in the U. S. rose rapidly until after the
Korean conflict, when mergers and failures
became fairly widespread. Generally hardest
hit were the producers lacking full lines to
offer dealers.
B ro a d re p e rcu ssion s

The basic appeal of these products rests in
their capacity to provide comfort, entertain­
ment or convenience and, possibly, obvious
evidence of their buyers’ affluence. That the
stepped-up spending for appliances, televi­
sion and autos has had a broad impact on
the nation’s economy, there can be little
doubt. Hard goods have changed the life of
the American consumer in many ways.
The time-saving features of automatic
clothes washers and dryers and other such
goods no doubt have played an active role in
the movement of women into the labor force.

Business Conditions, July 1958

And it seems clear that the desire to have
these “conveniences” has also spurred on
many women to augment family income. In
the early months of the current year, 33 per
cent of the female population 14 years of
age and older were employed, compared with
24 per cent in 1940.
The automobile, of course, tends to dom­
inate the consumer durables sector. Growth
of consumer outlays for private vehicles has
far surpassed the rise in spending for public
transportation (see chart). Distances have
melted with the continued rise in popularity
of the auto, stimulating and abetting the
move to the suburbs. Shopping centers cater­
ing to homemakers who drive continue to
spring up. Drive-in banks, eating places and
theaters have become commonplace. Today
there are over 56 million passenger cars
registered in the U. S. Three-fourths of the
nation’s families own at least one auto.
Despite the greatly increased use of a
wide variety of durables, the significance of
“apparent” market saturation ratios is diffi­

cult to interpret. A growing population, high
and generally rising levels of disposable in­
come and technological changes all serve to
bolster consum ption expenditures, even
where individual appliances are found in
nearly all households. In autos and television,
for example, the second car or TV set has
been rising in popularity. Radios too, though
in more than 90 per cent of all wired homes
through most of the postwar period, have
turned in steady gains in the past few years.
As in the past, new products can be ex­
pected to figure importantly in the consumer
durables future. A variety of innovations
such as picture-frame TV and solar batteries
even now are on the horizon. But as long as
durables remain durable, their purchase can
be postponed when the income outlook is
uncertain or when there is an inclination to
make the old model do for a while. Consumer
spending for these products, in consequence,
will probably continue to exhibit sharp short­
term variations as well as vigorous growth
over the longer pull.

Financing small business—a review
T Jast spring the Federal Reserve System
released the first two-thirds of a broad study
of the financial problems of small business.
Addressed to four Congressional committees
having a special interest in these matters, the
published report is available to the public.1
1 Financing S m all Business, Report to Commit­
tees on Banking and Currency and Select Com­
mittees on Small Business, U. S. Congress, pre­
pared by the Federal Reserve System, April 11,
1958. Government Printing Office, $1.50.

Too often, energy expended on the small
business question has, as the phrase goes,
“produced more heat than light.” The new
work, Financing Small Business, therefore,
attempts in the course of 549 pages to illum­
inate a subject which, unfortunately, is ex­
tremely difficult to delineate in a clear-cut,
unequivocal fashion.
The published volume condenses the find­
ings of two parts of a study begun by the
Federal Reserve System about a year ago.

Federal Reserve Bank of Chicago

A third part is tentatively scheduled for pub­
lication in 1959.
Part I consists of 16 “Background Studies”
by associates of private research organiza­
tions as well as members of the research
staffs of the Board of Governors of the Fed­
eral Reserve System and the 12 Reserve
Banks. These articles contain much original
thinking but are based largely upon pre­
viously published data and materials.
Part II contains the results of the spe­
cial “Surveys of Credit and Capital Sources”
which were undertaken and analyzed by the
Federal Reserve economists. New data were
developed for all major classes of lenders,
and much valuable information was obtained
on lending practices and the judgments of
experienced lenders and investors.
Part III of the study, still in the explora­
tory stage, will present results of a survey
of the “borrowers” who obtain funds or
goods on credit from the “lenders” discussed
in Part II. The Bureau of the Census is co­
operating in the careful preliminary sound­
ings which are necessary if this difficult proj­
ect is to achieve its fullest utility.
Even without Part III, Financing Small
Business stands as the only comprehensive
work on small business to appear in the
last decade. It represents, moreover, the
broadest cooperative attack on the problem
ever published.
W h y stu d y sm all b u sin e ss?


It is widely accepted as axiomatic that a
private enterprise economic system must be
constantly invigorated by the creation and
growth of new firms. The small business
financial “problem,” therefore, can be stated
as follows: Are credit and capital sufficiently
available to permit new entrants and smaller
existing firms to make their maximum con­
tribution to economic progress?

The question of the adequacy of the fi­
nancial resources available to small business
is not new nor is it confined to the United
States.2 The controversy of the postwar pe­
riod continues the argument of the 1920’s
and 1930’s. The recent resurgence of in­
terest, of course, is related to the “tight
money” period of 1955-57 when the nation
was faced with a situation in which aggregate
demand outran supply. During these years,
public policy-makers relied primarily upon
restriction of credit expansion to retard the
rise in prices. It has been suggested that the
stricter rationing of credit required under
these circumstances impinged more severely
upon small businesses than upon their larger
The primary interest of Congress in re­
questing the study is in the consideration of
legislation to “fill gaps” in the credit struc­
ture, if such are believed to exist. In the cur­
rent session of Congress, a number of bills
have been introduced providing for the char­
tering and financing of “capital banks” which
would be part of an organized system for
supplying small firms with long-term loans
and equity capital. In late June, one of these
bills had passed the Senate and had been ap­
proved by the House Banking and Currency
D e fin itio n a l difficulties

How large is a small business? What is
“adequate” access to funds? What is “equit­
able” treatment? What is a “legitimate need”
for funds? Attempts of the contributors to
the study to give these terms precise mean­
ing met with only partial success.
Some of these concepts are so elusive that
the discussions recall the Socratic dialogues
which grapple with the meaning of “truth,”
2 Same, p. 109.

Business Conditions, July 1958

“justice” and “virtue.” But the first question,
“What is small business?” must be answered
in some fashion if facts and ideas are to be
collected, tabulated and analyzed intelligent­
There are about 4.3 million business en­
terprises in the nation and most of them are
small by any criteria. Size of business, of
course, is a relative matter, depending upon
the industry. A “large” tool and die shop is
much smaller than a “small” steel firm. Elec­
tric utilities are by nature “large” in com­
parison with most retailers or establishments
providing personal services.
Most studies of small business utilize the
size breakdowns available in existing pub­
lished data. As a result, the Part I back­
ground studies employ various size defini­
tions, depending upon the particular statis­
tical series used by the author.
After weighing the relevant factors, the
Federal Reserve staff evolved size categories
for the major industrial groups for the spe­
cial studies of Part II .3 In the case of retail
trade, for example, organizations with less
than 50 thousand dollars of assets are desig­
nated “small,” while those with over 1 million
of assets are “large.” For miscellaneous man­
ufacturing, the comparable limits are 250
thousand dollars and 25 million; for sales
finance companies they are 5 million dollars
and 100 million. In most industries, the
“small” group includes at least 90 per cent
of the business population.
S m a ll bu sin e ss in th e p o stw a r p e rio d

Much recent discussion of the small busi­
ness situation implies that hardly anybody
starts a small business any more or that
those who do are soon snuffed out. This
approach, of course, badly distorts the true
3 Same, p. 161.

picture. There is ample evidence that the
postwar period was a particularly favorable
time for the formation and growth of new
In 1957 there were 400,000 or 10 per cent
more businesses than in 1948, when in turn
there were many more than prewar. Average
net growth, therefore, was 50,000 per year.
The gross number of new entrants was as
large as 380,000 in a single year. With­
drawals also ran over 300,000. Virtually all
of these new firms were very small at their
There was one business firm for every 40
inhabitants in the U. S. in 1957. This was
almost exactly the same ratio as in 1929.
The proportion was much lower at the end
of World War II, but the upsurge in net busi­
ness formations was rapid in the years that
followed, suggesting a suitable environment.
Millions of new firms were created since
World War II and a substantial proportion
has survived. Some have been very successful.
Although comparisons present many pitfalls,
the best test of success of business enterprise
of any size or age is profitability. Available
data suggest that the earnings of small cor­
porations on net worth compare favorably
with those reported by larger enterprises.4
Moreover, owner-managers of the smaller
corporations are able to vary the amounts
paid in executive compensation, more or less
at will, and thus influence reported corporate
As might be expected in a profit and loss
system, many small firms do not “make the
grade.” Last September, the failure rate, as
tabulated by Dun and Bradstreet, was almost
60 per 10,000 firms annually. This was a
postwar peak, but it compares favorably with
a rate of 70 in 1939 and 99 in the 1920-29
4 Same, p. 126.


Federal Reserve Bank o f Chicago

decade.5 “Discontinuances,” the number of
firms winding up operations, run about 30
times the number of “failures” which result
in loss to creditors. The great bulk of both
failures and discontinuances involve firms
which are both small and new.
All in all, one writer observes, “The data
suggest that incomes of small businessmen
have risen fairly steadily during recent years
and probably at a faster rate than that of the
whole population .”6 Moreover, these busi­
nessmen were sufficiently well-financed that
they had less than one-half of their assets
invested in their businesses, and their per­
sonal and mortgage debt was relatively lower
than the rest of the population.
Sm all in h e re n t d is a d v a n t a g e s

Virtually all lenders and students of small
business report that the principal problem is
not financial but managerial.7 A small firm
usually lacks executive depth. It may be
utterly dependent upon the abilities of one
man who may die or retire, leaving the enter­
prise without a competent helmsman. One
man may supervise production, sales, finance
and purchasing. Perhaps he is qualified to
do only one of these jobs adequately. In any
case, his time and energy are not inexhaust­
Small firms usually lack diversification and
cannot balance out adverse developments or
mistakes as easily as large firms. They may
sell to only a few customers or in a restricted
region. A small manufacturer may be a sub­
contractor who supplies an integrated pro­
ducer only with the portion of its total sup­
ply of a component that it cannot handle in
a period of strong sales. A reduction in final
sales may mean that the subcontractor is not
5 Same, p. 132.
6 Same, p. 127.

7 Same, p. 322.

needed at all. Needless to say, a limited mar­
ket may result in very large and sharp fluc­
tuations in sales and profits which the capital
cushion may be too scant to absorb. In short,
the small firm more often is vulnerable to
dips in the economy or shifts in demand.
Other disadvantages of the small firm re­
late to costs. It may have to ship in less-thancarload lots with freight charges up to 50
per cent higher than the bulk rates paid by
larger competitors. It may be unable to buy
goods in large enough quantities to get maxi­
mum discounts. Often it is not able to spread
such costs as advertising and research over
a large enough volume of business.
Borrowed money costs small firms more.
They are usually less “credit worthy” than
large firms by the usual standards. Also, the
administrative costs involved in granting and
policing loans are proportionately higher on
smaller loans. As a result, borrowing costs
usually are considerably higher than those
borne by large firms.
Against this formidable array of “econ­
omies of scale” possessed by the large com­
petitor, the small firm can oppose flexibility
of decision making. It can react more rapidly
to unexpected developments and is not usual­
ly burdened with large overhead expense.
That these advantages are sufficient in mil­
lions of cases is indicated by the large num­
ber of small firms which have been born and
which have prospered in the postwar period.
C o m p e tin g fo r fun ds

Broadly speaking, the sources of funds
tapped by small firms are similar to those
utilized by large firms. These sources can be
grouped under the two general headings—
equity and debt.
In virtually all cases some ownership cap­
ital must be provided before a firm can
begin operations. Additional amounts can be

Business Conditions, July 1958

added by the original owners or by others
who find the opportunity attractive. One of
the characteristics of small firms is that they
cannot sell securities to the general public
through investment bankers except at pro­
hibitive cost. But, once a firm is established,
the bulk of equity capital invested in most
businesses, large or small, comes through the
route of retained earnings. Thus, profitability
permits an increase in equity, and a larger
equity cushion provides additional borrowing
power— “nothing succeeds like success.”
Borrowing can be long-term— over one
year— or short-term. In whatever form funds
are borrowed, loans to small firms are more
likely to be secured than is the case with
those granted to large business. This is
understandable because the longevity and
future success of a small firm are less assured.
The longer the maturity of the loan and the
larger it is relative to equity and debt pre­
viously acquired, the greater the likelihood
that security will be necessary.
The reason that discussions of small busi­
ness financial problems often center around
equity is that there is no way to “secure”
ownership investment. The equity investor
shares in the profit or loss which results from
operations after all expenses are paid. More­
over, most small businessmen do not wish to
share profits or control with outsiders.8
Despite the special place of equity capital,
there is a similarity between ownership in­
vestment and long-term debt. Usually it is
difficult and sometimes it is impossible to
liquidate either of these types of investment
in a small firm. Once the commitment is
made, short-term credit may continually be
renewed and, in a sense, represents a semi­
permanent addition to a firm’s resources. But
the short-term creditor is able to review the
8 Same, p. 13.

loan at each maturity and determine whether
it would be desirable to withdraw further
support. Funds made available on a short­
term basis are not so likely to become “fro­
zen” as are longer-term commitments. Hence,
relatively little complaint has been heard over
the years about the availability of short-term
The crux of the small business problem
is found in the fact that many firms would
like to borrow money on a long-term basis
and avoid continuous negotiations with lend­
ers if loans could be be had unsecured and
at relatively modest rates of interest. Lenders,
for obvious reasons, are reluctant to make
such loans without a bevy of restrictive cov­
enants which break down the differentiation
between long- and short-term credits by ac­
celerating maturity dates on the occurrence
of a variety of contingencies.
Equity fo r th e g r o w in g e n te rp rise

Discussions of the small business prob­
lem, therefore, tend to concentrate on the
more romantic manufacturing sector, which
accounts for only 8 per cent of the small busi­
ness population. Of this group, only a small
fraction are growing rapidly or exploiting
new or improved products. It is this dynamic
type of enterprise which is supposed to face
a dearth of “venture” or equity capital.
But large quantities of equity money are
regularly being invested in small firms and
particularly in those which offer the prospect
of rapid growth. In the 1946-56 period, it
has been calculated, the net increase in the
number of firms involved an initial invest­
ment of at least 6 billion dollars in equity
form. This sum is approximately equal to
all the external equity funds obtained by
established corporations in comparable in­
dustries.0 Of course, only a small proportion
of this total involved sales of stock through


Federal Reserve Bank of Chicago

investment bankers. Rather, equity invest­
ment was provided directly by the owners
themselves, their friends and relatives and
by “angels” suggested by bankers or others.
There are large quantities of funds in
liquid form available for investment in busi­
ness firms at any time. Over 2 million spend­
ing units have $ 10,0 00 or more in liquid
assets. The average new firm involves an
equity investment of only about $ 1 2 ,000 ,
and personal contacts often can supply this
necessary nucleus.
Much has been written about the way the
tax system discourages risk-taking. But in­
vestment in small business often permits the
investor to take his profits as capital gains
taxed at only 25 per cent, thereby avoiding
the higher rates of the personal income tax.
Term lo a n s a n d m o r tg a g e s

It is readily apparent why lenders are
reluctant to grant loans maturing several
years hence to firms which have been in
existence only a few years. Even an estab­
lished firm which is expanding rapidly or
otherwise changing in character may have
difficulty in arranging long-term credits be­
cause past performance is not always a reli­
able guide to future ability to cover interest
and amortization payments.
Nevertheless, between 1948 and 1957—
or broadly through the postwar period—
loans over one year to maturity owed by
small manufacturing corporations increased
by over 250 per cent— more rapidly than
for all other manufacturers. Such credits in­
creased from 9 to 18 per cent of equity,
compared with a gain of 14 to 18 per cent
for all manufacturing enterprises .9
Of course, much of longer-term credit


9 Same, p. 144.
10 Same, p. 140.

owed by small business consists of real estate
mortgages or debts owed on equipment pur­
chased in time-sales contracts. Insurance
companies and banks are the principal sup­
pliers of real estate mortgage funds. In re­
cent years, time-sales financing has become
extremely competitive, with independent and
manufacturer-owned finance companies and
banks actively seeking these loans.
C red it fro m suppliers

One of the most important sources of funds
used by small firms is trade credit, a fact not
widely appreciated. For the most part, these
credits are offered by suppliers through open
book accounts. But in some cases suppliers
also provide cash loans or the loan of facil­
ities. There are also examples of “down­
stream” loans from large customers who wish
to assure their sources of supply .11
Indirectly, trade credit gives small firms
access to the national capital and money
markets through their larger associates. In a
real sense, the most important “bankers”
supplying working capital to small firms,
particularly retailers and wholesalers, are
the manufacturers who supply them with
goods. This was especially important in the
“tight money” period 1955-57. Trade credit
analysis suggests the extent to which small
and large firms complement rather than sup­
plement one another.
Trade creditors have many advantages
over banks or other financial institutions.
Often they know the product, the practices
of the trade and, perhaps, the borrower bet­
ter than the loaning officer. Moreover, they
have at risk only the time and materials
directly invested in the goods which may be
considerably less than the full sales price.
If necessary, they can liquidate the goods
11 Same, p. 482.

Business Conditions, July 1958

with minimum loss. The disadvantage of
trade credit to the customer is that it often in­
volves heavy cost on a per annum basis if
cash discounts are not realized.
All firms utilize trade credit more or less.
But in the 1946-55 period, only 4 per cent
of the funds obtained by 300 large corpora­
tions was represented by an increase in pay­
ables, whereas, for all other corporations,
the proportion was 13 per cent. For “small”
firms, the proportion of total financing ob­
tained in this manner was much higher.
Large firms also ease the financial prob­
lems of customers by leasing equipment, by
carrying inventory at widely dispersed ware­
houses for ready delivery and through pro­
viding financial advice. Sometimes, too, they
will endorse notes or help the customer to
establish a banking connection.
C om m e rcial b a n k s su rv e y e d

Frequently the small business firm can
turn to such specialized lending institutions
as commercial finance companies, the U. S.
Small Business Administration, various state
development corporations and “venture cap­
ital” companies. All of these organizations
operate directly in the area of “marginal
As a group, the commercial banks are the
most generalized of all lending institutions,
although, individually, they often specialize
in certain of the types of loans mentioned
earlier. In late 1957, there were close to 2
million business loans outstanding to almost
as many individual borrowers.
A broad sample of member banks was
contacted last fall to permit the tabulation
of loan asset data which could be compared
with the results of a 1955 survey.12 During
the intervening period the largest borrowers
12 Same, p. 371.

obtained a large share of the growth in total
Business loans in the aggregate grew by 32
per cent between 1955 and 1957. For bor­
rowers with assets of 25 million dollars or
more, the rise was 61 per cent; for firms
under this group, it was only 2 1 per cent.
There are a number of reasons which can
be put forth for the more rapid growth in
loans to the large firms. One factor was pure­
ly statistical. During a period of rapid growth
and price inflation, business firms tend to
“graduate” from one category to another.
The top group, of course, has no ceiling. Just
to hold their position in a given industry, it
was necessary for some firms to grow by 20
per cent or more between 1955 and 1957.
Another important consideration is that
the most pronounced contrast in bank loan
growth between large and small firms in the
period under review was in manufacturing.
The tendency was much less evident in non­
manufacturing lines.
The central feature of the 1955-57 busi­
ness upsurge was the boom in capital ex­
penditures. The bulk of these outlays was
in industries characterized by large-scale op­
erations. The “tight money” period also wit­
nessed rapid growth in working capital needs
of most business firms. Inventories and re­
ceivables of large firms expanded twice as
fast as those of small firms. In many cases,
they assumed, perhaps for competitive rea­
sons, a portion of the working capital burden
of their customers.
Because of this great increase in need for
funds, large firms ran down their extensive
holdings of liquid assets to low levels. They
also obtained record sums through the
issuance of securities. Firms which were not
able or did not choose to obtain all of the
money they wanted internally or through the
capital markets turned to the commercial


Federal Reserve Bank of Chicago

banks. Most of them possessed top-notch
credit ratings, and many had unused lines
of credit at large banks. Often they were
actually free of debt before the squeeze on
their cash position occurred. The expansion
in bank credit to large business during the
boom was built upon a small base relative to
total resources of these firms.
In the first half of 1958, with investment
needs off sharply and easier money condi­
tions prevailing, large firms, particularly
utilities, are taking the opportunity to sell a
heavy volume of bonds and are reducing bank
debt as they move to restore their dete­
riorated liquidity positions. In fact, it is prob­
able that a greater than proportional share
of the reduction in bank loans since last fall
is accounted for by large firms.
Doubtless, many small firms were unable
to pass the more stringent standards of creditworthiness during the 1955-57 period. But
there is evidence that their demand for funds
was less avid than that of the large firms.
Lending limits, usually 10 per cent of
capital and surplus, require small banks to
deal exclusively with small business. During
the 1955-57 period, the business loans of
banks with less than 10 million dollars in
deposits expanded by only 12 per cent, while
at banks with deposits of 1 billion dollars or
more, these loans rose by 42 per cent. Very
large banks, of course, are typically the
bankers for the giant firms. In order to satisfy
the credit demands placed upon them, large
banks were forced to liquidate holdings of
securities and borrow from the Federal Re­
serve Banks in order to accommodate their
S o lv in g th e "p r o b le m ”

The Federal Reserve study remains in­
complete. Tentative conclusions drawn from
these materials will be tempered by the re­

sults of the “borrowers survey” and other
information which will become available
with the passage of time. Nevertheless, much
material has been provided for guidance of
policy-makers and students of business fi­
Thus far the study has been most useful in
illuminating the variety of sources of direct
or indirect financing for small business. It
covers the financial institution environment
in which small business operates: the scope
of lending to small business by types of fi­
nancial institutions, the credit instruments
specifically tailored to the needs and limita­
tions of small business, the complementary
role of the large business suppliers in extend­
ing trade credit or its equivalent. Too often,
such background understanding is ignored
and there is a tendency to approach the small
business problem with one of two simple
preconceptions; either that it does not have
adequate access to financing or that it does.
To these could be added the logical possibil­
ity, evidenced, perhaps, by an excessive rate
of small business mortality, that not just
enough but too much financing may be avail­
able. Testing these, and other more compli­
cated but more realistic possibilities, is the
process by which the solution to the small
business financing problem will eventually
be found.

Business Conditions is published monthly by
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scriptions are available to the public without
charge. For information concerning bulk mail­
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