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BUSINE SS CONDITIONS A REVIEW BY THE FEDERAL RESERVE BANK OF CHICAGO Change of Pace in Business Loans . . . . . Mortgage Funds Tighten . .. . . . . . . . . . . Instalment Credit Trend Reversed . . . Farm Loans Continue Postwar Rise . . State and Local Capital Spending High The Trend of Business . , . ,I I I ■ B* * a i i i i i i i i i .^0 i • Change of Pace in Business Loans Variety of Factors Brake Ten-Month Rise After ten months of almost uninterrupted increase, bank loans to business leveled off during the month of April. As early as the last of March, an abrupt slowing of the spectacular growth in business loans at banks in leading cities throughout the nation had occurred. Modest increases after that date raised the total outstanding at these banks to an all-time high in mid-April, but in subsequent weeks only small changes, chiefly declines, have been reported. While it continued, the post-Korea boom in business loans had been of unprecedented size. An expansion of over thirty per cent occurred in the last half of 1950 alone. Another eight per cent rise was recorded in the first quarter of 1951, a period during which such loans usually show about a three per cent seasonal contraction. In total, business loans at banks in leading cities rose a record breaking 5.6 billion between mid-1950 and April 1951. The growth was surprisingly even inside and outside the major money markets. Between May 31, 1950 and April 11, 1951, business loans rose 47 per cent at report ing banks in New York City, 45 per cent in Chicago, and 41 per cent in reporting banks outside these two centers. The increase in the Seventh District paralleled very closely the national rise shown in the chart below. Over the entire ten-month period, the District’s reported in crease was only fractionally higher than the national growth of 43 per cent. Individual cities within the Dis trict, however, varied markedly. Indianapolis and Mil waukee reported increases approximating the national average, but Des Moines banks recorded a relatively small increase while Detroit banks upped their business loans by over 60 per cent. What Halted the Rise? Some inferences as to factors behind the recent change in trend can be drawn from special surveys of business loans at larger banks conducted by the Federal Reserve Banks. Loans to durable goods manufacturers for de fense contracts, while still relatively small in total, are rising much more rapidly than last fall. Concerns en gaged in retail and wholesale trade also appear to be borrowing more than in the earlier period. On the other hand, substantia] declines in inventory and working cap ital loans to concerns dealing in nondurable manufactur ing, mining, sales financing, and commodities have ap peared. Such loans played a dominant role in the ex pansion of business credit last year. Undoubtedly, seasonal influences had an important part in reversing the trend of such business borrowings. In normal years, the seasonal drop in business borrowing needs is greatest in the second quarter of the year. With in the Seventh District, for example, such important in Page 2 dustries as processors and distributors of foodstuffs usu ally repay a considerable volume of bank loans during this period. In addition, the large inventories accumulated by some borrowers in various industries have engendered a growing degree of reluctance on the part of bankers to extend additional credit to such concerns. Besides these normal and individual actions, however, two positive steps have been taken as part of a co-or dinated national policy of curtailing credit extension. Last March, formal organization was provided for the new Voluntary Credit Restraint Program for lending in stitutions. The commercial banking committees set up under the program have since published specific directives suggesting purposes for which business credit should not be extended. At about the same time, the Federal Reserve System initiated a new policy of allowing some declines and much greater flexibility in market prices of U.S. Government securities to develop. One of the major aims of this policy was to discourage large net sales of Gov ernment securities by lending institutions desiring to shift funds into private loans or other investments. Indications from individual bankers in this area are that these two policy actions have curtailed some loan extensions. The personal judgment nature of lending de cisions, however, prevents any accurate measurement of the effect of these influences as distinguished from other external influences. Whatever the potency of the new policy actions may be, they will be tested most critically during the late summer and early fall. By that time sea sonal influences will have become expansionary, inven tories will appear less excessive, and defense borrowing will be substantially larger. To hold business loan ex pansion to a modest total under such conditions will re quire a maximum of effectiveness from the credit restraint programs of the commercial and central banks. THE TREND OF BUSINESS LOANS AT REPORTING MEMBER BANKS IN THE UNITED STATES BILLIONS OF DOLLARS______________________ _______________________BILLIONS OF DOLLARS Mortgage Funds Tighten Investors Reluctant to Make New Commitments With a continuing strong consumer demand for homes, shortage of mortgage funds is the principal problem faced by the home-building industry in the Seventh Dis trict currently. Other restrictive influences, such as Regu lation X and the uncertainties about being able to get building materials, also are limiting the volume of new housing projects but appear to be less important. Thus, mortgage volume and number of housing starts—both at high levels for the year to date—are likely to be re duced sharplj’- as the year progresses. The principal reasons for the shortage of money to finance new residential construction are (1) in stitutional investors still are carrying a backlog of mort gage commitments and have adopted, at least temporar ily, the policy of making few additional commitments until these backlogs have been worked off; (2) the re cent rise in interest rates on long-term bonds (see Chart 1) has not been matched by increases in all mort gage rates; and (3) sale of long-term Government secur ities to obtain loanable funds entails a capital loss at current lower prices. Government guaranteed mortgages are in an especially disadvantageous position because of the fixed interest rates paid on these investments. The rise in general in terest rates has forced the secondary selling price of many of these mortgages to a discount in order to provide a competitive net return. As a result, the market for these loans, particularly the GI’s and FHA 608’s, has about dried up. BOND YIELDS WEEKLY. JANUARY 6-APRIL 26. 1951 ccJRPORATE Boa MOODY'S • 1 CORPORATE Aoo uoooy’s ---------U.S. GOVE RNMENT IS YEARS DR MORE ......................... MUNICIPAL (HIGH-GRADE) ------ 1------- 1------ 1____ 1____ , .1...... 1------1 Mortgage Loan Volume For the nation as a whole, mortgage recordings to taled 16.2 billion dollars during 1950. Of this, about 6.8 billion dollars represented an increase in the amounts outstanding on one-four family residences. The balance consisted largely of refinancing of existing residential mortgages, repayments, and mortgages on nonresidential properties. Mortgages recorded in Seventh District states totaled an all-time high of 2.6 billion dollars, which was 16 per cent of the national total (see Chart 2). Being a dollar figure it reflects the rise in construction costs and house prices but, primarily, is the result of the tremendous volume of single family homes that were built during 1950. Mortgages recorded in Seventh District states during the first quarter of 1951 were about 15 per cent above the levels reached during the same months of 1950. This situation appears to be related to the carry-over in com mitments, however, and a substantial drop probably will take place later in the year. The Market for Mortgage Money During the last six months of 1950—and particularly during the July to October period of that year—institu tional investors made unusually heavy commitments to purchase mortgages covering planned housing projects, both large and small. Many of these arrangements were made just prior to the effective date of Regulation X. Such commitments extend for periods of three months to a year or more, depending upon the time required to obtain the necessary land, clear the titles, put in the im provements, and take care of the many details required before actual construction starts. At the time these finan cial commitments were made, the institutional investors planned to meet them through increased savings inflow or by selling Government securities. The changed support policy of the Board of Gover nors of the Federal Reserve System, in the face of a strong demand for funds, has resulted, however, in about a one-fourth per cent rise in long-term interest rates since March. Following the end of fixed-price support buying by the Federal Open Market Committee, Govern ment bond prices have declined—and yields have in creased correspondingly—so that the sale of these secur ities now entails a capital loss. Also, short-term rates have been advancing steadily and now are about onehalf a percentage point above the year-ago level. This recent change in the general money market, and particularly the rise in long-term rates, means that honor ing past mortgage commitments now entails disad Page 3 vantageous investment. If the funds are on hand they must be put into mortgages at less competitive interest rates. If funds are not available, Government securities must be sold at a loss: In addition, the set rate for guaranteed and insured mortgages has resulted in a sig nificant narrowing in the yield differential between such mortgages and alternative long-term investments. It is quite understandable that, under these circumstances, in vestors are reluctant to make new mortgage commit ments in large volume. Whereas homebuilding seems practically certain to operate this year at a substantially reduced volume com pared with 1950, other needs for capital funds will be even greater than last year (see Business Conditions, May 1951). Expenditures for industrial plant and equip ment, nationally, are expected to total 25 per cent more than during the previous peak year of 1948. Evidence of this is apparent in the Seventh District where in dustrial and commercial construction contract awards for the current year to date are about 60 per cent higher than during the same months of last year. The exceedingly high volume of industrial and com mercial construction throughout the nation will require a good deal of debt financing, even though retained earnings will continue to be a major source of funds. These borrowers are able to offer sufficiently attractive interest rates to obtain funds. Thus, it seems likely that money for Government insured mortgages at current fixed interest rates will continue tight until a basic readjust ment in this demand-supply situation occurs. Sources of Mortgage Funds Mortgage funds come primarily from personal savings. In the main, they reach the mortgage market through institutional sources. During 1950 the following estimated dollar amounts of new funds were supplied for real es tate mortgage purposes: life insurance companies, 3.2 billion; savings and loan associations, 2.1 billion; com mercial banks, 1.8 billion; mutual savings banks, 1.6 billion. Except for savings and loan associations—which had net borrowings from the Federal Home Loan Banks —all of these institutional groups sold Government se curities to meet a substantial part of these new mortgage commitments. Other sources of mortgage funds, such as individuals, educational endowments, pension funds, and trusts, are important in the mortgage market but have participated less actively in the recent housing boom. Certain elements of correction seem likely to occur in the mortgage market. Rates on conventional mortgage loans in this District already have shown a tendency to rise by approximately one-half per cent. In addition some increases in interest rates paid on time deposits of com mercial banks have taken place, which may have the effect of increasing savings inflow. If announced plans of Government spending and restrictions upon civilian production are carried out, a rise in savings inflow should result from the increased personal income and restricted consumer expenditure. Moreover, the augmented flow of principal repayments Page 4 on existing mortgages will be available for reinvestment. These developments, in conjunction with the working down of existing commitments, will free additional funds for residential investment, while at the same time the demands for new funds are declining because of the re duced volume of building this year. These processes work slowly, however. A further increase in the supply of mortgage funds might occur if steps were taken to alter the terms of Government insured and guaranteed loans. One step might be the establishment of flexible interest rates for VA and FHA mortgages. It is claimed by some that this step would be a major change in the Government’s anti-inflation policy and would upset the announced in tention of reducing the level of residential starts to 850, 000 units this year. The plans which resulted in Regula tion X, however, did not contemplate a basic shift in interest rates at the time they were drawn up. It could be argued that flexible rates would merely keep Govern ment insured and guaranteed mortgages in line with the now freer general money market. An indirect way to accomplish rate flexibility would be to permit larger closing fees, the cost of which would be borne by the home buyer. A second possibility, but of doubtful advisability, would be the making of precommitments by the Federal National Mortgage Association (FNMA). Currently, FNMA may purchase eligible mortgages within 60 days after the completion of the house but will not make a prior commitment to do so. Builder, developers, and mortgage bankers would go ahead on some projects now delayed if such prior commitment were made. Precom mitment would be an outright reversal of anti-inflation ary policy, however, since it would result in a direct out flow of Federal funds and would require additional Con gressional authorizations to FNMA if widely used. More over, many observers contend that it is not good general policy for Government to purchase loans which it pre viously has insured and guaranteed. NONFARM MORTGAGES RECORDED* (1941-49 ANNUAL AVERAGES; 1950-SI MONTHLY FIGURES) 3NS OF OOLLARSMILLIONS OF OOLLARS ...................................... ..................... UNITED STATES SEVENTH DISTRICT STATES * RECORDINGS OF $ 20,000 AND UNDER. SOURCE: FEDERAL HOME LOAN BANK BOARD. .. 2,000 Instalment Credit Trend Reversed Regulation W Cuts Buying on the Time Payment Plan It has become increasingly apparent that the sharply upward postwar trend in consumer instalment credit ended last fall with the imposition of Regulation W by the Federal Reserve Board. Actually, instalment credit outstanding has declined since then, despite near-record levels of retail sales of consumer durable goods. Although the drop from October through March amounted to only 360 million dollars, it was in sharp contrast with the 1,180 million increase in the same period a year earlier and the 2,270 million rise of the preceding six months. In fact, before the recent declines, outstanding credit had fallen in only three months since the end of the war. The restrictions of Regulation W regarding down pay ment percentages and contract maturities have curbed the volume of new credit extended by reducing the ca pacity of consumers to contract for such credit. In addi tion, the amount of credit which can be obtained on a purchase is smaller because of higher down payment requirements. Moreover, a more rapid repayment of the credit which is extended results from the enforced shortening of contract periods. It is probable that instalment debt will increase some- CONSUMER INSTALMENT CREDIT GRANTED, REPAID, AND OUTSTANDING JUNE 1949 -MARCH 1951 MILLIONS OF DOLLARS 2,000 MILLIONS OF 00LLARS ------------ REPAYMENTS NEW CREDIT GRANTED FALLS BELOW REPAYMENTS. J___ l —1... I BILLIONS OF DOLLARS l BILLIONS OF DOLLARS SO OUTSTANDINGS BEGIN TO DROP. # EXCLUDES FHA HOME REPAIR AND MODERNIZATION LOANS AND ACTIVITY OF MISCELLANEOUS LENDERS. what in the current months of seasonally high spring and summer credit buying, but gains will be moderate in com parison with other postwar years. There will continue to be a substantial downward pressure on instalment credit, given the extension of Regulation W beyond June 30. Also, repayments on the large debt now outstanding will continue at high levels. These factors, combined with the coming sharp reductions in the production of metal-using consumer durable goods already announced (and con sequent liquidation of the present high inventories of such goods), are likely to result in a further decline in out standing instalment credit later in the year. Repayments Exceed New Credit Changes in the amount of instalment credit outstand ing are determined by repayments of existing debt and the volume of new credit extended. As is shown in Chart 1, the recent decline resulted from both a drop in the volume of credit granted (averaging about 20 per cent) and a moderate increase in repayments. Although the 20 per cent reduction in credit granted which occurred between the summer and winter months was substantial, it cannot be said that a drastic curtail ment in credit buying has occurred. The volume of new credit extended had been moving sharply upward since early in 1949. It was boosted even higher by the surge of consumer buying of durable goods which took place after the outbreak of war in Korea. Thus, the post Regulation W decline was from a record-high level of credit activity. The volume of credit granted during the winter was large in comparison with earlier years. The total amount extended during the fourth quarter was only six per cent below the same period of 1949, and a less than seasonal decline during the first quarter of this year brought the volume granted up to about equal with the early months of 1950. The steady upward trend in repayments was also an important factor in bringing about the recent decline in instalment debt. Based upon the total amount of credit outstanding, the level of repayments was affected more importantly by the large additions to debt which had taken place during the summer than by the reduced amounts of new credit currently being granted. In addi tion, the new credit extended under the terms of Regu lation W was subject to larger monthly repayments be cause of the shorter maturities allowed. Consequently, repayments totaled 7.5 per cent more from October through March than during the previous six months. The reversal of trend in instalment credit has con stituted a deflationary force in the general business pic ture, since the substantial net amount of purchasing power provided consumers from this source in earlier Page 5 months was changed to a net drain during the winter. Instalment credit is usually extended for specific pur poses, most frequently the purchase of relatively expen sive consumer goods, such as automobiles, radio and tele vision sets, home appliances, furniture, and floor cover ings. Thus, the effects of the decline in the volume of credit extended fell largely upon the consumer durable goods industries in the form of reduced credit demand for their products. At the same time, the increases in re payments of credit outstanding subtracted from the amount of purchasing power in the hands of consumers which would otherwise have been available for spending. INSTALMENT CREDIT GRANTED AS A PROPORTION OF TOTAL SALES FOR SELECTED TYPES OF RETAIL OUTLETS JANUARY 1949 - MARCH 1951 PER CENT PER CENT 401 -----140 1 FURNITURE I AN0 H0USEM0L0 APPLIANCE ST0?ES ___ Credit Buying Loses Ground Consumer credit curbs are important chiefly because of their effect upon the demand for specific types of consumer goods. This fact is apt to be overlooked if increments of credit outstanding are compared with total spending power available to individuals as a result of current income or holdings of liquid assets. During all of 1950, the increase in instalment credit outstanding was 2.6 billion dollars while total consumption expend itures reached 191 billion. Nevertheless, the impact of the increase in instalment credit was highly important in the acquisition of such major purchases as automo biles, furniture, and appliances. Consumer credit data is not compiled for specific types of goods in most cases, but figures are available on credit extended by the prin cipal classes of retail outlets which handle these items. Examination of this data reveals the extent to which Regulation W has restricted instalment credit expansion. The major portion of such credit can be traced to its point of origin. A comparison of the volume of instalment credit granted with total sales of the three major classes of retail outlets which utilize credit extensively indicates that the ratio of credit to sales has dropped in each case since Regulation W went into effect (see Chart 2). The greatest instalment credit activity in the past several years has been in automobile sales financing. In 1950, credit granted for financing the purchase of cars was nearly 40 per cent of the total. While a large volume of automobile credit is originated by dealers, substantial amounts of instalment loans for this purpose are made directly by financial institutions, particularly commercial banks. Probably because of the relatively high price of auto mobiles, the impact of Regulation W has been substan tial here. The volume of credit extended dropped 35 per cent from the third to the fourth quarter of 1950, while total sales of automobile dealers declined only 21 per cent. New credit increased four per cent in the first quar ter of this year, but sales advanced 16 per cent in the same period. Consequently, the proportion of total dollar sales financed by instalment credit has fallen steadily, from nearly 30 per cent in July to a low of 20 per cent in February. An even more significant decline in the proportion of credit to total sales was experienced by furniture and Page 6 DEPARTMENT STORES AND MAIL-ORDER HOUSES J 1__I—I__ L SEPT. ■I, ■ ■ L—1-JL MAR. JUNE 1990 * INCLUDES INSTALMENT LOANS PURCHASE OF AUTOMOBILES. SEPT. DEC. MAR. JUI* 1951 MADE DIRECTLY BY COMMERCIAL BANKS FOR household appliance stores. The volume of credit granted by this group of retailers dropped by about a fourth from the third quarter to the final months of 1950 and nearly a third more in the first quarter of this year. Sales, on the other hand, held up well during the Christmas season and fell less sharply than credit in the early months of this year. As a result, the ratio of credit to total sales dropped from an average of about 33 per cent in the summer months to 26 per cent in the fourth quarter of 1950 and seasonally further to 21 per cent in early 1951. The ratio of credit granted to total sales of depart ment stores and mail-order houses reflects not only the importance of credit in the demand for goods but also the proportion of total sales accounted for by durable goods. Thus, the high credit ratio of last summer (see Chart 2) was caused in large part by the unusually large volume of sales of homefurnishings. It does appear, how ever, that the credit restrictions of last fall reduced the credit activity of this class of retailers to a significant extent. The proportion of total sales financed with instal ment credit during the Christmas season fell consider ably more sharply than in earlier years. Moreover, the subsequent recovery was quite limited, in view of the second surge of consumer buying of durable goods which occurred early this year. An important part of total instalment credit cannot be related to sales of particular types of retailers or pur chases of specific kinds of goods and, therefore, has not been included in this analysis of the decline in credit buying. Included in this category are a major portion of the instalment loans of financial institutions and credit originated by other classes of retailers. For the group as a whole, the volume of new credit granted declined seven per cent between the third and fourth quarters of 1950, and 10 per cent further in the January-March period of this year. Although the impact cannot be pinpointed, this reduction obviously was also a factor in limiting the cur rent expenditures of consumers for goods and services. Farm Loans Continue Postwar Rise Rising Prices Increase Credit Requirements Agricultural loans of country banks increased further in the first quarter of 1951. The rise was at a slower rate than in the fourth quarter of 1950 but more than seasonal. Farm real estate loans advanced 3.2 per cent; CCC guaranteed loans, 10.2 per cent; and “other” loans to farmers, 1.5 per cent. In dollar amounts, the rise totaled about 7.5 million dollars of which over two-fifths was due to the increase in “other” loans to farmers (see Chart 1). Agricultural loans of Chicago banks in creased about two per cent, indicating a continued mod erate demand for funds by outlying correspondent banks. These increases occurred even though country bankers have attempted to restrict loan expansion in response to inflation control measures and the heavy debt position of some farmers. The farmer demand for credit continues strong, reflecting the increased capital required to carry necessary inventories of crops, livestock, and production materials such as feed, seed, fertilizer, and the like. Farm capital requirements have increased also because farm ers expect prices to rise further. This encourages delayed marketings, the carrying of relatively large inventories of crops and livestock, and advance buying of farm production supplies. The continued strong demand for farm machinery, due in part to anticipated shortages, contributes importantly to the demand for credit in many areas. This has been supported by the near-record rate of farm machinery production in the first quarter of 1951 which permitted most farmers to buy all the equipment they desired if they could obtain the necessary funds. Bank loan expansion on farm real estate in the first quarter continued at about the same rate as in other re CHART I AGRICULTURAL LOANS SEVENTH DISTRICT MEMBER BANKS JUNE AND DECEMBER, 1940-50 MILLIONS OF DOLLARS MILLIONS OF DOLLARS TOTAL OTHER (SHORT TERM) FARM * REAL ESTATE ' C.G.G. . .1 .1 1940 ■■ L1941 J■ -1 ...1-lZnTr 1942 1943 1944 J/ OCTOBER 4. 1950. it APRIL 9,1951. I X—I 1945 1949 1947 1948 1949 1950 1951 cent periods. Largest increases were reported for Illinois and Indiana whereas in the fourth quarter of 1950 these two states experienced smaller increases than the remain der of the District (see Chart 2). The continued expansion in real estate credit reflects, in part, the strong demand and rising prices for agricultural land. In addition, the higher debt position of some farmers necessitates the mortgaging of real estate to obtain operating capital or to make farm improvements. The volume of “other” loans to farmers rose moder ately in most areas during the first quarter of the year, the larger increases appearing mostly in the more produc tive and intensively cropped areas. This differed from the second half of 1950 when the largest expansions were concentrated in important cattle feeding areas. Commercial banks’ agricultural loan totals are influ enced importantly by the large changes in holdings of CCC guaranteed loans. Although such loans increased 10 per cent in the first quarter of 1951, the volume was far below a year ago. This reflects the small amount of 1950 corn placed under price support loan. From De cember 1949 to June 1950, for example, the volume of CCC guaranteed loans held by Seventh District member banks increased from 50 million to 110 million dollars. In December 1950, such paper totaled only 16 million dollars, rising to 17 million on April 9, 1951. This reduction in CCC guaranteed loans resulted largely from the higher prices for farm products, espe cially corn, which made price support loans much less attractive to farmers. The shift from CCC guaranteed to “other” loans has made an important change in the character of country banks’ loan portfolios, as the “other” loans are not backed by Government credit. The volume of agricultural loans held by commercial banks, although more than double the outstandings dur ing the World War II years, still appears to be reasonable when compared with current and prospective levels of farm income or with the value of farm assets. It is recognized, of course, that much of the increase in agri cultural loans has resulted from larger rather than in creased number of loans. Furthermore, the earnings and assets of the borrowers rather than of agriculture gen erally will determine the soundness of the loans. Now, as usually is the case, some borrowers would get into financial difficulty rather quickly if they should experi ence a bad crop year, reduced margins between produc tion costs and prices received, or similar adverse develop ments. The growing reliance of farmers on purchased ma terials and services for their production activities inten sifies this situation and makes most farmers increasingly vulnerable to a financial squeeze any time they suffer a decline in cash receipts. Page 7 Does Higher Income Indicate More Credit? Farm product prices are expected to continue at about the present level for the remainder of the year if a large volume of production is achieved. This would result in cash receipts from farm marketings in 1951 about one-fourth larger than in 1950. The realized net income of farm operators would materially exceed the 13 billion dollars realized in 1950 and might surpass the 1947 record of nearly 18 billion. The dollar volume of farm credit usually has risen in periods of rising farm prices, costs, and income. World War II years, however, were an important exception to this general pattern (see Chart 1). Farmers used their high wartime incomes to retire farm mortgage debt, finance their increased requirements of machinery and other production materials, and, in addition, accumulated substantial holdings of liquid financial assets. The future trend of farm loans is problematical. The current moderate uptrend in farm mortgage debt may continue so long as there is a strong demand for agricul tural land and an expectation that inflationary pressures will dominate the economy. Loans to farmers for produc tion and living purposes in the next few years are likely to follow the trend of prices and costs more closely than in World War II, unless relatively complete mobilization materializes. In this latter circumstance, reliance on direct price and ration controls would be more extensive as would shortages of farm machinery, building materials, and other items commonly purchased by farmers. With limited opportunity to spend income for consumption purposes and to invest funds in the farm business, liquid financial assets probably would be accumulated in ag riculture and the demand for short-term financing would stabilize or decline. With less extensive mobilization, CHART however, there would be greater freedom of markets and prices, and larger supplies of civilian goods and services would be available. In this circumstance, the demand for short-term credit may be somewhat more active and the volume of such loans to farmers probably would tend to increase. A moderate tightening of agricultural credit at this time probably would have no serious adverse conse quences and may be justified in view of the over-all in flationary potential of the economy. It is important, of course, that any tightening be limited to the less produc tive uses of credit. The over-all high demand for farm products, now indicated to continue for several years, necessitates the maintenance of a high and expanding volume of farm production with a reduced farm labor force probable. Thus, further selective mechanization of agriculture probably is a desirable use of capital at the present time. Uncertainties as to the availability of farm labor, however, are causing some farmers to make unduly large investments in machines for which they have only limited use. New capital investment in soil improvements such as fertilizer, lime, drainage, waterways, terraces, and the like would increase the productivity of some land very materially with only a nominal expenditure of crit ical materials and probably should receive even more at tention than it is getting at the present time. The major factors to be considered when determining the desirability of making new capital investments in an economy which is shifting resources to ordinance pro duction and is plagued by inflation should be: (1) How essential is it to obtain increased output of the product involved? (2) To what extent and how soon will the investment result in additional output? These judgments may well guide country bankers as they adjust their loan policies to the demands of present national needs. 2 AGRICULTURAL LOANS BY SEVENTH DISTRICT AREAS* PER CENT CHANGE IN SELECTED PERIODS REAL ESTATE LOANS ON FARM LAND OTHER LOANS TO FARMERS (EXCLUDES C.C.C. ITEMS ) TOP: JANUARY I TO APRIL 9, 1951 BOTTOM: OCTOBER 4 TO DECEMBER 51, 1950 TOP: JANUARY I TO APRIL 9, 1951 BOTTOM: OCTOBER 4 TO DECEMBER 31, 1950 1 +7.5 ; 1-0.2! f 10.4 '+$. JANUARY I OCTOBER 4 TO APRIL 9, TO DECEMBER 31, 1951_____________1950 JANUARY I OCTOBER 4 TO APRIL 9, TO DECEMBER 31, 1951_____________ 1950 MICHIGAN ♦ 0.7 + 7.2 WISCONSIN 7TH DISTRICT + II +1.5 - 0.2 + 3.0 7TH DISTRICT + 3.2 * CHICAGO ILLINOIS BANKS EXCLUOED. Page 8 -3.6 *-3.! State and Local Capital Spending High Large Volume of Projects Under Way to Limit 1951 Cutbacks State and local governments typically react to changes in the economic environment in much the same way as do individuals and businesses. While not all governments have reacted similarly to changes since the outbreak of the Korean war, recent indications are that the states and their local subdivisions, particularly the latter, will continue construction projects planned or under way, to the full extent permitted by the availability of resources and prospective costs. Government capital spending, while generally erratic in timing in total, cannot be in creased or reduced rapidly with ease, largely because construction projects require lengthy periods for planning, authorizing, financing, and programming. Most types of capital spending, whether public or private, which do not immediately result in a substantial increase in the production of scarce materials or products, have an inflationary impact in a boom period. It diverts materials and manpower from the production of finished goods, while at the same time generating additional em ployment and income. State and local capital spending, moreover, has been financed in recent years to a large extent (more than 40 per cent in 1950) by borrowing, thereby adding to the inflationary pressures. Restraint of the less essential types of state and local capital out lays, therefore, assists in maintaining price stability as well as in the job of diverting scarce materials and man power into higher-priority uses. These goals are put forth in Bulletin No. 3 of the Voluntary Credit Restraint Com mittee, released on May 7, which sets up standards and procedures designed to curb state and local borrowing for nonessential purposes. Continued high levels of capital expenditures by state and local governments have been indicated in recent months by large volumes of public construction contract awards and municipal bond sales and by plans submitted to the 44 state legislatures meeting this year in the gov ernors’ budgets. An important motivating factor in these plans is the determination of some state and local gov ernment officials not to repeat the World War II expe rience. At that time, public construction was cut back almost to the vanishing point. Governments came out of the war with a large backlog of construction and main tenance needs. In addition, the increase in population during the 1940’s and the boom in home building since 1945, particularly in suburban areas, have created large needs for schools and new water and sewerage systems which can hardly be deferred. The present mobilization period promises to continue for some time. Many of the construction projects planned by state and local governments, of which primary high ways are probably the best example, are essential to the continued smooth functioning of the economy over this long-run period. A factor of considerable importance in the prospects for continued high levels of state and local construction activity consists of the Federal grant and loan programs. Although Federal aid supplied only about one-tenth of the more than five billion dollars spent by state and local governments for construction in 1950, these aids had in duced the spending of at least a comparable amount from funds raised locally. The most important Federal aid construction programs heretofore have been those for highways, airports, hospitals, and public housing. For most of these programs, the funds authorized for any one year are available to state and local governments for two, three, or even more years. In practice, this means that, at any date, a government can spend not only its allotment for the current fiscal year but also any unused allotment from previous years. For example, at the beginning of fiscal 1951, around one billion dollars was available to the states for highway work in the planning stage or actually under construction. Within some of the aid programs, existing allotment practices tend to frustrate the announced policy of spend ing only for defense-related purposes—for instance, 30 per cent of authorized highway grants are allotted to secondary rural roads, which are seldom of any impor tance to defense. Revision of these features of Federal policy could remove some of the most important deter rents to cutbacks in Federally-aided nonessential projects. Obstacles to Plans Whether in fact the capital spending intentions are realized depends on various developments. Rising costs will price many projects out of the market. Governments are quite sensitive to changes in the cost and availability of borrowed funds and the action of the Voluntary Credit Restraint Committee can have a potent effect. Probably the only development which can affect projects already authorized or financed would be difficulties in regard to the physical availability of resources, particularly struc tural steel. The National Production Authority’s Order M-4, originally issued on October 27, 1950, prohibits public or private construction of recreational of amuse ment facilities. These types of construction constitute a minor share of the state-local total. The May 3 amend ment to the NPA order will present a more serious ob stacle. This requires that all public and private construc tion projects using more than 25 tons of steel receive authorization from the NPA before construction is begun. To obtain authorization, a project must “further the de fense effort” or be “essential to maintenance of public health, safety or welfare.” Other projects may be per mitted, depending on the need and the materials supply. Page 9 Construction at Record Levels Post-Korea Bond Sales During 1950, state and local government construction activity reached new record levels, in dollar terms. School and highway construction, which have comprised well over half of total activity in the postwar period, ac counted for most of the increase over the previous year. In physical terms, however, the increase was undoubtedly much smaller since during the latter half of the year, in which most construction work is done, costs were about ten per cent greater than those prevailing in 1949. Data on construction contract awards shed some light on the prospects for the months immediately ahead, since most public construction projects take six to twelve months from the date of the contract award to the com pletion of the job. The accompanying chart shows con tract awards by type of construction, from 1948 to the present. The unusually high level of awards in the latter part of 1950, especially for public housing, school build ings, and highways, is of special interest and indicates that the high levels of activity during calendar 1950 will extend well into 1951. In January 1951, the latest date for which data are presently available, awards were almost two-thirds greater than those in the same month in 1950. In the Seventh District, as the following data reveal, awards during 1950 were above those for the preceding year, although in three of the five District states, the increase was less than the national average (amounts are in millions of dollars). 1948 1949 1950 Seventh District States: Illinois ......................... ... 190 205 189 Indiana......................... ... 61 61 89 Iowa ............................. ... 59 68 76 Michigan ..................... ... 108 118 177 Wisconsin..................... ... 88 84 93 Total......................... ... 506 536 620 United States................... ...3,565 4,103 4,946 In some respects, information on state and local bond sales provides a better forecasting device than contract awards, since for debt-financed projects, bonds are sold considerably in advance of the awarding of contracts. By and large, local governments, especially cities and school districts, finance most of their capital spending by borrowing, while the states, especially those in this part of the country, finance construction from current rev enues. During the years since the end of World War II, sales of state and local bonds have risen steadily. In 1950, the record figure of 3.4 billion dollars of gross new financing was reached. About 18 per cent of this total represented borrowing for veterans’ bonus payments, and most of the remainder was for construction purposes. Although bond sales have declined somewhat from the record proportions of the first six months of 1950, they have continued to be substantial by earlier standards. As the table indicates, non-bonus bond sales in the nine months since the outbreak of the Korean war were about 12 per cent below in the nine months prior to that event for the country as a whole. In the Seventh District states, the decline was somewhat greater, largely because Iowa had sold about 26 million dollars worth of bonus bonds in the earlier period. The large declines for Illinois and Michigan were due mostly to a reduction in largescale borrowing by Chicago and Detroit local govern ments. Construction borrowing during the first half of 1951 will probably continue at levels somewhat lower than those prevailing a year ago, in part because of the un usually low rate of approvals by the voters of issues on the ballot in the November 1950 elections. The District picture will be somewhat different, largely because Mich igan has recently sold a 65 million state bond issue for hospital construction approved by the voters last No- STATE AND LOCAL PUBLIC CONSTRUCTION VALUE OF CONTRACTS AWARDED BY TYPE OF CONSTRUCTION MILLIONS OF DOLLARS SOURCES: CONSTRUCTION AND BUILDING MATERIALS Page 10 ANO PUBLIC CONSTRUCTION. STATE AND LOCAL GOVERNMENT BOND SALES BEFORE AND SINCE THE KOREAN WAR BEGAN (Amounts in millions of dollars) State Seventh District States: Illinois................................ Indiana............................. Iowa.................................... Michigan.......................... Wisconsin........................ Total............................. United States: Ronus issues................... Other.................................. Total............................. October 1949June 1950 July 1950March 1951 Per cent change, nine months pre-Korea to nine months post-Korea 94.2 20.9 44.8 85.4 17.4 262.7 70.0 31.0 18.7 68.8 17.6 206.2 —26 +48 —58 —19 +1 —22 537.6 2,293.8 2,831.4 137.5 2,024.6 2,162.1 —74 —12 —24 SOURCE: The Bond Buyer. vember. The reduced supply of bonds should produce further strengthening of the municipal market in the weeks ahead. Interest costs are unlikely to increase and thus should not act as a force restraining capital spend ing plans. In view' of the large proportion of government cap ital spending financed by bond issues, the May 7 state ment of the Voluntary Credit Restraint Committee is of particular importance. The Committee urged financing institutions to “carefully screen loans to state and local governments as well as loans to other borrowers. Ex pansion programs that under normal conditions would be financed without hesitation should be critically ex amined. Ordinary government as well as private expend itures should be met largely out of current revenue rather than financed by new borrowing. If not urgently needed for preservation of public health and safety or for pur poses directly related to defense, public works should be deferred.” Among the specific types of spending, the financing for which the Committee recommends be postponed are (1) veterans’ bonuses, (2) replacement of existing facil ities which still have some useful life, (3) construction of recreational facilities and war memorials, (4) acquisi tion of sites and rights-of-way not immediately needed, and (5) purchase of privately-owned utilities by munici palities. The Committee further recommended that lend ers work with local governments to hold short-term bor rowing to a minimum. In a letter to a large number of state and local government officials, Defense Mobiliza tion Director Wilson requested all public bodies to sub mit financing of one million dollars or more to regional consultation committees established by the Voluntary Credit Restraint Committee “for a ruling as to con formance with the program before negotiation for private sale or advertising for public sale.” 1951 State Budgets Most of the budgets submitted to state legislatures in the early months of 1951 include some reference to the fact that defense requirements and previously-formed capital spending plans will often conflict in the next two years (the period for which most state budgets are formu lated). Most states, however, apparently feel that the urgent character of their backlog of construction needs justifies continuing high levels of capital spending. In fact, in many states, substantial increases are included in the budgets. Of the first 22 state budgets to be sub mitted this year, two states plan capital spending at substantially the same rate as in the most recently-con cluded fiscal year. Another 15 states plan to spend con siderably more for capital purposes, and only five states plan significant reductions. Expected increases in highway construction expenditures, which typically account for about two-thirds of state capital outlays, appear to ex plain these developments. For the Seventh District states, the picture is mixed. In Illinois, Governor Stevenson’s message emphasized accommodating the defense effort and urged that the State “build no buildings which can be deferred and use no manpower which can be conserved.” Recommended appropriations for construction for the 1951-53 period are down one-third from the 180 million dollar level of the 1949-51 biennium, with the decline concentrated on highways and building construction for state colleges and universities. Indiana’s State Budget Committee stated in its Budget Report that the proposed construction pro gram was a minimum, if the State is “to avoid even greater future expenditures.” The increase in appropri ations recommended for 1951-53 is about 20 per cent, to nearly 90 million dollars. A substantial increase for high ways more than offsets declines for other construction. In Iowa, the legislature appropriated no new funds for capital outlay purposes; the 1949 session had provided about 12 mdlion dollars. The State Highway Commission, however, anticipates a substantial increase—about onethird—in expenditures for primary road construction. New funds available for construction in Wisconsin are expected to be at levels close to those provided by the 1949 legislature; a ten per cent increase in highway con struction outlays, which means little change in the phys ical volume, is expected. In Michigan, the picture is somewhat more compli cated. Total recommended capital outlay appropriations from current revenues are at about the current level. Within the total, highways are up sharply and appropri ations for construction at the State’s welfare, health, and educational institutions will decline. Michigan has recently embarked on a course shunned by most Midwestern states in the past few decades—that of borrowing for state construction purposes. While some prosperous states in other parts of the country have gone heavily into debt to supply funds for capital purposes, in the Midwest this practice has been largely restricted to the issuance of revenue bonds to finance auxiliary activities at univer sities, such as dormitories and stadiums. Michigan voters changed this pattern in approving a 65 million dollar bond issue for hospital construction at the 1950 general election. In this period, financing urgently-needed public works from current revenues rather than by borrowing would be a more appropriate policy, as the above-quoted statement of the Voluntary Credit Restraint Committee indicates. Page 11 The Trend of Business More Upward Pressure on Prices Ahead A further slackening in the demand for consumer goods has occurred during the past few weeks. Produc tion in general, however, continues at the high level at tained during the first quarter of the year. As a result of these two factors, wholesale and retail inventories in creased further in relation to sales. Attempts of retailers to reduce their inventory burden have been relatively mild. Promotional activity has been increased slightly, but distress selling is rare. Retailers’ relative complacency in the face of rising inventories in dicates a feeling that during the next few months, Gov ernment required cutbacks in the production of many consumer goods combined with rising consumer income will tend to bring inventories into line with sales. Un employment during April reached a new postwar low for that month despite layoff's in some durable goods in dustries, television and automobiles in particular. During the past few weeks, raw materials prices con tinued the decline which started in the middle of Febru ary. Wholesale prices remained steady. Consumer prices, on the other hand, rose slightly. For the first time since February 1950, however, retail food prices failed to share in this advance. The continuation of Government price controls is cur rently being challenged. Tremendous pressure is being brought by producer and distributor interests relative to control of commodity prices. Increased participation by organized labor in policy making for defense mobiliza tion may tend to weaken attempts to regulate wages and salaries. These pressures may result in a weakening of price control programs in this interim period before the major impact of defense spending has really begun to be felt. Production—Industrial production, as measured by the Federal Reserve Board index, remains at the high levels established during the first quarter of the year, 11 per cent above June 1950 and 17 per cent above a year ago. However, a smaller proportion of total industrial INDUSTRIAL PRODUCTION CONTINUES HIGH* output consists of consumer goods. For example, in the consumer durable goods field, production of television sets, automobiles, and refrigerators has continued to drop. In the soft goods field, textile production has declined. The increased output of capital goods, among them ma chinery and freight cars, did not offset completely these declines. Increased production of defense materiel made up the difference. And during the period immediately ahead, as defense spending rises from the present rate of about two billion dollars a month, war goods will make up an increasing percentage of total industrial produc tion. Sales—During the first quarter of 1951, the dollar volume of all sales of consumer goods averaged about 17 per cent higher than those of the corresponding period of 1950. Currently, however, sales are near year-ago levels, although they are lagging in terms of physical volume. The most important causes of the recent soften ing in demand are the (1) reaction from earlier forward buying, (2) failure of expected shortages to materialize, (3) continued relative stability of prices. In addition, Regulation W has curbed instalment sales, particularly of expensive items such as automobiles, television sets, and refrigerators. Nationally, sales of new automobiles declined slightly during April. Inventories—Caught temporarily between declining demand and large stocks, many wholesalers and retailers are somewhat apprehensive about their ability to con tinue to finance their inventories. However, most deal ers realize that within a few months their problem may be that of inadequate rather than excessive supplies. Currently the greatest amount of overstocking appears to be among radio-television, used car, and furniture dealers. In sharp contrast to dealers, many producers have inventories which are low in relation to both current and expected sales. Steel, chemical, petroleum, and rubber producers are included in this group. DEPARTMENT STORE SALES APPROACH YEAR-AGO LEVELS* DEPARTMENT STORE STOCKS CONTINUE HIGH* PER CENT CHANGE FROM 1950 1950 INDEX OF INDUSTRIAL PRODUCTION. Page 12 1950 * SEVENTH DISTRICT SALES. * SEVENTH DISTRICT STOCKS
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