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FEDERAL RESERVE BANK OF RICHMOND MONTHLY REVIEW Banking in the Consumer Protection Age Forecasts 1972 1971 Farm Financial and Credit Conditions The M o n t h l y R e v i e w is produced by the Research Department of the Federal Reserve Bank of Richmond. Subscriptions are available to the public without charge. Address inquiries to Bank and Public Relations, Fed eral Reserve Bank of Richmond, P. 0 . B ox 27622, Richmond, Virginia 23261. Articles may be reproduced if source is given. Please provide the Bank’s Research Department with a copy of any publication in which an article is used. Banking in the Consumer Protection Age: Part III Parts I and II of this series reviewed the develop ment of consumer protection legislation in the United States, with particular reference to the Truth in Lending A ct and the range of criminal and civil sanctions that may be imposed for failure to comply with it. Am ong the subjects discussed in this final part are the following: (1 ) elements of an internal Truth in Lending compliance program for banks; (2 ) principal features of the Fair Credit Reporting A c t ; (3 ) important recent and pending legislation involving bank credit cards; and (4 ) the work of the National Commission on Consumer Finance. An important protective clause of the Truth in Lending A ct provides that a creditor may not be held liable for civil penalties “ in any action” if it can clearly show that its violation was not intentional and resulted from a bona fide error even though it maintained procedures designed to avoid any such error.1 Obviously, the same evidence would preclude any possibility of criminal prosecution. Banks can take advantage of this protective clause by following a number of comparatively inexpensive steps, thereby placing themselves in a favorable position when dis putes with consumers or regulatory authorities arise because of errors in disclosure statements. Elements of a Truth in Lending Compliance Program A n effective program begins with designation of a particular officer to be responsible for establishing and maintaining compliance pro cedures on a regular basis within the organization. The first task of this officer is to equip himself with a file of essential published materials. A t minimum, this should include a copy of the Truth in Lending A ct and a copy of Regulation Z of the Board of Gov ernors, including amendments and formal inter pretations by the Board relating to it. Copies of these materials may be obtained free of charge from any Federal Reserve Bank or from the Publications Section, Board of Governors of the Federal Reserve System, Washington, D. C. 20551. Although the coverage of these materials is comprehensive, sup plemental information applicable to particular lending or credit sales transactions will be useful in many situations. The most helpful supplemental source is the large number of informal opinions that have been 182 Stat. 157 (1968). Section 130(c) of the Act. written by members of the Board of Governors and its staff. W ell over 500 opinion letters had been written through December 1971, all in response to inquiries from creditors or the public presenting basic compliance issues in the context of stated factual situations.2 These informal opinions do not have the same legal status as the formal interpreta tions of Regulation Z published by the Board of G ov ernors ; nevertheless, they do represent the con sidered judgment of the staff or of individual mem bers of the Board on a subject committed to the Board for administrative decision by Congress. Pre sumably, therefore, the courts will give weight to these informal opinions in the event of litigation, even though they do not have the same legal status as the Board’s official interpretations. The practical problem a bank or any other creditor faces is how to prove in court that it does in fact maintain procedures designed to prevent uninten tional violations from occurring. One important document to help accomplish this is a written com pliance policy that has been distributed to all per sonnel in the organization responsible for the ex tension of consumer credit. By now, all banks should have forms that meet the disclosure requirements of Truth in Lending. The next logical step for a bank, therefore, is to be able to show that all per sonnel with responsibilities for completing the forms and transmitting them to customers have been trained to complete them properly. One way to accomplish this is to furnish credit personnel with sample forms properly filled out as they would be in actual or hypothetical transactions, accompanied by written e x planations where needed. A s a supplement to direct written instructions to credit personnel, banks should also consider issuing a written directive to their Auditing Departments to make periodic spot checks of compliance. Auditing representatives should examine copies of completed disclosure forms that have been given to customers and make additional investigations as may seem necessary under the circumstances at any particular time. There is yet another advantage to this pro 2 One commercial publisher of these opinions is Commerce Clearing House, Inc., 4025 W . Peterson Avenue, Chicago, Illinois 60646, in 4 CCH Consumer Credit Guide. Another useful source for many of them, and for many other useful Truth in Lending materials as well, is the Truth in Lending Manual by Ralph C. Clontz, Jr., pub lished by Warren, Gorham & Lamont, Inc., 89 Beach Street, Boston, Massachusetts 02111. FEDERAL RESERVE B A N K OF R IC H M O N D 3 cedure. It increases the likelihood that the bank might be able to take advantage of the second creditor defense written into the Truth in Lending Act. Section 130(b) provides that a creditor has no liability for civil penalties if, within 15 days after discovering an error and prior to the institution of a legal action by the consumer or the receipt of written notice of the error from the consumer, the creditor notifies the consumer of the error and makes whatever adjustments are necessary to insure that the consumer will not be required to pay a finance charge in excess of the amount or percentage rate actually disclosed.3 A program of regular surveil lance increases the chances of detecting and cor recting errors prior to notification from the con sumer. If spot checks suggest that particular lend ing officers are prone to error in completing dis closure statements, more thorough review of their disclosure statements may be in order. For larger transactions, such as real estate loans, it might be feasible to have a single individual complete all dis closure statements, thus reducing further the chances of error. The Truth in Lending compliance officer or de partment can also play a particularly useful role in monitoring the adequacy of disclosure by retail dealers for whom the bank discounts installment paper on a regular basis. Here again, as discussed in Part II, if Truth in Lending violations occur, banks may well be equally as liable for civil penalties as retail dealers themselves. Am ong the measures that can reasonably be taken by banks to reduce ex posure to loss are (1 ) advance examination and approval of disclosure forms used by dealers; (2 ) spot checks of disclosure forms completed by dealers for accuracy; (3 ) insistence that dealers obtain written acknowledgments by consumers that they have received required disclosures; and (4 ) in sistence that dealers forward copies of disclosure statements and acknowledgment of receipt of dis closures by consumers to the bank along with in stallment contracts that are assigned. W hile the last step will be of no help if the disclosures have not in fact been received and if the credit transactions in volve security interests in real property, such acknowledgments are conclusive evidence of com pliance by assignee banks in all other situations, pro vided the violations are not apparent on the face of the disclosure statements and the assignee did not know of the violation when the assignment was made. For insured banks, good faith compliance with the Truth in Lending Act and Regulation Z is essential 3 82 Stat. 157 (1968). 4 M O N TH LY not only because of the threat of legal proceedings for money damages by consumers but also because examiners are likely to become increasingly alert to the requirements of Truth in Lending and other new consumer protection laws. Already, examiners of the Federal supervisory agencies carry checklists of im portant Truth in Lending points to aid in their examinations of insured banks. A n excellent recent article by Mr. Griffith L. Gar wood, Chief of the Truth in Lending staff of the Board of Governors of the Federal Reserve System, reviews developments with the Truth in Lending A ct since 1968. It is published in The Banking Law Journal, 89, No. 1 (January 1972). The Fair Credit Reporting Act W ith the grow th of consumer credit, a necessary satellite industry dedicated to the accumulation and sale of information relating to individuals and their credit standing came into being. This industry is composed, for the most part, of credit bureaus, investigative reporting com panies and other organizations whose business it is to gather and report information about consumers. Am ong the principal users of consumer reports are banks, retail merchants, lenders, insurance companies, and other companies who regularly decide whether individuals who are the subjects of these reports are to receive credit, be granted insurance, or be em ployed— and, if so, upon what terms. Erroneous information in a person’s file can cause serious injury if it leads or contributes to the denial of credit, insurance, or employment. Prior to en actment of the Fair Credit Reporting A ct on October 26, 1970,4 many people were apparently damaged by inaccurate information, yet there was little they could do about it.5 Only one state had legislation designed to protect consumers against false and inaccurate reports affecting their financial standing, eligibility for insurance, or employment op portunities. Furthermore, common law rights of con sumers have been almost completely ineffective.6 The individuals themselves had no way of knowing what information was contained in credit files main tained on them. The typical credit investigation re quired only 30 minutes, and much of the information obtained was not verified. Frequently, victims of erroneous and harmful information were not even aware that a credit report had been used against 4 Public Law 91-508, 84 Stat. 1127 (1970). The Fair Credit Re porting Act was added as Title V I of the Consumer Credit Pro tection Act of 1968. 5 Hearings before the Subcommittee on Financial Institutions of the Committee on Banking and Currency, 91st Cong., 1st Sess., on S. 823 (1969), especially pp. 427-30. 6 Ibid., pp. 437-42; see also, “ Credit Investigations and the Right to Privacy: Quest for a Remedy,” Georgetown Law Journal (Febru ary 1969). REVIEW, FEBRUARY 1972 them. In addition, because many people have the same or similar names (John Smith, for example), adverse information about a particular Smith mis takenly found its way into the files of other, innocent Smiths. As data became automated, and as the files of different credit bureaus were interconnected by telecommunication techniques using direct access re mote terminals, errors in the process of coding, key punching, programming, or transmission became more likely, entirely apart from the problem of multiple John Smiths. Cases of abuse or misuse of consumer credit information also came to light in the course of Congressional hearings.7 The Fair Credit Reporting Act was designed to provide remedies for consumers adversely affected by false or inaccurate consumer reports and to limit the uses of such reports to legitimate business purposes. However, the statute is complex, and its effect in any particular factual situation depends upon three key definitions: (1 ) of “ consumer report” ; (2 ) of “ investigative consumer report” ; and (3 ) of “ con sumer reporting agency.” 8 A bank may well become a “ consumer reporting agency” unless it is scrupulously careful in limiting the types of information about consumers it com municates to third parties. But even where this classification is avoided, every bank is a regular user of information about consumers obtained from third parties; and the statute imposes a number of duties upon users, regardless of whether the infor7 Supra, note 5, pp. 42-430. 8 “ (d) The term ‘consumer report’ means any written, oral, or other communication of any information by a consumer report ing agency bearing on a consumer’s credit worthiness, credit standing, credit capacity, character, general reputation, per sonal characteristics, or mode of living which is used or ex pected to be used or collected in whole or in part for the purpose of serving as a factor in establishing the consumer’s eligibility for (1) credit or insurance to be used primarily for personal, family, or household purposes, or (2) employment purposes, or (3) other purposes authorized under section 604. The term does not include (A ) any report containing information solely as to transactions or experiences between the consumer and the person making the report; (B) any authorization or approval of a specific extension of credit directly or indirectly by the issuer of a credit card or similar device; or (C) any report in which a person who has been requested by a third party to make a specific extension of credit directly or indirectly to a consumer conveys his decision with respect to such request, if the third party advises the consumer of the name and address of the person to whom the request was made and such person makes the disclosures to the consumer required under section 615. (e) The term ‘investigative consumer report’ means a con sumer report or portion thereof in which information on a consumer’s character, general reputation, personal charac teristics, or mode of living is obtained through personal inter views with neighbors, friends, or associates of the consumer reported on or with others with whom he is acquainted or who may have knowledge concerning any such items of in formation. However, such information shall not include specific factual information on a consumer’s credit record obtained di rectly from a creditor or from a consumer reporting agency when such information was obtained directly from a creditor of the consumer or from the consumer. (f) The term ‘consumer reporting agency’ means any person which, for monetary fees, dues, or on a cooperative nonprofit basis, regularly engages in whole or in part in the practice of assembling or evaluating consumer credit information or other information on consumers for the purpose of furnishing con sumer reports to third parties, and which uses any means or facility of interstate commerce for the purpose of preparing or furnishing consumer reports.” Public Law 91-508, Section 603 (d ), (e ), and (f) (October 26, 1970); 84 Stat. 1128 (1970). mation comes from a consumer reporting agency or from other third parties who do not fall within this classification. Every user must inform the consumer orally or in writing if information received in a consumer report from a consumer reporting agency causes the user to deny, or increase the cost of, credit or insurance or to deny employment. The user must also inform the consumer of the name and address of the consumer reporting agency issuing the report. The user is not required, however, to tell the consumer the nature of the information in the report. In turn, every consumer reporting agency must, upon request and proper identification by any con sumer, clearly and accurately disclose the nature and substance of all information (except medical infor mation) in its files on the consumer at the time of its request. In addition, the agency must reveal the sources of any information unless it is to be used in an “ investigative consumer report.” 9 The agency must also disclose the names of recipients of any re port on the consumer that it has furnished for em ployment purposes within the two-year period pre ceding the request, and for any other purposes within the six-month period preceding the request. A different rule applies to information obtained by a creditor, insurance company, or employer from a source other than a consumer reporting agency. N o disclosures of any kind need be made to the consumer in this situation unless credit is involved. If credit is denied, however, or if its cost is increased either wholly or partly because of information bearing upon the consumer’s credit worthiness, credit standing, credit capacity, character, general reputation, per sonal characteristics, or mode of living, then the user of the information must disclose its nature to the consumer if, within 60 days after learning of the adverse action, the consumer asks in writing to know the reasons for it. The statute specifically requires the user clearly and accurately to disclose to the con sumer his right to make a written request at the time the adverse action is communicated to him. A bank or other financial institution may become a “ consumer reporting agency” if it regularly passes on information in its files about consumers, other than information solely confined to its own transac tions or experiences with the consumer.10 The bank or financial institution may, however, relate informa tion based solely upon its own transactions or ex periences with the consumer without becoming a 9 The sources of information acquired solely for use in an “ in vestigative consumer report” and used for no other purpose need not be disclosed except in the event of litigation. 10 See note 8, supra, for definition of “ consumer reporting agency.” FEDERAL RESERVE B A N K OF R IC H M O N D 5 consumer reporting agency, even if it regularly fur nishes such information to a consumer reporting agency. If a bank or other financial institution becomes a consumer reporting agency, it must comply with a number of duties to the consumer. First, information about consumers may not be disclosed to anyone except as authorized by Section 604 of the A ct.1 1 Second, certain types of obsolete information may not be furnished to anyone except in connection with a credit transaction expected to involve $50,000 or more in principal, or the underwriting of insurance expected to involve a face amount of $50,000 or more, or employment at an annual salary of $20,000 or more. Third, reasonable procedures must be main tained to assure maximum possible accuracy of all information in every consumer report, and certifica tion must be obtained from all users that the infor mation disclosed will only be used for authorized purposes. Fourth, a consumer reporting agency may not furnish a consumer report to any person if it has reasonable grounds to believe that the report will not be used for an authorized purpose. Finally, the identity of all new users must be verified by the agency. Banks and other financial institutions that wish to avoid becoming consumer reporting agencies must be particularly cautious in discounting installment paper for retail dealers. W hen a dealer calls the bank or other institution before credit is extended to inquire whether the contract will be purchased or credit will be extended to the consumer directly, and the bank or institution denies the credit or increases the cost even partially because of information ob tained from outside sources, then the dealer and the bank or other financial institution must each make certain disclosures to the consumer if the bank or other institution is not to become a consumer re porting agency. First, the dealer must advise the 1 Section 604 provides: “ A consumer reporting agency may furnish 1 a consumer report under the following circumstances and no other: (1) In response to the order of a court having jurisdiction to issue such an order. (2) In accordance with the written instructions of the con sumer to whom it relates. (3) To a person which it has reason to believe— (A ) intends to use the information in connection with a credit transaction involving the consumer on whom the information is to be furnished and involving the extension of credit to, or review or collection of an account of, the consumer; or (B) intends to use the information for employment purposes; or (C) intends to use the information in connection with the underwriting of insurance involving the con sumer: or (D) intends to use the information in connection with a determination of the consumer’s eligibility for a license or other benefit granted by a governmental instrumentality required by law to consider an ap plicant’s financial responsibility or status; or (E) otherwise has a legitimate business need for the information in connection with a business trans action involving the consumer.” Digitized 6 FRASER for MO N TH LY consumer of the name and address of the bank.12 The bank must then follow the normal procedure a user of information follows. If the bank’s decision is based on information in a consumer report, the bank must give the consumer the name and address of the agency. If the information comes from a third party, other than a consumer reporting agency, the bank must disclose to the consumer his right to make a written request within 60 days for the nature of the information. If, however, the bank’s decision was based on its own prior experience with the consumer or its own internal credit policies, then it need not make any disclosures at all. Special rules apply to a bank or other financial institution that uses or prepares an “ investigative consumer report.” A s a user, if a bank requests such a report from a consumer reporting agency, the bank must mail or deliver written notice to the consumer within three days that an investigative consumer re port may be made and that it may include informa tion regarding the character, general reputation, per sonal characteristics, and mode of living of the con sumer. The consumer must also be informed that he may make a written request for disclosure of the “ nature and scope” of the investigation. If the con sumer then requests this information within a rea sonable time thereafter, the bank must within five days furnish the consumer with a complete and ac curate written description of the “ nature and scope” of the investigation. If a bank or other financial institution denies or increases the cost of credit or insurance or denies employment based upon information in an investiga tive consumer report, it must make the same dis closures a user must make if it takes such action on the basis of an ordinary consumer report. No disclosures at all need be made, however, if an in vestigative consumer report is to be used for em ployment purposes and the consumer has not specifically applied for the position, or if the bank or other institution conducts the investigation for its own purposes, using its own employees. These and many other important questions relat ing to the Fair Credit Reporting A ct are discussed in two documents, both of which should be in the file of every bank or affiliated institution engaged in extending consumer credit. The first is a pamphlet containing the text of the A ct and 61 specific ques tions and answers, entitled “ Guidelines for Financial Institutions in Complying with the Fair Credit R e porting A ct.” The pamphlet was prepared jointly by 1 4 CCH Consumer Credit Guide, f99,486; Section 603(d) (3) (C) of 2 the Fair Credit Reporting Act. REVIEW, FEBRUARY 1972 the Board of Governors of the Federal Reserve System, the Comptroller of the Currency, the Fed eral Deposit Insurance Corporation, and the Federal Home Loan Bank Board. Copies may be obtained free of charge from any of the foregoing organiza tions or from any Federal Reserve Bank. The second useful document, entitled “ Compliance with the Fair Credit Reporting A ct,” may be obtained free of charge from the Bureau of Consumer Protection, Federal Trade Commission, Washington, D. C. 20580. Both publications represent the informed views of the staffs of the agencies publishing them, but are not substantive rules having the force and effect of law. A s a matter of fact, none of the agencies charged with enforcement of the A ct has the authority to issue substantive rules, as does the Board of Governors with respect to Truth in Lending.12a Consumers may bring legal actions for money damanges against users of information and consumer reporting agencies who fail to comply with the Act, if they can prove that the agency or user was either willful or negligent in its noncompliance. This stands in sharp contrast to Truth in Lending where, as shown in Part II published last month, monetary penalties may be assessed for inadvertant violations. Moreover, no user or consumer reporting agency may be held liable for any violation of the provisions of the Fair Credit Reporting Act pertaining to in vestigative consumer reports if it can prove that at the time of the alleged violation it maintained “ reasonable procedures” to assure compliance.13 Once again, then, the new consumer protection laws favor companies that take positive steps to comply. For users of consumer information who are not “ consumer reporting agencies,” this involves the following procedures, at minimum. (1 ) Instruct credit personnel in writing that consumer reports may only be obtained for per missible purposes, and list these purposes. (2 ) Establish procedures to insure that proper disclosures are made to consumers when credit is denied or the charge is increased based on information in a consumer report or received from third parties. Even though the A ct does not require it, it is good practice to develop forms for making the required disclosures and 1 a Nevertheless, the courts are likely to give great weight to es 2 tablished administrative practices of the agencies responsible for enforcing compliance. F.T.C. v. Mandel Brothers, Inc., 359 U.S. 385 (1959). Although, as discussed in Part I, FTC does not appear to have jurisdiction over banks themselves, it may have over bank holding companies and other affiliates of banks. 13 Section 61 5 (c), 84 Stat. 1133 (1970). to retain copies showing that the disclosures were made. (3 ) Maintain records, even if only in the form of handwritten notations, of information received from others so that such information will be available in the event the consumer asks for it. Banks and other financial institutions face much more formidable compliance problems if they become consumer reporting agencies. The document pre pared by the F T C entitled “ Compliance with the Fair Credit Reporting A ct,” mentioned above, is one es sential source of information on this subject. Another useful one, entitled “ H ow to Comply with the Fair Credit Reporting A ct,” has been prepared by A s sociated Credit Bureaus, Inc. Copies may be ob tained free of charge by sending a stamped, self address envelope to Associated Credit Bureaus, Inc., 6767 Southwest Freeway, Houston, Texas 77036. Credit Cards and the Proposed Fair Credit Billing Act N o survey of current consum er p ro tection laws affecting banks would be complete without brief reference to recent and pending legis lation relating to credit cards. Approximately 25 million bank cards are now in use, involving about 375 million purchases and over seven million loans annually. Outstanding charges based on bank credit cards at the end of 1971 approached $4 billion, a dra matic increase from the level of $633 million reported by the Federal Reserve System as recently as Sep tember 1967. Even though credit extended on the basis of bank cards accounts for something less than 10 percent of total consumer credit extended by banks at the present time, nearly 200 million state ments were sent to consumers in connection with bank credit card programs in 1971. Most credit card plans permit the cardholder to obtain a direct cash advance, up to a certain stated amount, from a participating bank, or to use the card as a substitute for currency or a check to pay for merchandise or services purchased from par ticipating retailers. W here cash is advanced directly by a bank, an initial transaction charge of approxi mately 2 to 4 percent of the amount of the advance may be assessed, depending upon the particular credit card plan. In addition, finance charges may begin to accrue from the date the funds are initially made available to the cardholder, or at some later date. W here merchandise or services are purchased, the cardholder is ordinarily allowed a “ free ride” period averaging about 45 days from the date of the pur chase before finance charges begin to accrue. No charge is assessed if payment is received before the FEDERAL RESERVE B AN K OF R IC H M O N D 7 end of the “ free ride” . Finance charges (exclusive of transaction and minimum charges) on both cash advances and retail purchases range from around 10 to about 18 percent per year, depending upon the particular plan. Acceptance and use of a bank credit card is regu lated by a complex network of contractual arrange ments among banks and individual cardholders, on the one hand, and among banks and retail merchants, on the other. Under their agreements with mer chants, banks take all of the credit risks associated with sales of merchandise or services by retailers honoring bank cards. Retailers accepting the cards for purchases discount the sales drafts with a par ticipating bank, usually receiving immediate credit in their account for somewhere between 92 and 100 percent of the face amounts of the drafts depending upon the particular agreement between retailer and bank in individual cases. The average discount for credit card sales handled by mediants is said to be about 3 percent of the face amount of the sales drafts, or 54 cents on the average sale. Currently, income to banks from bank credit card programs, based upon finance and other charges paid by card holders, is said to account for about 77 percent of total revenues of such banks from their credit card programs, while the remaining 23 percent results from merchant discounts in connection with sales transactions involving credit cards.14 A key feature of the cardholder’s agreement with and many of these may be subject to the law of more than one state. Some 1,450 banks are now issuing bank credit cards, in cooperation with about 8,000 “ agent” banks, approximately 4,200 of which are in the Master Charge system and about 3,600 of which are associated with the BankAmericard group. The functions and powers of agent banks vary ac cording to the terms of their individual agreements with card-issuing banks, subject, however, to con trolling interchange regulations governing the e x change of debits and credits among all the par ticipating banks. These interchange rules are ad ministered by the Interbank Card Association, in the case of Master Charge cards, and by National Bank Americard, Inc., in the case of BankAmericards. Interchange regulations are essential to bank credit operations for two reasons. First, a substantial (and increasing) use of the cards is in connection with interstate transactions, where the issuing or agent bank is in one state and the bank extending credit or the merchant selling to the cardholder is in a dif ferent state. Second, such regulations are needed for intrastate transactions if more than one bank is involved. Prior to October 26, 1970, the legal status of in dividuals holding credit cards depended almost en tirely upon their contractual agreements with par ticipating banks under the laws of the 50 states, except for disclosure requirements imposed by the Truth in Lending Act. On that date, Title V of the the issuing bank (a feature, by the way, that may Consumer Credit Protection A ct became law.16 This be changed by pending legislation and by a proposed regulation of the Federal Trade Commission, as dis statute prohibits issuance of a credit card except in response to a request or application, although the cussed below) is the cardholder’s undertaking to look prohibition does not apply to issuance of a card in to the merchant from whom the goods or services renewal of, or in substitution for, an accepted card. were purchased for warranties of performance and It also limits the liability of a cardholder for un not to the bank to whom payment is to be made.15 authorized use of his card to a maximum of $50. Three states, Massachusetts, California, and New Even this liability does not exist unless the card Jersey, have recently enacted legislation making such issuer has given adequate notice to the cardholder of banks responsible for claims by consumers against his potential liability for unauthorized use and unless merchants arising out of credit card sales. two additional conditions are met. These a re : In the neighborhood of 30 percent of the 382 (1 ) that the card issuer has provided the cardholder million annual purchase and loan transactions by means of credit cards involve more than one bank, with a self-addressed, prestamped notification to be mailed by the cardholder in the event of loss or theft of the ca rd ; and (2 ) that the unauthorized use occurs 14 For a comprehensive review of current financial aspects of bank credit cards, see Andrew F. Brimmer, “ Growth and Profitability of Credit Card Banking,” paper presented at the 1971 National Credit Card Conference of the American Bankers Association (October 27, 1971). 15 Interestingly, when the FTC issued its Trade Regulation Rule proscribing the issuance of unsolicited credit cards in March of 1970, it took the position that “ the activity of issuing credit cards by banks appears to fall within the jurisdiction of the Commission.” This seems exceedingly doubtful in view of the specific language of Section 5 of the FTC Act excluding banks from the Commission’s jurisdiction. It is understood that most bank credit card plans are operated by banks directly, and not through nonbanking sub sidiaries or affiliated corporations. 8 MO N TH LY before the cardholder has notified the issuer that an unauthorized use may occur as the result of loss or theft. Furthermore, after January 25, 1972, no liability for unauthorized use exists with respect to any credit card unless the card issuer has provided 16 Public Law 91-508, 84 Stat. 1126 (1970). REVIEW, FEBRUARY 1972 a method whereby the user of the card can be identi fied as the person authorized to use it.17 A s pointed out in a letter from the three Federal bank supervisory agencies to all insured banks in the autumn of 1971, many card issuers have continued to issue cards with statements imprinted on the re verse side such as the following: legal effect of preventing cardholders from refusing to pay issuing or agent banks when merchandise or services, purchased by means of the cards, turn out to be defective. Pending in Congress is S. 652, the “ Fair Credit Billing A ct,” sponsored by Senators Proxmire and Brooke, which, among other things, contains the following provision: In case the credit card is lost or stolen, the cus tomer shall be responsible for any extensions of credit to anyone through use of the card until the card issuer receives written notice of its loss or theft. §169 Rights of Credit Customers A card issuer who has issued a credit card to a cardholder shall be subject to all claims and de fenses arising out o f any transaction in which the credit card is used as a method o f payment or extension o f credit. The letter advised banks that continued issuance of cards with statements such as the above would not appear to be justified under present law. Except for the above provisions of Federal law, and except for more general Federal authority under antitrust and trade regulation laws, state laws now control the legal relationships among cardholders, banks, and merchants. This situation is said to be un satisfactory to both the credit card industry and to consumer groups, but for different reasons. The principal objections of the credit card in dustry to the present state of the law center around the lack of uniformity of state laws and the high proportion of credit card transactions involving two or more states.18 Serious conflict-of-law problems may arise when disputes occur in multi-state trans actions, and this situation is aggravated by the tendency of states to enact different types of consumer protection laws or to enact similar types but with significantly different provisions. Vexing questions arise regarding which state laws should apply, and such controversies may well wind up in the courts. The credit card industry is said to believe that as credit cards evolve from the present concept of a currency substitute with a credit feature into an identity card by means of which the holder can gain access to a wide range of financial services on a na tionwide scale, more uniform legal rules throughout the United States will become increasingly necessary. Consumer groups advocate greater Federal regula tion of credit card practices on the ground that many historic provisions of state law are unfair to con sumers. Under particularly heavy attack are the so-called “ holder-in-due-course” doctrine and the “ waiver of defense” clause, both of which have the 17 The statute places the burden of proof upon the card issuer to show that the use was authorized or, if the use was unauthorized, to show that the conditions of liability set forth above have been met. In a separate provision, the statute declares that any person who, in a transaction affecting interstate or foreign commerce, uses any counterfeit, fictitious, altered, forged, lost, stolen, or fraudulently obtained credit card to obtain goods or services, or both, having a retail value aggregating $5,000 or more, shall be fined not more than $1,000 or imprisoned not more than five years, or both. 18 The American Banker (October 27, 1971). Presumably, this section is designed to increase the consumer’s leverage by permitting him to with hold payment from the bank in the event of disputes with merchants regarding products or services pur chased. Conceivably, however, the broad language might be construed to render card issuers subject to liability for tort claims arising out of use of the merchandise. Moreover, in many situations, par ticularly involving interstate transactions or small purchases, a credit card is not used to obtain credit in the traditional sense, but instead is merely a con venient substitute for cash or a check. Probably no finance charges are imposed in the vast majority of interstate sales or sales involving small purchases because the cardholders pay before expiration of the “ free ride” period. It seems questionable, therefore, whether there is any rational basis for using a statute purportedly dealing with the regulation of consumer credit as a means of eliminating statecreated legal rights where the transactions have only a distant relationship, at best, to the extension of consumer credit. This section of the proposed A ct is under heavy fire from creditors, many of whom argue that it would force them out of business.19 Other significant provisions of the proposed “ Fair Credit Billing A ct” are summarized in the footnote below.20 A n informative and extensive review of 10 The American Banker (October 28, 1971). Apart from S. 652, and the new state statutes in Massachusetts, California, and New Jersey referred to earlier, the Federal Trade Commission has pro posed a “ Trade Regulation Rule,” which would require a merchant’s “ promissory note or other instrument of indebtedness” in a credit sale to provide that any holder in due course who takes the in strument takes it subject to all claims and defenses of the mer chant’s customer arising out of the sale. 16 C.F.R. §433, 36 Fed. Reg. 1211 (1971). 20 The proposed bill would also: (1) amend §127 (b) (2) of the Truth in Lending Act by adding a requirement that the card issuer identify on the periodic statement the “ vendors and/or creditors in volved” ; (2) amend §127(b) to require that periodic statements contain an address or telephone number for use by the cardholder in making inquiries about his billing statement; (3) require the card issuer to acknowledge complaints about billing statement errors within 10 days and correct the account within 30 days, or send the cardholder an explanation with documentary evidence of the ac curacy of the account; (4) prohibit open-end creditors offering a “ free ride” period from imposing a finance charge unless the billing statement was mailed at least 21 days prior to the date payment must be made; (5) require the creditor, in determining the balance upon which the finance charge is computed, to reduce the opening balance in the account at the beginning of the billing cycle by de ducting all payments and credits made during the cycle; (6) pro hibit open-end creditors from imposing minimum finance charges; (7) prohibit credit card issuers from offsetting a cardholder’s indebtedness against funds of the cardholder held on deposit with the card issuer; and (8) assure the consumer of his right to refund of any credit balance in his account. FEDERAL RESERVE B A N K OF R IC H M O N D 9 pending Federal and state regulatory developments operating on a national or regional basis; about 2,000 affecting the credit card industry may be found in The Business Lawyer, 27, No. 1 (Novem ber 1971), credit unions; and approximately 1,500 retailers. All 50 states and the District of Columbia were rep 93-138. resented in the sample. The National Commission on Consumer Finance Basic research of great potential significance for the future of the consumer credit industry in the United States is now in progress by the staff of the National Commission on Consumer Finance. Created in 1968 by Title IV of the Consumer Credit Protection A ct,21 the Commission is composed of Senators John J. Sparkman (D .-A la .), William Proxmire (D .-W is c.), and William E. Brock (R .-T enn .) ; Representatives Henry B. Gonzales (D .-T e x .), Leonor K. Sullivan (D .-M o .), and Lawrence G. Williams (R .-P a .) ; and Dr. Robert W . Johnson, Professor of Industrial A d ministration, Purdue University, Douglas M. Head, Minneapolis attorney and former Attorney General of Minnesota, and Ira M. Millstein, New Y ork City attorney, who is Chairman. principal duty is to The Commission’s . . study and appraise the functioning and structure of the consumer finance industry, as well tions generally.” as consumer credit transac The law requires it to report to Congress on or before July 1, 1972, on . . the adequacy of existing arrangements to provide con sumer credit at reasonable rates.” In an interview with this writter in W ashing ton, D. C., Mr. Milton W. Schober, General Attorney for the Commission, and Professor Robert P. Shay, Professor of Banking and Finance, Co lumbia University, and consulting economist to the Commission, described two major data-gathering projects now in progress by the Commission’s staff. The first is a massive survey of consumer creditors, entitled “ Survey of Consumer Credit Volume, Out standings, and Rates.” Designed by Dr. Shay, the objective of the survey is to determine the amounts of all of the various types of consumer installment credit outstanding in each state and the corresponding finance charges. The initial purpose is to assess the influence of state laws and regulations on the price and availability of consumer installment credit. The survey is based upon questionnaires approved by the Office of Management and Budget, which were sent to 2,325 commercial banks; 490 mutual savings banks; 1,375 finance companies, including the large nationwide sales finance companies as well as ap proximately 30 large, diversified finance companies 2 82 Stat. 164 (1968) as amended 84 Stat. 440 (1970). 1 10 M O N TH LY Am ong other things, the questionnaires call for information on the volume of consumer credit e x tended during the second quarter of 1971 and the amount of such credit outstanding on June 30, 1971. It is understood that the response rate has been well over 90 percent for every class of creditor except credit unions, whose response rate has been some what lower. Most of the data was collected by the Bureau of the Census, and all of it was processed and tabulated by that Bureau’s data processing facilities and personnel. It is now being analyzed by the Commission’s staff. The second important project is an evaluation of the effectiveness, under the laws of the 50 states, of creditors’ legal remedies to enforce payment of con sumer debt. One objective of this survey, entitled “ Survey Consumer of Collection Practices and Creditors’ Remedies,” is to find out which legal remedies of creditors are actually used and which ones are not. A questionnaire running to 30 legal- size pages, also approved by the Office of Manage ment and Budget, has been distributed to 1,250 com mercial banks, 600 credit unions, 650 finance com panies, 380 retail creditors, and 300 collection agencies. Here again, it is understood that the re sponse rate has been high. The data is currently being analyzed by the Commission’s staff. In conjunction with the gathering of data, the Commission held public hearings in Washington, D. C., in June of 1970, on methods used to collect consumer debts. In announcing the hearings, Mr. Robert Braucher, Professor of Law at Harvard and Chairman of the Commission at the time, stated: “ W e believe there are widespread abuses of creditor remedies which place a particularly harsh burden on unsophisticated or uneducated low -in com e families. Indications are that these abuses have had severe economic and social consequences on thousands of American families.” Subjects explored at the hearings included (1 ) legal tactics or devices that may be used to circumvent the consumer’s ability to contest claims against him, including the holder-in-due-course doctrine, (2 ) confessions of judgment, (3 ) wage assignments, (4 ) postbank ruptcy suits, (5 ) debtors’ prisons, and (6 ) misuse of the small claims court. Additional public hearings were held in June of 1971 to determine the extent REVIEW, FEBRUARY 1972 of Federal and state enforcement of existing con sumer credit protection laws.22 in Lending A ct was enacted that year, applying equally to commercial banks and their affiliates en The next step planned by the staff is the prepara gaged in extensions of consumer credit and to other, tion of an econometric model that will include de nonbanking enterprises. The rapid expansion of un regulated one-bank holding companies, beginning in mographic data of the consumer credit market in each state. The Commission’s staff will then attempt the spring of 1968, led to extensive changes in bank to tie together the results of its two surveys. In holding company regulation in 1970, greatly enlarg particular, the staff plans to look closely at “ con venience and advantage” laws in many of the states, ing the permissible range of activities for all types which have the effect of limiting freedom of entry into the consumer finance industry. The staff plans to evaluate the possible effects of these laws on availability of consumer credit, as well as rates of finance charges for consumer credit. Another responsibility of the Commission is to study the adequacy of existing Federal and state en forcement mechanisms to prevent violations of con sumer credit protection laws. The Commission is itself reviewing enforcement practices of Federal regulatory agencies. In cooperation with the Com mission, the National Conference of State Bank Su pervisors is undertaking to study the capability of state banking departments to enforce state laws. The Commission’s report to Congress may be ex pected to comment on both Federal and state en forcement laws and practices, and their effectiveness. of bank holding companies both functionally and geographically. Although banks themselves con tinue to be specifically exempt by statute from the enforcement jurisdiction of the Federal Trade Com mission, bank holding companies and their affiliates may not be. In 1970, the Fair Credit Reporting A ct was en acted. Like Truth in Lending, it covered banks, bank holding companies and other bank affiliates, as well as nonbanking organizations, and imposed affirmative disclosure requirements. Credit card usages were also brought under certain Federal re strictions, and more extensive legislation may be enacted. The work of the National Commission on Consumer Finance may lead to greatly expanded Federal legislation in the area of consumer finance. Concluding Comments U ntil 1968, banks and bank holding companies had little reason to be con cerned about Federal consumer protection laws. The Federal Trade Commission A ct was the principal Federal statute dealing with prevention of unfair and deceptive business practices, but it did not apply to commercial banks (and still does n ot). Multi bank holding companies were severely restricted in the performance of consumer credit functions, and the activities of unregulated one-bank holding com panies were only beginning to be of importance. A combination of events commencing in 1968 drastically changed the entire situation. The Truth Banks and bank holding companies that fail to establish and maintain effective internal compliance programs to deal with the broadening requirements of Federal and state consumer protection laws may find that the risks they have assumed far outweigh the effort and expense they have avoided. This will be even more probable if Congress accepts the recom mendation of the Board of Governors in its Annual Report to Congress for the Year 1971 that the Truth in Lending A ct be amended to provide for a “ good faith” defense such as is contained in the Securities and Exchange A ct of 1934— one which would apply not only to the Board’s Regulation Z, but also to all interpretations of it by the Board.23 William F. Upshaw 22 A t this hearing commercial banks and savings and loan associa tions were criticized by the Chairman of the Federal Trade Com mission, Miles W . Kirkpatrick, for their alleged failure to refuse to discount retail installment paper not in full compliance with the Truth in Lending Act. As discussed in Part II, the Federal supervisory agencies have taken positive action to call to the at tention of regulated financial institutions their responsibilities in connection with dealer paper. 23 The relevant section of the Securities and Exchange Act states: “ No provision of this subchapter imposing any liability shall apply to any act done or omitted in good faith in conformity with any rule or regulation of the Commission, notwithstand ing that such rule or regulation may, after such act or omission, be amended or rescinded or be determined by judicial or other authority to be invalid for any reason.” 12 U.S.C. §77s(a). The M o n t h l y R e v i e w wishes to express its appreciation to Mr. Griffith L. Garwood, Chief, Truth in Lending Section, Division of Supervision and Regulation, Board of Governors of the Federal Reserve System, for his many useful suggestions and comments and for making available materials that were most helpful in the preparation of “ Banking in the Consumer Protection Age.” FEDERAL RESERVE B A N K OF R IC H M O N D 11 FORECASTS 1972 Success for the New Economic Program? Like the economy itself, economic forecasting has its peaks and troughs. Based solely on last year’s forecasts for current dollar G N P, one would con clude that some recovery is under way in the fore casting accuracy cycle. A more comprehensive evaluation of last year’s forecasts, however, calls this conclusion into question. In general, last year’s forecasts were close to pre dicting current dollar G N P accurately, but overly optimistic with regard to the rate of inflation. The forecasters did not expect cost-push inflation to con tinue in 1971 to the extent that it did. Thus, they overestimated the increase in both real G N P and the index of industrial production but underestimated the rise in the unemployment rate. In retrospect, cost-push forces could have been expected for 1970 and 1971, since an extraordinarily large number of workers were due for contract re negotiation in those years. But the forecasters ap parently did not think that cost-push forces would be sufficient to outweigh the excess capacity and easing employment markets that resulted from the 1970 recession. This year the forecasters are relying upon Presi dent N ixon’s New Economic Program to restore the economy to a healthier rate of real growth and a lower rate of price increase and to engender a de cline in the unemployment rate. The large increase in residential construction spending in 1971 is ex pected to lead to rather substantial increases in con sumption spending for major household goods and appliances in 1972. This rise in the demand for con sumer home durables, coupled with an expected high level of domestic automobile sales due to the excise tax cut and the lessening of import competition, is expected to generate a 9.1% growth rate for total durable goods expenditures. Most of the forecasters are also predicting a good year for the steel industry because of strong durable goods demand, rebuilding of inventories, and lessened import competition. The consensus of forecasts examined in this article indicates a 1972 G N P of around $1,141.0 billion. Based upon current Department of Com growth of G N P throughout the year with no major strikes expected. Inventory replenishment will be a notable source of strength if the recovery proceeds as expected. The 1972 forecasts summarized here represent the best efforts of business and academic economists during the autumn and winter of 1971 to predict the performance of the U. S. economy in 1972. This article attempts to convey the general tone and pattern of some 60 forecasts reviewed by the R e search Department of this Bank. Not all of them are comprehensive forecasts, and some incorporate estimates of the future behavior of only a few key economic indicators. Several represent group rather than individual efforts. merce estimates for 1971 GN P, this figure would ticipating an increase in the implicit price deflator represent a gain of approximately 9.0% , which is for G N P of around 3.6% , which would indicate a somewhat real growth rate for G N P of almost 4.2% . larger than the 7.5% rate in 1971. Economists are predicting a rather steady rate of 12 The views and opinions set forth in this article are those of the various forecasters. N o agreement or endorsement by this Bank is implied. 1971 FORECASTS IN PERSPECTIVE The consensus forecast for 1971 G N P, published in last February’s Monthly Review, was $1,049.6 billion, an increase of 7.8% over 1970. The col lection of forecasts ranged from a low of $1,031.0 billion to a high of $1,059.0 billion. After allowing for expected price increases, the growth of real G N P was predicted to account for more than half of the 7.8% rise. On the government side of the forecast ing spectrum, the controversial forecast made by the Council of Economic Advisers from the now wellknown Laffer model projected a G N P of $1,065.0 billion for 1971. Latest estimates by the Depart ment of Commerce indicate a 1971 G N P total of $1,046.8 billion, which is reasonably close to the consensus forecast of the business and academic economists. Compared to 1970, when the seers overestimated the G N P by $10.0 billion, and to 1969, when they underestimated it by $18.0 billion, 1971 was a better year. A t least so far as current dollar G N P is concerned. In late 1970 and early 1971 forecasters were an In fact, the implicit price deflator for G N P rose 4.6% , and M O N TH LY REVIEW, FEBRUARY 1972 RESULTS FOR 1971 AND TYPICAL FORECAST FOR 1972 Unit or Base Percentage Change Preliminary Forecast 1970/ 1971/ 1972* 1971 1972 1971 7.5 7.5 13.3 5.3 7.8 11.5 6.0 33.6 — 6.2 —2.1 12.6 9.0 8.4 9.1 7.7 8.8 11.0 7.5 9.1 __ 8.4 —7.1 15.0 2.07 10.5 5.4 42.0 20.2 2.0 3.9 113.2 116.1 125.1 146.0 -0 .4 3.0 4.3 4.6 billions billions billions billions billions billions billions billions billions billions billions 1,046.8 662.2 100.4 278.8 283.0 150.9 108.2 40.6 2.1 233.1 0.7 1,141.0 717.8 109.5 300.3 307.9 167.5 116.3 44.3 6.9 252.7 3.0 Plant and equipment expenditures ___________ ___ $ billions Corporate profits before ta x e s ________________ ___ $ billions 81.43 84.9 87.25 97.6 2.03 10.1 6.0 106.3 113.7 121.3 141.5 Gross national product ______________________ ___ Personal consumption expenditures _______ ___ Durables ________________________________ ___ N ondurables_____________________________ ___ Services_________________________________ ___ Gross private domestic investment _________ ___ Business fixed investment _______________ ___ Residential construction _________________ _ _ Change in business inventories __________ ___ Government purchases of goods and services ___ Net exports of goods and services__________ ___ $ $ $ $ $ $ $ $ $ $ $ Private housing starts________________________ ___ Automobile sales _____________________________ ___ Rate of unemployment _______________________ ___ millions millions percent Industrial production index __________________ __ _ _ __ Wholesale price index _______________________ ___ Consumer price index _ _ _ __ _ _ __ Implicit price d efla tor______ ________________ 1967 1967 1967 1958 — 6.5 2.1 3.1 3.2 * Figures are constructed from the typical percentage change forecast for 1972. real G N P increased only 2.8% . Thus, although the forecasters predicted current dollar G N P relatively accurately, they underestimated the rate of inflation and overestimated the rate of real growth. This type of forecasting error is hardly a new phenomenon. The consensus predictions have substantially under estimated the rate of inflation for each of the last four years. The 1971 inflation forecast, in particular, would have been even less accurate if the wage-price freeze had not been ordered. The consensus of the quarter-by-quarter forecasts for 1971 was that current dollar G N P was expected to rise by approximately $30.0 billion during the first quarter, $20.0 billion in the second, $17.0 bil lion in the third, and $18.2 billion in the fourth. G N P actually increased $32.4 billion, $19.2 billion, $13.4 billion, and $19.6 billion for the four quarters, respectively. Again, the estimates were remarkably close to the actual quarter-by-quarter figures. The quarterly inflation predictions of 3.9% , 3.5% , 3.4% , and 3.1% made by the forecasters were too low for the first half of the year and too high for the price-controlled second half. During 1971 the annual rate of price increase was 5.3% in the first quarter, 4.2% in the second, 2.5% in the third, and 1.5% in the fourth. On the consumer side, 1971 personal consumption expenditures were expected to total $663.4 billion, but they now appear to be $662.2 billion. Gross private domestic investment was underestimated; that account was predicted to reach $145.0 billion, but it actually totaled $150.9 billion. Much of this underestimate is attributable to the greater-than-expected upsurge in residential construction. Fore casters had predicted that private housing starts would total only 1.7 million units in 1971, but they actually totaled over 2.0 million. W ith respect to the public sector of the economy, government purchases of goods and services were predicted accurately. The consensus of forecasters expected these outlays to total $233.9 billion. Actual spending was $233.1 billion, according to the pre liminary estimates. Because it overestimated the rate of real growth of the U. S. economy, the consensus forecast for the average unemployment rate was overly optimistic. FEDERAL RESERVE B A N K OF R IC H M O N D 13 The rate, predicted to average 5.5% for the year, was actually 6.0% . The tendency to expect a more rapid recovery was also evident in the forecast for the index of in dustrial production. The predictors expected a 3.6% increase, but the index actually fell 0.4% . Strangely enough, the seers, having overestimated the fall in the unemployment rate, the rate of real growth, and the index of industrial production, underestimated corporate profits. Pretax corporate profits, estimated to increase 8.0% , actually rose 12.6%. If their expectations for a stronger recovery had been correct, their corporate profits estimate would have been even farther from the mark. The consumer price index rose 4.3% from its 1970 average, a figure close to the consensus fore cast of a 4.0% rise. The wholesale price index, however, predicted to rise 2.0% , rose approxi mately 3.0% . Many of last year’s forecasters apparently thought that the U. S. economy in 1971 would recover from its recessionary and inflationary woes more vigor ously than it did. On the other hand, the consensus of forecasters for the year before that, 1970, under estimated the extent of the downturn. Although this tendency to underestimate a downturn and to over estimate an upturn might tempt the analyst to accuse the business and economic forecasters of a maidenly optimism, the more likely explanation is that years of recession and recovery are much more difficult to project than those of more normal growth. 1972 FORECASTS IN BRIEF G ross N a tio n a l P ro d u c t Forecasts for 1972 cu r rent dollar G N P are concentrated around $1,141.0 billion. This estimate represents an approximate 9.0% yearly gain, which is somewhat more than the 7.5% advance registered in 1971. However, price rises are expected to account for only about onethird of the anticipated increase, whereas they ac counted for nearly two-thirds of the 1971 increase in current dollar G N P. The forecasts range from a low of $1,135.0 billion to a high of $1,155.0 billion. Most of those who made quarterly forecasts expect G N P, measured at seasonally adjusted annual rates, to increase by almost $26.5 billion during the first quarter and by about $25.5 billion in each of the three succeeding quarters. Personal consumption expenditures are estimated to total $717.8 billion in 1972, an 8.4% increase compared with the 7.5% rise registered during 1971. The forecasters expect relatively more of the 1972 increase to stem from expenditures for durable goods 14 MO N TH LY TYPICAL* QUARTERLY FORECAST FOR 1972 Q u a rte r-b y -Q u a rte r C hanges in Unless O th e rw is e B illio n s o f D o lla rs N oted I Gross National Product II III IV 26.5 25.4 25.8 25.6 15.1 14.0 15.0 15.0 5.0 4.5 5.5 4.9 1.0 0.5 0.2 0.6 Personal Consum ption Expenditures G ross Private D om estic Investm ent N e t E xp orts G overnm ent Purchases 5.6 5.0 6.1 5.1 Im plicit Price D e fla to r f 3.4 3.0 3.3 3.3 Rate of U n em p loym en t ( % ) 5.7 5.5 5.3 5.1 * M edian. f Percentage changes at annual rates. than from nondurable goods spending. The fore casts call for a 9.1% increase in durables spending and a 7.7% rise in outlays for nondurables. Government purchases of goods and services are expected to total $252.7 billion in 1972. This pro jected increase of 8.4% , larger than the 1971 gain of 6.2% , reflects the probability that defense spend ing will again begin to rise. Gross private domestic investment is expected to rise by about 11.0% to $167.5 billion, which is only slightly smaller than the 11.5% increase during 1971. However, compared to the 3.1% decline in 1970, the projected gain for 1972 represents a continuation of the substantial recovery achieved in 1971. The forecasters' estimates for gross private domestic in vestment ranged from $163.0 billion to $178.0 billion. N o clear-cut consensus emerged, so a median figure was chosen for use in the accompanying table. Fully half of the forecasters’ estimates, it should be noted, were between $166.0 billion and $169.5 billion. The leading growth component of gross private domestic investment during 1971 was residential construction, which increased 33.6% from its de pressed 1970 level. Residential construction is ex pected to rise approximately 9.1% in 1972, a reduced but still healthy rate. Business fixed investment ex penditures are projected to rise 7.5% , an improve ment over the 6.0% growth registered for 1971. Finally, businessmen are expected to rebuild their inventories in 1972. O f the expected $16.6 billion increase in gross private domestic investment, $4.8 billion stems from inventory buildup. The estimates for inventory investment ranged from $5.1 billion to $10.1 billion. REVIEW, FEBRUARY 1972 Industrial Production M ost predictions call for the Federal Reserve index of industrial production (1 9 6 7 = 1 0 0 ) to average 113.2 during 1972, an in crease of 6.5% over the previous year. This com pares with a 0.4% actual decline for 1971 and a 3.0% drop for 1970. The forecasters are expecting increases in automobile production, steel production, and an expansion in the production of consumer household durables. Construction T h e value of new construction put in place is expected to total around $117.0 billion or $118.0 billion in 1972, an increase of around 9.0% or 10.0% over 1971. Both private residential construction and private nonresidential construction are expected to do well in 1972. Private residential construction is predicted to increase 9.1% for the year. This forecast is considerably below the 33.6% increase actually registered during 1971, because much of the pent-up demand for housing appears to have been satisfied. Private nonresidential construc tion is expected to increase 5.0% to 6.0% over its 1971 total. Private housing starts are commonly ex pected to increase only a slight 2.0% over the very large 1971 total of 2.03 million units. The prediction that they will remain as high as the 1971 level, how ever, implies that the housing industry will have another good year. Business Fixed Investment M ost forecasts in dicate that firms will put $116.3 billion in fixed in vestment spending in 1972. This figure represents an increase of 7.5% over 1971. This projected in crease over the 6.0% rate realized in 1971 stems from an expected moderate resurgence of investment spending during the second half of the year. Most of the forecasters based their predictions on the as sumed passage of President N ixon’s investment tax credit. Corporate Profits Forecasters are far from unanimous about the future for corporate profits, and predictions for the growth of corporate profits before taxes range from around 8.0% to 20.0% . Most of the estimates, however, center around a 15.0% growth, which would raise the total to $97.6 billion for the year. Such a growth of corporate profits sug gests a more profitable year for businesses than either 1970 or 1971. In 1971, pretax profits grew approximately 12.6% ; in 1970 they fell 9.4% . Unemployment T he unem ploym ent rate is p ro jected to average 5.4% by most of the observers of the 1972 scene. Individual forecasts range between 5.0% and 5.7% . The unemployment rate reached 6.1% in December 1971 and averaged 6.0% for all of 1971. Hence, forecasters are predicting a moderate fall in the rate. Prices This year all forecasters are predicting a more moderate rate of price increase. The most common prediction is that the implicit deflator for G N P will increase by only 3 .2% — well below the 4.6% increase of last year. The most pessimistic of the forecasters predicts an increase of 4.0% . The consumer price index is expected to rise 3.1% during the year. Predictions of the increase in this index ranged from 2.0% to 3.5% . Wholesale prices are expected to increase by a smaller amount, approxi mately 2.0% , during the year. Quarter-by-Quarter Forecasts Fourteen fore casters made quarter-by-quarter predictions for 1971. A s indicated by the quarterly table, these forecasters call for a fairly steady rate of increase of around $25.0 billion per quarter in G N P measured at an nual rates and adjusted for seasonality. Prices are expected to rise at an annual rate of about 3.4% in the first quarter, 3.0% in the second, 3.3% in the third, and 3.3% in the last. The rate of unemploy ment is expected to fall steadily from an average of 5.7% in the first quarter to an average of 5.1% in the fourth. Summary T h e forecasters for 1971 were rela tively close to the target in predicting current dollar G N P for the year. However, they rather sub stantially underestimated the rate of inflation, thereby overestimating the rate of real growth. The unem ployment rate, expected to average 5.5% , actually averaged 6.0% . The 1972 consensus forecast indicates a healthy rate of real growth, an abatement of inflation, and a decline in the unemployment rate. These fore casts seem to be based on the presumption that Presi dent N ixon’s program will continue to show results on the inflation front. They can be termed “ gen erally optimistic.” If these expectations are realized, the economy should show more health and vigor in 1972. FEDERAL RESERVE B A N K OF R IC H M O N D William E. Cullison 15 A Fifth District Review o f . . . 1971 FARM FINANCIAL AND CREDIT CONDITIONS This analysis, prepared in December 1971 at the request of USDA’s Agricultural Finance Branch, is based on a sample survey of Fifth District bank agricultural specialists and on data from the U. S. Department of Agriculture, the Farm Credit Administration, and the Federal Deposit Insurance Corporation. W eather’s capricious nature, continued tightening of the cost-price squeeze, effects of present Govern ment farm programs, less expensive credit, and an increase in the availability of funds for farm loans were prime factors influencing the financial and credit conditions of Fifth District farmers in 1971. A full review of the situation turned up the follow ing major findings. Farmers’ cash income from farming may well have been slightly below the im proved level of 1970, but their off-farm income con tinued to climb. Farm and family living costs also rose further. Expenditures for capital items showed a slight advance, as did spending for family living items. Prices of farmland continued to rise and at a much faster pace than in the past several years. Farm real estate market activity remained slow but apparently not as slow as in 1970. Farmers’ de mand for farm credit was strong, and the availability of bank loan funds improved. Bankers’ loan policies were generally about the same as those a year earlier. Farm Income and Costs Location and type of farming determined the level of farm income more than ever in 1971. Many livestock farmers, espe cially poultry and hog producers, experienced a poor year. Crop farmers had widely different experiences. Viewed as a whole, it seems quite likely that total District farm income was moderately below that in 1970. Bankers’ views concerning farm income in 1971 relative to farm income in 1970 varied con siderably but indicated a slightly improved level over all. Even if gross cash income from farming records a modest increase, the gain will probably not be high enough to offset the persistent rise in farm produc tion expenses. Lower livestock prices, particularly for poultry and hogs, were the major reason for the reduced level of income from livestock and livestock products in 1971. Livestock prices were below year-earlier levels in all District states, in fact, with average de 16 M O N TH LY creases ranging from 2 % in Maryland to 8 % in the Carolinas. Market supplies of milk and cattle and calves were about the same as in 1970. Broiler supplies were about 5% smaller, and supplies of eggs were down around 2 % . H og marketings, on the other hand, were 13% larger, and the number of turkeys marketed was up some 4 % . Farmers’ January-October cash receipts from sales of livestock and livestock products were 5% below those in the comparable period of 1970. Losses were recorded in all District states and ranged from 1% in Virginia to 8 % in North Carolina. The produc tion and price indications since October, coupled with the fact that more than four-fifths of all live stock income is normally received during the first ten months of the year, suggest that the reduction in livestock receipts for the entire year may ap proximate that of the January-October period. The 1971 growing season was generally good, and farmers had prospects for excellent harvests. Yields per acre were up, and, except for tobacco, acreages for harvest were mostly larger because of the changes in Government farm programs. During the height of the harvesting season, however, Hurricane Ginger struck, follow ed by four weeks of heavy rains. Damage to the cotton, corn, and soybean crops was high, and losses suffered b y the V irginia-N orth Carolina peanut crop were of drastic proportions. Seven per cent of the peanut acreage had to be abandoned, yields dropped 25% below 1970 yields, and total production was down 31% . Despite the cotton, corn, and soybean losses re sulting from the poor harvesting conditions, produc tion of these crops was well above that in 1970—cotton by 8 % , corn by 2 3% , and soybeans by 15%. Output of each of the small grains showed impres sive gains, and the pecan crop was five times the small 1970 crop. Other production increases were: Irish potatoes, 7% ; hay, 6 % ; and apples, 3% . REVIEW, FEBRUARY 1972 The tobacco, peach, and sweet potato crops were smaller, however— tobacco by 7 % ; sweet potatoes, 8 % ; and peaches, 11%. W ith the price of corn the chief exception, crop prices generally proved to be a major source of strength in 1971. Except in W est Virginia, where prices were lower, crop prices averaged moderately higher in Maryland, Virginia, and North Carolina and were up some 4 % in South Carolina. Fluecured tobacco prices were the highest in history, averaging some 8 % above those a year earlier. Prices of peanuts, soybeans, and cotton were also higher. District farmers’ cash receipts from crop market ings for the first ten months of 1971 were some 2 % larger that at the same time the previous year. In view of overall crop production prospects and the generally favorable price situation which has pre vailed, it would seem that total crop receipts for the year as a whole might well be on the plus side. The increase will help to offset a good part of the re duction in livestock income. Farm production expenses appear to have kept up their record-setting pace in 1971. Prices paid by farmers for commodities and services, including in terest, taxes, and farm wage rates, advanced almost 5 % — about the same as in 1970. Many farmers’ costs were further increased because they had to buy additional inputs. Nearly two-fifths of the respond ing bankers, in fact, held the view that the volume of purchased inputs had risen. The increase appears to have been somewhat larger than in 1970. Income from off-farm employment— an important source of buying power for farm families— con tinued to increase. This belief, expressed by threetenths of the replying bankers, applied to both farm operators and to other members of farm families. The pace of this upward trend in nonfarm earnings appeared to have tapered off in some localities, how ever, since some bankers reported slight declines in this source of income. The declines, which applied chiefly to the off-farm income of farm family mem bers other than the operator, resulted in several in stances from the closing down of industrial plants in rural communities. Farmers’ Savings and Spending T h e financial savings and reserves of Fifth District farmers at year’s end appeared, on balance, to be slightly larger than a year earlier. This situation no doubt resulted from several factors. W ith the lowering of interest rates, for example, farmers generally were not as re luctant to borrow as they were in 1970 and hence did not draw down their savings to meet current operating and capital needs. Still others reduced their expenditures for machinery and equipment, fa cilities, and other capital goods. Farmers’ spending for family living purposes con tinued to advance. Like their urban counterparts, farmers were again confronted with a general in crease in the cost of living. The farm family living index— a measure of the prices farm families pay for food and tobacco, clothing, household operation items and furnishings, house building materials, and so on — rose some 4 % during 1971, the same as in 1970. W ith this increase and farmers’ spending patterns generally, it is not surprising that 65% of our survey responses indicated that farmers’ expenditures for family living items were slightly higher than a year earlier. Most of the remaining respondents felt that farmers had held this type spending to about the same level as in 1970. Farmers also stepped up their investment in capital goods in 1971. Capital outlays for machinery and equipment appear to have been larger than those for facilities and other capital goods, however. Farmers’ purchases of machinery and equipment were re ported to be larger— though just slightly so— than in 1970 by 45% of the replying bankers. A like proportion were of the opinion that there had been little change in this kind of spending, while 10% expressed the belief that machinery and equipment purchases had declined. Spending for facilities and other capital goods was believed to have been slightly larger by 35% of the respondents, one-half felt that purchases of this nature had changed little, and the remaining 15% thought that there had been a slight decline. Much of the increase in capital expenditures in 1971, which is in sharp contrast to the situation in 1969 and 1970, can doubtless be attributed to the lower cost and increased availability of credit. Farm real estate prices in the District as a whole picked up momentum during the year ended March 1, 1971, rising slightly more than 8 % . The rate of in crease marked the fastest year-to-year advance since 1967 and compared with only a 3 % gain nationally. Market values moved upward in all District states, with increases of 8 % or better occurring in all states except W est Virginia. There the advance was about 4 % . Though no official state estimates of farmland prices have been released since March 1, our banker respondents, when asked how prices of farmland for calendar year 1971 compared with those a year earlier, indicated for the most part that the uptrend in prices had continued. On balance, activity in the farm real estate market in 1971 appears to have remained rather slow, al though slightly renewed activity occurred in some FEDERAL RESERVE B A N K OF R IC H M O N D 17 availability of loan funds, the District’s farmers ac celerated their use of both long-term and short-term credit as they sought to catch up on capital improve ments and meet the seemingly ever-increasing costs of production inputs. A s a result, short-term farm debt grew at a faster pace than a year earlier, both at commercial banks and at production credit as sociations. There was some slackening in the growth of long-term debt held by the Federal land banks. Commercial banks, however, resumed more vigorous activity in the farm-mortgage lending field after hav ing cut back in 1970. The resulting increase in the dollar volume of long-term loans held by banks was more than double the amount by which the growth in Federal land bank loans was reduced. (T h e gain in the volume of bank held farm real estate loans would have been even larger had the method of re porting Farmers Home Administration insured notes on the Call Report not been changed as of m id-1971. Because of this change, F H A insured notes are no longer reported as farm real estate loans.) Our survey findings showed that the overall de mand for farm credit strengthened in 1971. Sta tistical evidence supports these findings. Farmmortgage loans held by all the District’s insured com mercial banks in m id-1971, for example, totaled $304.7 million, around 5% or $13.9 million above a year earlier. This increase contrasts with a reduc tion of roughly 1% or $1.7 million in bank held long-term farm debt during the year ending at mid year 1970. In comparison, outstanding loans held by the Federal land banks on June 30, 1971 amounted areas. In certain instances, very little farmland was reported to be for sale. Purchases of farmland for farm enlargement were apparently not quite as slow' as in 1970. Slight declines in the number of en largement purchases were indicated by only one-fifth of the bankers surveyed in 1971, compared with 65% a year earlier. On the other hand, one-fourth of the survey responses noted an increase, mostly slight, in the purchase of land for farm expansion, while only 5% reported such gains in 1970. The remaining 55% believed there had been little change in pur chases of this type. Buying farmland for nonfarm purposes seems to have generated a little more market activity than purchases for farm enlargement; however, market demand overall was apparently somewhat below that of the previous year. One-third of the responding bankers reported slight increases in buying for nonfarm reasons as against one-fourth who noted gains in purchases for farm enlargement. The 33% who felt increases in nonfarm purchases had occurred in 1971 compared with 40% who believed likewise in 1970. In contrast, 27% of the 1971 respondents, about the same proportion as a year earlier, indicated slight declines in the purchase of farmland by non farm buyers. Generally, quite a few who bought farmland for reasons other than farm enlargement were said to have done so for speculative purposes. Farm Credit Situation Farm ers’ demand credit showed renewed strength in 1971. for W ith the softening in interest rates and an increase in the FARM DEBT: AMOUNT OUTSTANDING HELD BY SPECIFIED LENDERS, BY TYPE United States and Fifth District by States, June 30, 1971 com pared w ith June 30, 1970 F a rm -M o rtg a g e S ta te or A ll Insured C om m e rcial Banks D eb t N on -R ea l-E sta te Farm D eb t Federal Land Banks A ll In su re d C o m m e rc ia l Banks P ro d u ctio n C re d it A sso cia tio n s Am ount O u ts ta n d in g 1971 C ha n g e fro m 1970 Am ount O u ts ta n d in g 1971 C ha n g e fro m 1970 Am ount O u ts ta n d in q 1971 C ha n g e fro m 1970 Am ount O u ts ta n d in g 1971 C ha n g e fro m 1970 $ M illio n A re a Per C ent $ M illio n Per C ent $ M illio n Per C ent $ M illio n Per C ent 38.4 + 1 .4 40.5 + 114.2 61.5 + 10.4 M a r y la n d * 74.6 + 8.6 66.8 V ir g in ia W e s t V ir g in ia 89.5 35.1 + 7.1 120.1 + 6.7 + 6.6 12.3 - 0.7 19.2 + 5.3 - 0 .7 N o rth C a ro lin a 7 6.5 - 1 .1 206.6 + 11.3 137.7 + 7.2 225.0 + 20.7 S outh 2 8.9 + 2.8 118.3 + 8.6 43.3 -3 .6 110.7 + 17.2 304.7 + 4.8 5 24 .0 + 9.1 352.9 + 4.1 446.8 + 16.6 3,970.2 -1 .5 7,578.7 + 8.4 12,232.2 + 8.8 6,273.2 + 17.1 F ifth C a ro lin a D istrict U n ite d S ta te s ** * Includes D is tric t o f C o lu m b ia . N o te : Source: + 10.2 * * States a n d o th e r area s. D a ta m a y n o t a d d to to ta ls because o f ro u n d in g . Federal D ep o sit In su ra nce C o rp o ra tio n a n d Farm C re d it A d m in is tra tio n . 9.0 + 6.4 7.6 to $524.0 million for a gain of 9 % or $43.8 million during the same 12-month period. The increase, however, was lower than the 12% or $49.6 million gain recorded by the Federal land banks during the preceding 12 months. Non-real-estate farm debt outstanding at District banks at midyear 1971 totaled $352.9 million. The loans outstanding were up 4.1% or $13.8 million, compared with a gain of 3.8% or $12.5 million during the year ended in m id-1970. The volume of non-real-estate debt held by the P C A ’s, on the other hand, amounted to $446.8 million for an increase of 17% or $63.7 million during the same 12 months. The gain in PC A loans compares with the 15% or $48.8 million upturn recorded by the P C A ’s during the 12-month period ended in m id-1970. The number of farmers borrowing from com mercial banks dropped slightly, primarily because of fewer farmers. But the average size farm loan in creased again, and in a good many cases by a con siderable amount. Bankers’ farm loan repayments, on balance, were better than in 1970, and the num ber of delinquencies was generally lower. Farm loan renewals wrere down, but only moderately so. Bankers’ loan policies or practices, for the most part, were about the same as a year earlier, or gen erally tight. One-fifth of the respondents indicated, however, that they adopted more lenient policies during 1971. Bankers in general continued to weigh heavily good management ability and repayment capacity when evaluating loan requests. Bank funds available for lending to farmers in 1971 were reported to have been larger than in 1970 by 55% of the bankers surveyed. The remainder indicated that their available funds had been about the same as in the previous year. Without excep tion, all bankers said they had not found it necessary to turn down farm loan applications because of lack of funds. Fifty-five per cent of the sampled banks indicated that they had had requests for farm loans from cor porations during 1971. Of those replying in the af firmative, 18% said their requests came from family farm corporations, 27% indicated they came from other types of corporations, and 55% pointed out Farm Financial and Credit Outlook for 1972 On balance, some improvement in farm income is an ticipated in 1972. Assuming that the weather will be average or better during both the growing and harvesting seasons, one-half of the replying bankers looked for an increase— primarily slight— in income from farming, two-fifths expected little change, while the remainder foresaw a decline. Farm operating costs appear likely to increase further. This view was held by four-fifths of the survey respondents. The remainder believed there would be little change. O f those anticipating a further rise in farm costs, the majority felt that the increase over 1971 would be slight. Farmers’ demand for credit in 1972 is expected to be about the same as, or slightly larger than, that in 1971. Half of the participating bankers, in fact, looked for farm loan demand to continue at roughly the same level as in the current year. The other half anticipated some slight step-up in demand. The e x pected increase in the costs of farm production items will no doubt add to the credit demand. The level of farmers’ spending and investment in 1972 may well be moderately higher than a year earlier. This was the opinion of two-fifths of the survey participants. The remaining three-fifths be lieved farmers will hold their spending and invest ment to about the same level as in 1971. The outlook indicates that bank funds for farm loans will be more readily available to farm borrowers in 1972 than in 1971. This indication applies more to funds for short- and intermediate-term loans than to those for long-term loans. Some increase in the availability of funds for long-term farm loans was anticipated by 16% of the banker respondents, howrever. Despite the expected increase in available loan funds, bankers emphasized that the more credit worthy farmers with sound farming operations would have the best chance of obtaining needed loans. Basically, little change in bankers’ current policies on farm loans, already said to be fairly restrictive, is expected for 1972. A tally of survey responses re vealed that although 85% of the bankers indicated they would adhere to about the same policies as in 1971, the remaining 15% said their loan policies that the requests had come from both kinds. would be more lenient. O ver all, there seemed to have been little change from The somewhat softer interest rates that banks 1970, either in number or amount, in the requests charged on farm loans in 1971 can be expected to of corporations for farm loans. Where changes were prevail in 1972. indicated, they were in an upward direction. On according to survey results, were 8 % for long-term the whole, a higher proportion of family farm cor loans and a range of 7y2c to 8 % for both short/o The most prevalent rates quoted, porations increased their requests for farm loans than and intermediate-term loans. But interest rates cited did other types. for 1972 showed FEDERAL RESERVE B A N K OF R IC HM O ND considerable variation. Rates 19 ranging from 7% to 9 % were quoted for long-term 1971, most farm owners are in an improved equity loans, from 7% to 8 % for short-term loans, and position as they enter the new year. from 7% to 10% for intermediate-term loans. come position of farmers varies considerably, how To The cash in the question “ What trends in interest rates do you ever. foresee?” farmers to improve their debt position by paying off little seven-tenths of the responses indicated change, one-fifth looked for some Better incomes in 1971 enabled a good many further old debts. But unfavorable 1971 returns reduced the softening, and the remaining one-tenth expected an financial position of farmers in some locations— upward trend. especially in the Coastal Plains of North Carolina The general debt and financial position of Dis and Virginia. Many of these farmers were unable trict farmers overall apparently will not be sub to meet their loan obligations in 1971 and will need stantially different in 1972 from that in 1971. W ith to borrow heavily if they are to continue in farming. the advance in the market values of farmland in Sada L. Clarke The Federal Reserve Bank of Richmond is pleased to announce the publication of F i f t h D i s F i g u r e s — 1971 Edition and B u s i n e s s F o r e c a s t s f o r 1972. F i f t h D i s t r i c t F i g u r e s is a compilation of economic statistics on Fifth District States and Standard Metropolitan Statistical Areas, as well as on the United States. B u s i n e s s F o r e c a s t s is a compilation of representative business forecasts, with names and details of estimates, for the coming year. Both publications are available free of charge from this Bank. Please address requests to Bank and Public Rela tions, Federal Reserve Bank of Richmond, P. 0 .B ox 27622, Richmond, Virginia 23261. t r ic t 20 M O N TH LY REVIEW, FEBRUARY 1972