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ifies Review
FEDERAL RESERVE BANK OF ATLANTA

MAY/JUNE 1988

FINANCIAL MARKETS
Are Futures a Guide to Stock Prices?




CORPORATE FINANCE
Debt Ratios of U.S. Corporations

FORESTRY
After the 1986 Tax Act

Economic
Review
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Robert P. Forrestal
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ISSN 0732-1813




V O L U M E LXX1II, NO. 3, MAY/JUNE 1988, ECONOMIC REVIEW

I

The Relationship between the
SS-P 500 Index and S&P 500 Index
Futures Prices

Movements in index futures can forecast
changes in securities prices, but how
reliable is this relationship?

Ira G. Kawaller, Paul D. Koch,
and Timothy W. Koch

12

Leverage Ratios of Domestic
Nonfinancial Corporations
Larry D. Wall

30

F.Y.I.

While their debt-to-equity ratios appear
to be higher now than in the past, on
closer scrutiny U.S. corporations seem
neither overleveraged nor
underleveraged.

W. Gene Wilson

The Southeastern Forest Industry after
the Tax Reform Act of 1986

36

Book Review

Stock Market Activity

Peter A. Abken

The Brady, CFTC, and SEC Reports

44

Statistical Pages
Finance, Employment, General, Construction

FEDERAL RESERVE BANK O F ATLANTA 3




in October

1987:

The Relationship between
the S&P 500 Index
and S&P 500 Index Futures Prices
Ira G. Kawaller, Paul D. Koch, and Timothy W. Koch

The Standard

and Poor's 500 Index and the related index futures prices are influenced

each other's movements,
these two important

and current

market

indicators

market

information.

by their own

histories,

This study explores the temporal relationship

and measures the change in this relationship

as futures expiration

between
day

approaches.

The advent of markets for stock index futures
and options has profoundly changed the nature
of trading on stock exchanges. These markets
offer investors flexibility in altering the composition of their portfolios and in timing their
transactions. Futures and options markets also
provide opportunities to hedge the risks involved with holding diversified equity portfolios. As a consequence, significant portions of
cash market equity transactions are now tied to
futures and options market activity.
The effect of the stock index futures and
options markets on traditional stock trading has
aroused both the ire of critics and the acclaim of
supporters. Critics allege that futures trading
unduly influences the underlying equity markets, especially on days when futures contracts
expire. For example, on various expiration days

The authors are Director of the New York office of the
Chicago Mercantile Exchange; Associate Professor of Finance at the University of Kansas and former visiting scholar
at the Federal Reserve Bank of Atlanta; and Chair of Banking
at the University of South Carolina, respectively. These views
are the authors'and do not necessarily reflect those of the
Chicago Mercantile Exchange, the Federal Reserve Bank of
Atlanta, or the Federal Reserve System. A more comprehensive description of this study, which reports the theoretical
model and empirical results in detail, was published as
"The Temporal Price Relationship between S&P500 Futures
Prices and the S&P 500 Index," The Journal of Finance
(December 1987).




from 1984 to 1985, the stock markets closed with
equity prices either rising or falling dramatically
during the final hour of trading.1 The phenomenon of sharp price swings and the seeming
relation to futures market activity has, especially
in the wake of the October 19,1987, stock market
crash, prompted various suggestions for modifying the design of the contracts to lessen their
impact on the market.2 (For a related discussion,
see this issue's Book Review by Peter A. Abken
on p. 36.)
Proponents of futures markets, on the other
hand, do not view the final-day price swings as a
problem, since the swings are generally temporary and nonsystematic. In fact, proponents
argue that such markets provide an important
price discovery function and offer an alternative
marketplace for adjusting equity exposure. The
term price discovery function refers to the
ability to use a certain market indicator—in this
case, stock index futures—to forecast upcoming
changes in the prices of securities. For the price
discovery function to be most helpful, though,
an investor must be able to determine when a
change in the futures market will be reflected in
the underlying market.
This article addresses some basic questions
that have a fundamental bearing on the debate
between the critics and advocates of futures
markets. Do intraday movements in the index
futures price provide predictive information
4 E C O N O M I C REVIEW, MAY/JUNE 1988

about subsequent movements in the index, or
do movements in the index presage futures
price changes? Is the price relationship different on expiration days and the days leading
up to expiration?
Analysis of the Standard and Poor's (S&P) 500
futures and the S&P 500 index can help answer
these questions. This article shows that lags
exist not only between movements in index
futures prices and subsequent movements in
the index, but also between the index and subsequent index futures prices, though these lags
are not symmetrical. The index lags behind the
index futures price by up to 45 minutes, but the
index futures price tends to trail the index only
briefly. Examination of the lagged relationships
on expiration days and the days prior to them
indicates that the relationships are remarkably stable, implying that neither expiration day
volatility nor the climate preceding these days
interferes with the price discovery function that
index futures seem to offer.3

An Overview of the S&P 500 Index
and Index Futures
The S&P 500 stock index represents the
market value of all outstanding common shares
of 500 firms selected by Standard and Poor's.
FEDERAL RESERVE BANK O F ATLANTA




Prior to April 6,1988, this group always consisted
of 400 industrials, 40 financial institutions, 40
utilities, and 20 transportation firms.4 Though all
of the shares are not traded on the New York
Stock Exchange (NYSE), the cumulative market
value equals approximately 80 percent of the
aggregate value of NYSE-listed stocks. The
index changes whenever the price and thus the
cumulative market value of any underlying stock
changes.
An S&P 500 futures contract represents the
purchase or sale of a hypothetical basket of the
500 stocks underlying the S&P 500 index, set in a
proportion consistent with the weights set by
the index, with a market value equal to the
futures price times a multiplier of 500. The
futures price should be tied to the cost of investing in and carrying an S&P 500 look-alike basket
of stocks until the expiration of the index future.
The cost of carry incorporates transactions fees,
taxes, and the expense of financing the investment, minus the dividends derived from the
basket of stocks and any additional reinvestment income.
As a requirement for gaining access to the
market, traders must post an initial margin
deposit or collateral equal to a fraction of the
futures contract market value (price x 500).
Futures prices change intermittently throughout each trading day, and at day's end traders
must cover any losses when prices move against
3

them. Alternatively, they may withdraw any profit in excess of their initial margin requirement
should prices move favorably During the period
from which data for this study were drawn, contracts expired on the third Fridays of March,
June, September, and December, with the
futures contracts marked to the closing index
value at 4:15 p.m., Eastern time.5

Basic Functions
of Stock Index Futures
Stock index futures typically serve three
functions: trading, hedging, and arbitrage. First,
traders can take speculative positions in futures
to take advantage of anticipated broad market
price movements. Second, hedging, which involves the purchase or sale of index futures in
anticipation of an intended cash market trade,
compensates for adverse price moves in the
cash market, and thus reduces aggregate risk.
Simple hedges typically involve the purchase
(sale) of an asset in the cash market and sale
(purchase) of futures contracts on the same
asset. As long as the cash-futures spread remains the same and the costs of effecting and
financing the transaction are covered, gains
(losses) on the cash market purchase are countered by losses (gains) on the future. The investor
thus may mitigate the risk of loss and the possibility of gain on the cash market purchase.
Arbitrage is a third strategy served by stock
index futures. It involves the simultaneous
purchase and sale of stocks and futures and
subsequently enables an investor to capture
profits from realignments of relative prices
following an apparent inconsistency in the
index and the index futures price. When the
index futures price moves outside the range
determined by the cost of the look-alike basket
and the cost of carry, arbitrage will tend to drive
the futures price and the index toward their
cost-of-carry relationship. If the actual futures
price is higher than the cost of the look-alike
basket and the cost of carry, the futures contract
is overvalued, justifying the purchase of the
look-alike basket of stocks and the simultaneous sale of the futures contract. If the futures
price falls below the price of the look-alike
portfolio plus the cost of carry, the futures con4




tract is undervalued, and the reverse trade
would be profitable. In both cases, the arbitrage
transactions realign the futures price and the
index.
Because physical delivery does not take
place, the futures contract is said to be "settled
in cash." Cash settlement is an important feature of stock index futures. An arbitrageur who
has sold futures and bought the underlying basket of stocks does not deliver the basket of
stocks to the investor who bought futures.
Instead the arbitrageur must sell the basket of
stocks. Any open futures positions are marked
to the final settlement index calculation when
the futures expire. Once the arbitrageur pays or
receives the value of the price change from the ,
prior day, the position is closed. A common
practice for arbitrageurs, however, is to trade
large blocks of stocks or whole portfolios at
prices tied to closing prices on the futures
expiration days. As a result, these large volumes
of orders late in the day have tended, on some
occasions, to create at least temporary imbalances in the cash equity markets.
Movements in Futures Prices. Numerous
studies have explained the price relationship
between stock index futures and the underlying stocks in terms of arbitrage behavior. Futures prices normally vary relative to stock
prices within ranges that are not sufficient to
trigger arbitrage. In fact, arbitrage opportunities
are often not available. A number of scholars
have attempted to identify and measure arbitrage trading boundaries.6 Their results indicate that the futures to cash price differential,
referred to as the basis, should fall within
boundaries determined by the cost of carry.
Because market interest rates have historically
exceeded the dividend rate on common stocks,
the "fair value" or theoretical stock index futures price normally exceeds the stock index.7
Conventional wisdom among professional
traders dictates that movements in the S&P 500
futures price affect market expectations of subsequent movements in cash prices. The futures
price presumably embodies all available information regarding events that will affect cash
prices. Purchase or sale of index futures requires one transaction, while purchase or sale of
a look-alike portfolio generally involves 200 or
more stocks and a minimum $5 million investment. Consequently, the index futures price is
E C O N O M I C REVIEW, MAY/JUNE 1988

likely to respond to new information more quickly than cash market prices in general and, thus,
more quickly than the S&P 500 index. This lag of
the index behind the futures price results because the underlying stocks must be traded in
order for the index to reflect a change in value.
Since most index stocks do not trade each
minute, the cash market responds to the new
information with a lag.8 S&P 500 index movements may similarly convey information about
subsequent price variation in the futures contract; however, the lag of the futures price
behind the index is likely to be much shorter
than the lag of the index behind the futures
price.
If new information on the health of the economy is bullish, a trader has the choice of buying
either S&P 500 futures or the underlying stocks.
While the futures trade can be effected immediately with little up-front cash, actual stock
purchases require a greater initial investment
and may take longer to implement since they
require a subsequent stock selection. This preference for index futures as a vehicle for speculative transactions explains why changes in futures
prices may lead changes in stock prices and the
S&P 500 index. Futures prices may thus provide
an indicator of forthcoming cash prices, which
follow when investors who are unwilling or unable to use futures incorporate the same information that led to changes in futures prices into
their own cash market transactions.
Changes in the S&P 500 index can also lead
changes in the futures price, if the value of the
index conveys information that affects futures
prices. Futures traders are likely to incorporate
recent changes in the index in their pricing
decisions. For example, if the index declines
because investors are selling stocks connected
with options trading, the decline may induce a
change in sentiment that is reflected in subsequent futures prices.9
Potential lead and lag patterns between
index futures and the index are complicated by
two more possible relationships: the futures
and the index may move together as new information affects both index futures and cash
market trades. Each measure may lead the
other as market participants find clues about
impending values of index futures and broad
market movements in previous futures prices
and broad cash market movements, respecFEDERAL RESERVE BANK O F ATLANTA




Table 1.
Possible Effects of Movements
in the S&P 500 Index
and S&P 500 Index Futuies
M o v e m e n t in t h e S & P 500 I n d e x
may be affected by

may affect

• prior index levels

• upcoming index levels

• current futures prices
• prior futures prices

• upcoming futures prices

• other market
information

M o v e m e n t in S & P 500 Index Futures Prices
may be affected by

may affect

• prior futures prices

• upcoming futures prices

• current index levels
• prior index levels

• upcoming index levels

• other market
information

tively. Technical analysts, or chartists, rely
heavily on patterns of relationships between
past and future values of series such as the S&P
500. A summary of possible relationships between the S&P 500 index and S&P 500 futures
prices is shown in Table I.

Tests of the Intraday Relationship
between S&P 500 Futures
and the S&P 500 Index
A complex set of potential relationships
could exist between S&P 500 futures and the S&P
500 index prices. Movements in each are thought
to be influenced by the past and current movements of both as well as by other market information. The study reported on in this article
tried to gauge the magnitude and variability of
the relationships between the index and the
futures by estimating distributed lags between
the two prices. Distributed lags employ a method
of weighting past data to determine their effects
on the data under study.
5

The pattern of lags between index futures
and the index may not be constant over time.
While shifting patterns are conceivable throughout the life of the futures contract, the focus of
interest on expiration day effects begs the
question of whether these temporal relationships show any differentiation on those days. On
expiration days, the traders' need to close
positions may generate market imbalances that
could conceivably overwhelm the mechanism
by which new information influences index
futures and cash market prices. An expirationday breakdown in this mechanism would diminish the benefits of the index futures market—at least on expiration day—as a medium for
discovery.
The data are minute-by-minute prices of
index futures contracts and the S&P 500 index
on all trading days in 1984 and 1985. The Chicago
Mercantile Exchange provided the data.10 Pairing the reported index with the last index
futures price quoted during the minute that the
index appeared yielded 360 pairs of index and
futures observations each day (six-hour trading
day x 60 observations per hour). To judge
whether the index futures-index relationship
changes as the expiration day approaches, lags
were estimated for six trading days in each quarter beginning in the second quarter of 1984 and
ending with the last quarter of 1985.'1 The days
are 88,60, 30, and 14 days prior to expiration,
1 day prior to expiration, and expiration day.
These days were chosen to represent the approach of expiration and the effect of this
approach on the index futures-index relationship.
The nature and extent of the lead/lag relationships between index futures prices and the
index were measured using a number of analyses. First, a time series analysis was performed
to study the movements of futures prices relative to prior futures prices. Next, the same
method of analysis gauged movement of the
S&P 500 index based on past index performance. These time series analyses studied the
minute-to-minute changes in both the index
and the futures prices. The next step in the
analysis was to construct a model to describe
the dynamic intraday price relationships between the index and the futures prices. In this
model, index movements depend on their own
6




past movements, current and past movements
in the futures price, and other relevant market
information (see Table 1). Likewise, futures
price movements are modeled to depend on
their own past movements, current and past
movements in the index, and other relevant
market information.12
Consistent evidence on both the form of the
lag relationships and their stability over time
emerges from these tests: first, the contemporaneous relationship between futures prices
and the index is quite strong—dwarfing the
lagged relationships. In fact, the futures and
index move almost in lock step. Second, lags
between index futures prices and the index are
not symmetrical. The index lags behind the
index futures price by up to 45 minutes, while
the futures price lags behind the index only
briefly if at all. This result supports the contention that index futures do, in fact, serve a price
discovery function. Third, the lagged relationships do not appreciably change as expiration
day approaches or on expiration day itself.
Different patterns of lagged relationships
between S&P 500 futures and the S&P 500 index
are given in Chart 1. It shows the distributed lag
coefficients for two days in the fourth quarter of
1984; results for other days in this contract
period, as well as days in other contract periods,
are quite similar. Typically, the first coefficient,
which describes the contemporaneous relationship, is the greatest, or one of the greatest, on
each day. In the panels showing lags from futures to the index, relatively large and statistically significant coefficients show up with lags
as long as 45 minutes. Panels showing lags from
the index to futures typically show the oneminute lag as the largest coefficient and the only
one that is significant. These results parallel
evidence garnered from earlier time-series
analyses.13
Chart I also shows quite similar patterns in
the distributed lag coefficients 88 days prior to
expiration day and on expiration day. Coefficients showing the lead from futures to the
index continue to be mostly positive even on
expiration day. They are significant or nearly
significant through 20 to 30 minutes on each day,
though the lag appears somewhat less on expiration day. Other quarters record quite similar
patterns.
E C O N O M I C REVIEW, MAY/JUNE 1988

Implications
Evidence uncovered in the tests of lagged
relationships between S&P 500 index futures
prices and the S&P 500 index points to the
usefulness of the futures as a predictor of broad
equity market movements measured by the
index. The S&P 500 futures price and underlying
index evidently respond to market information
simultaneously, and the index shows lags of up
to 45 minutes behind the futures. Importantly,
the magnitudes of the contemporaneous effects on different days are consistently much

FEDERAL RESERVE BANK O F ATLANTA




larger than the lagged effects. Thus, though the
price discovery function has been demonstrated, the indications of forthcoming cash market
changes provided by past futures prices are not
sufficient to provide an exploitable trading
strategy.
Consistency in the lagged relationships over
the days approaching expiration day and on
expiration day also indicates that the pattern of
lags between futures and the index is not disturbed by the closing out of arbitrage positions.
This consistency implies that index futures trading continues to make its contribution to price
discovery, even on expiration days that transpired without market activity restrictions.

7

Chart 1.
Sample Distributed Lags for the
S&P 500 Index and S&P 500 Index Futures Prices

k

0.0

-.5

-1.0
5

10

15

20

25

30

09/24/84: 88 days prior to expiration

35

40

45

5

10

15

20

25

30

35

40

45

12/21/84: expiration day

Chart 1 shows the relationship between minute-to-minute movements in the S&P 500 futures price and the S&P 500 index.
The top graph in each set shows how past minute-to-minute movements in the futures price affect current movements in the
index, and the bottom figure shows how past movements in the index affect current movements in the futures price.
The vertical axis in each figure represents the magnitude of the minute-to-minute impacts of each value on the other. The
horizontal axis charts the number of minute-to-minute lags incorporated into the model. For example, for k= 1 minute lag, the
value plotted in the top graph shows the impact of the futures price change one minute earlier on the current index value. At
the number '20' on the horizontal axis, the effect on the current index value of the futures price 20 minutes earlier is
plotted.
When the vertical lines within the graph fall between the two dotted horizontal lines, the magnitude of the distributed lag
coefficient is less than twice its standard error, and thus is not statistically significant. When the vertical lines within the graph
fall outside the dotted lines, the magnitude of the distributed lag coefficient is more than twice its standard error, and, thus, is
statistically significant.
When the vertical lines are concentrated in the positive portion of the figure (above 0.0), most of the lagged impacts of one
price on the other are positive, that is, increases in one price are then followed by increases in the other price.
When the vertical lines are concentrated in the negative portion of the figure (below 0.0), most of the lagged impacts of one
price on the other are negative, that is, increases in one price are then followed by decreases in the other.

8




E C O N O M I C REVIEW, MAY/JUNE 1988

Notes
1

2

The term "triple witching hour" was used to describe this
trading period because the Chicago Mercantile Exchange's
(CME) S&P 500 futures, the Chicago Board of Trade
Options Exchange's (CBOE) S&P 100 options, and contracts on individual stock options all expired on the third
Fridays of March, June, September, and December. After
March 1987, the final day of trading for S&P 500 futures was
moved to the day prior.

The U.S. Securities and Exchange Commission, the Government Accounting Office, and the executive branch (the
Brady Commission), as well as various exchange and
private research groups, are currently studying the relation of price swings to futures market activity.

^These results do not explain expiration day swings, nor do
they suggest that such swings are desirable.
4
Standard and Poor's has recently announced that the
composition of the S&P 500 will now be flexible.
5
Since this study, the final settlement procedures for S&P
500 futures have changed. Contracts currently expire one
business day prior to the third Friday of the contract
month, with the final settlement price based on a special
calculation of the Friday opening prices for each of the 500
stocks. Upon expiration, one final cash adjustment is
made to reflect the last day's gains or losses.
Cornell and French (1983a, b); Figlewski (1984a, b) ; Modest
and Sundaresan (1983); and Stoll and Whaley (1986).
7
The theoretical upper and lower bounds are discussed
extensively in the literature. For example, see Stoll and
Whaley (1986): 8-10, or Kawaller (1987): 447-49.
8
New information could affect a subset of index stocks disproportionately relative to the entire stock market. In

FEDERAL RESERVE BANK O F ATLANTA




such cases, not all index stocks must be traded each
minute for the index to adjust completely and quickly to
new information.
9
ln options trading, an investor purchases the right to buy
or sell a given security at a fixed strike price before a
specific date in the future. If the investor does not exercise this right before the date in the contract, the option
expires and the option buyer forfeits the money.
l0

At the time of this study, the index was available only
each minute. Since then, index quotations have been
calculated and disseminated at about 15-second intervals.

11

Prior to the June 1984 contract, S&P 500 futures expired on
Thursdays. This article's sample is restricted to the last
three contracts in 1984 and all contracts that expired in
1985. Also note that futures trade for 15 minutes after the
stock markets close. Quotes from these 15 minutes are
not considered in this analysis. Finally, since September 30, 1985, quotes are available beginning at 8:30 a.m.,
but the analysis is restricted to the six hours (360 observations) from 9:01 a.m. and 3:00 p.m. so that the results
can be compared across quarters.

12

ln the context of this model, zero restrictions are tested on
the distributed lag coefficients, allowing, alternately, the
contemporaneous coefficient and the coefficient at lag
one minute to remain unconstrained. See Kawaller, Koch,
and Koch (1987) for details.

13

The tests with no restrictions on the contemporaneous
and first coefficients also confirm the longer lags from the
futures to the index and the very short lag from the index
to the futures.

9

Bibliography
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Index Futures." journal of Futures Markets 3 (Summer
1983a): 1-14.

Kawaller, Ira G. "A Comment on Figlewski's 'Hedging with
Stock Index Futures: Theory and Application in a New
Market' " lournal of Futures Markets 5 Fall 1985) : 447-49.

, and
. "Taxes and the Pricing of
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1984): 129-37.

"A Note: Debunking the Myth of the Risk-Free
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1987): 1309-29.
Koch, Paul D„ and James F. Ragan, Jr. "Investigating the
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(January 1986): 61-83.

Figlewski, Stephen. "Explaining the Early Discounts on
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. "Hedging Performance and Basis Risk in Stock
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"Hedging with Stock Index Futures: Theory
and Application in a New Market." Journal of Futures
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Gastineau, Gary, and Albert Madansky. "S&P 500 Stock
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Complete Dynamic Simultaneous Equations Model."
lournal of Econometrics 6 (April 1978): 163-85.
Granger, Clive W. "Investigating Causal Relations by Econometric Models and Cross-Spectral Methods." Econometrics 37 (July 1969): 423-38.
Haugh, Larry D. "Checking the Independence of Two
Covariance-Stationary Time Series: A Univariate Residual Cross-Correlation Approach." Journal of the American Statistical Association 71 (June 1976): 378-85.

10




Koch, Paul D„ and Shie-Shien Yang. "A Method for Testing
the Independence of Two Time Series that Accounts for a
Potential Pattern in the Cross-Correlation Function."
Journal of the American Statistical Association 81 (June
1986): 533-44.
Modest, David, and Mahadeaum Sundaresan. "The Relationship between Spot and Futures Prices in Stock Index
Futures Markets: Some Preliminary Evidence." Journal of
Futures Markets 3 (Summer 1983) : 15-41.
Stoll, Hans R., and Robert E. Whaley. "Expiration Day Effects
of Index Options and Futures." Vanderbilt University,
March 1986.
U.S. Securities and Exchange Commission. Letter to the
Honorable lohn D. Dingel], June 13, 1986a.
Letter to Mr. Kenneth J. Leiber and others,
June 13, 1986b.
Roundtable on Index Arbitrage, July 9, 1986c.

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0 8 8 - 3

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Zip

Return t o t h e P u b l i c I n f o r m a t i o n D e p a r t m e n t , Federal Reserve Bank o f A t l a n t a , 104 M a r i e t t a Street, NW, A t l a n t a , GA 30303-2713.

FEDERAL RESERVE BANK O F ATLANTA




11

Larry D. Wall
Gauging
determine

optimum

leverage ratios for a corporation

these levels. By considering

debt-to-equity

or for an economy is difficult

ratios with those of companies in competing

are overleveraged

or

economies, the author

present

investigates

corporate

whether

companies

underleveraged.

Corporations fund their purchases of assets
by issuing debt and stock, and by retaining their
earnings. The use of debt by U.S. corporations
may have important implications for individual
firms and the economy. If debt levels are too
low, companies' cost of funds may be overly
high, implying that they are inefficiently managed. If debtlevels are too high, the nation may
be too vulnerable to severe economic downturns.1
One can find arguments that U.S. corporations' debt ratios are too high and too low. The
case for believing that ratios are at approximately the correct level is based on the assumption that, on average, the corporate sector
operates in the most efficient manner possible.
However, some observers note that debt ratios
of U.S. corporations appear to be below the
debt ratios of their major international competitors, especially West German and Japanese
firms. Richard R. Ellsworth (1983), for example,
suggests that U.S. companies are underleveraged because their managers devote insuffi-

The author is a senior economist in the financial section of
the Atlanta Fed's Research Department. He wishes to thank
Sharon Fleming, Rob McDonough, Marilyn Shores, and
Gretchen Lium for research assistance.

 12


since no model exists to

past data on the debt of U.S. firms and comparing

cient consideration to financial strategy. Ellsworth
contends that U.S. firms could cut their cost of
capital and become more competitive if they
relied to a greater extent on debt financing.
Other observers including Henry Kaufman
(1986), noting a substantial increase in leverage
ratios since the end of World War II, typically
argue that high debt levels could leave corporations excessively vulnerable to failure during a recession. As a result, a shock that might
otherwise cause only a small downturn in the
economy could cause a major recession.
This article examines the arguments that U.S.
corporations are either underleveraged or overleveraged. No model currently exists that allows
an easy answer to the question of whether
leverage ratios are at optimum levels for the firm
or the economy. Therefore, researchers must
rely on empirical comparisons of historical and
international data. A comparison of U.S. debt
ratios with those of foreign firms does not support the argument that American companies are
underleveraged. Examination of the historical
data provides some support for the contention
that U.S. firms are more leveraged than they
were in the past, but debt ratios calculated on
the basis of book value accounting data significantly overstate the magnitude of the increase in debt ratios.
E C O N O M I C REVIEW, MAY/JUNE 1988

Determinants of
Corporate Financing Policies
Individual corporations choose debt levels
based on the costs and benefits of leverage to
the firm and its managers. This process may
result in debt levels that are too high or too low.
If a corporation's management focuses on its
own gains and losses from leverage rather than
the gains and losses to the corporation's shareholders, debt levels may be too low. Alternatively, debt levels may be too high if corporations do not consider the costs that debt
can impose on society, such as an increase in the
risk of recession.
Corporations face competitive pressure to
choose the level of debt that maximizes firm
value. Failure to maintain this level may raise
the company's cost of funds and reduce its
ability to compete. Failure to maximize value
may also prompt a takeover attempt by others
who will issue the amount of debt that will maximize the company's value. One of the first
rigorous analyses of the problem of firm debt
levels concludes that, under certain restrictive
assumptions, leverage will have no effect on
firm value. In a seminal paper, Franco Modigliani and Merton H. Miller (1958) show that if a
change in leverage merely redistributes cash
flow between owners and creditors, then a company's leverage will not influence its overall
value.2 Thus, to influence firm value, leverage
must somehow alter the amount of cash flow
returned from existing assets or investment in
new assets.
Cash Flow and Taxes. Subsequent research
on corporate leverage elaborates on the 1958
Modigliani and Miller model by analyzing the
effect of leverage on operating cash flows and
taxes. One way in which leverage will affect firm
cash flows is shown in a subsequent paper by
Modigliani and Miller (1963). They note that a
firm can deduct interest payments, but not dividend payments, from its taxes. If a company
increases its leverage, more cash flow will go to
investors and less will go to the government
because the company will pay lower taxes. If the
only influence on corporate debt ratios were
corporate taxes, the researchers' elaboration
suggests, firms would be almost exclusively
debt-financed.
FEDERAL RESERVE BANK O F ATLANTA




Miller (1977) extends the analysis of taxes
further to show that the incentive to use corporate leverage is reduced by personal taxes.
He suggests that for individuals tax rates on
bond returns are greater than tax rates on
returns to equity. Moreover, this difference
increases as an individual's marginal tax bracket
rises. Thus, in order to induce individuals in successively higher tax brackets to purchase debt,
the rate of return on corporate debt must
increase as more is supplied. Accordingly, corporations on the whole will continue to issue
debt until the tax benefits from debt are eliminated, that is, until the tax rate on corporations
issuing debt equals the tax rate paid by the
marginal investor in new debt securities. At that
point, changes in a firm's leverage will not
influence its value because the marginal tax
consequences of debt and equity will be equal.
Benefits of leverage are reduced by individual taxes in a model developed by Harry DeAngelo and Ronald W. Masulis (1980), but taxes
nevertheless influence individual corporate
debt ratios. Higher debt ratios provide an advantage by reducing corporate taxes, but these
ratios also provide a disadvantage in that they
raise the possibility that the firm will be unable
to exploit other provisions of the tax code. For
example, by both taking on added debt and
investing in new equipment, a company could
reduce taxable income by the amount of depreciation and interest. Yet doing so might
lower corporate earnings below the company's
depreciation and interest expense. In this case,
the firm may have to defer part of its tax savings
to a future year or face losing the tax write-offs
permanently. Companies in this model increase
their debt ratios until the marginal tax gains
from higher leverage are offset by the marginal
expected cost of losing other tax privileges.
Costs of Financial Distress. A possible offset
to the tax benefits of debt is that an increase in
leverage can raise a corporation's probability of
financial distress. lerold B. Warner (1977) analyzes direct bankruptcy costs for a sample of
failed railroads and finds that the direct costs
are a small percentage of firm value—2.7 percent and 1.7 percent of total market value of
traded securities for the largest corporations in
his sample. His findings imply that the direct
costs of bankruptcy are at most a minor determinant of corporate leverage decisions.
13

Nevins Baxter (1967) argues that the costs of
failure go beyond the direct costs of bankruptcy.
Firms approaching bankruptcy may lose potential customers and suppliers, as well as higher
quality workers and managers. These firms may
also be unable to raise funds to exploit profitable investment opportunities.
If bankruptcy costs were the only factor influencing leverage ratios, businesses would be
financed entirely with equity. To the extent that
businesses face both bankruptcy costs and tax
advantages of debt, a mix of debt and equity is
generally indicated.3
Agency Costs. A fundamental problem with
models which rely solely on income taxes to
generate corporate issuance of debt is that corporations used debt long before the adoption
of income taxes. The application of agency
theory to corporate finance by Michael C. Jensen
and William H. Meckling (1976) provides a
powerful tool for understanding corporate
leverage. Agency theory recognizes that a corporation's owners, managers, and creditors may
be different parties with different interests.
Owners or managers may take actions that
increase their own utility at the expense of the
other two parties. The overall value of the firm
might be reduced as well.
Managers in Jensen and Meckling's model
earn pecuniary and nonpecuniary benefits, such
as the size of their offices. For a manager who
owns 100 percent of a firm, every dollar spent on
nonpecuniary benefits reduces the manager's
equity by one pretax dollar. However, if the
manager owns 75 percent of the firm, each dollar
spent on nonpecuniary benefits reduces the
manager's return by 75 cents. Thus, managers
who own 75 percent of their companies are more
likely to spend on nonpecuniary benefits than
those with 100 percent ownership. The costs of
overspending on nonpecuniary benefits are
ultimately borne by the owner-manager as potential shareholders reduce the price they pay
for new stock in recognition of management's
increased incentive to spend on perks.
Debt issues reduce the incentive for managers to spend resources on nonpecuniary benefits. Since debt issues contain unconditional
promises to pay, debtholders need not bear the
costs of nonpecuniary benefits unless managers
overspend on these benefits and drive the company to bankruptcy.
14




Debt may also reduce management's incentive to waste resources even if the firm issues
outside equity. Jensen (1986) notes that both
interest payments on debt and dividend payments on equity holdings reduce the resources
available for nonpecuniary benefits to management. However, while the firm must pay a
market rate of interest on its debt, dividend
payment need only be minimal.
Although debt financing may encourage more
efficient management of existing assets, businesses cannot replace all of their existing outside equity with debt. Stewart C. Myers (1977)
shows that a conflict between shareholders and
creditors can arise over the firm's investment
policy. Investment in new projects with a positive net present value may benefit a company's
creditors by reducing its probability of bank-

"If bankruptcy costs were the only factor influencing leverage ratios, businesses would be financed entirely with
equity. To the extent that businesses
face both bankruptcy costs and tax
advantages of debt, a mix of debt and
equity is generally indicated."

ruptcy. The value that creditors receive comes at
the expense of the firm's shareholders and may,
for some projects, be so large that the project
will not enhance shareholders' wealth. Businesses with excellent growth potential may
choose to avoid the potential conflict by minimizing debt levels. Michael S. Long and Ileen B.
Malitz (1985) provide support for Myers' conclusion by showing that a firm's leverage is inversely related to its research and development
(R&D) expenditures, since R&D is positively
associated with growth opportunities.
Agency theory takes account of conflicting
interests of owners, creditors, and managers. It
shows that recognition of these conflicts will
influence owners' and creditors' valuation of a
company in such a way that their willingness to
finance will vary with the amount of leverage.
Consequently, financing costs will be affected
E C O N O M I C REVIEW, MAY/JUNE 1988

by leverage and a leverage ratio that maximizes
the company's value will exist.
Costs of New Issues. An additional determinant of corporate financing policies is the cost of
new debt and equity issues. Myers (1984) suggests that the costs of new issues—especially
new equity issues—are so great that firms develop a "pecking order" of sources of additional
funds. In this model, firms will turn first to internally generated funds from operations. When
internally generated funds are exhausted, the
corporation will seek to issue additional debt.
The company will issue equity if it decides to
make investments that will cause it to exceed
some maximum leverage ratio. Myers' model
also notes that businesses may depart from
their optimal leverage ratio for extended periods of time.

"Summing up past research on what
determines corporations' use of leverage, the key factors appear to be taxes,
costs of fìnancial distress associated
with higher debt, and the costs entailed in the relationship among owners, management; and creditors."

Summing up past research on what determines corporations' use of leverage, the key factors appear to be taxes, costs of financial distress
associated with higher debt, and the costs
entailed in the relationship among owners,
management, and creditors. In addition, optimal leverage is likely to vary across industries,
among firms within industries, and even across
time for individual firms as changes occur in the
tax code, the costs of operation, the investment
opportunities available to the firm, and the
market for corporate control.

Why Corporations
May Be Underleveraged
Ellsworth (1983) contends that U.S. firms are
sacrificing international competitiveness beFEDERAL RESERVE BANK O F ATLANTA




cause they are underleveraged. He postulates
that many firms are underleveraged because
managers devote insufficient consideration to
their firm's financial strategy. Many businesses
let their desire to achieve or maintain a particular credit rating control the resources available for new investments. Ellsworth recommends
that firms should re-evaluate their financial
practices in light of new investment opportunities.
Another argument consistent with the hypothesis that companies are underleveraged is
that management may be more risk-averse than
the firm's shareholders. Management may have
developed firm-specific human capital that
would be lost upon bankruptcy. In contrast,
many shareholders own a diversified portfolio
of stocks, and the portfolio's value would not be
significantly influenced by the failure of any
given business. Thus, even if an increase in
leverage had a proportionate increase in both
the managers' wealth and the value of the company's stock, management may be unwilling to
assume additional risk.
Management and shareholder interests might
be better al igned if management compensation
were tied to the performance of the corporation's common stock; however, this approach
has its limits. Common stock prices are influenced by a variety of factors that management
cannot control. If managers' compensation depended solely on the firm's stock price, managers would demand compensation for the
possibility that factors outside their control
would reduce the firm's stock price. In an attempt to forestall these demands, businesses
instead typically provide a compensation package to management that includes payments
which are independent of the company's stock
price.
The other common method of aligning management and shareholders' interest is through
the market for corporate control. A firm may be
acquired by new managers if a sufficiently large
gap exists between the firm's current stock
market value and its potential value. Until recently, most takeovers occurred when large
companies bought smaller ones. Large firms
could increase the leverage of their existing
operations to obtain acquisition funds without
significantly reducing their credit ratings. However, smaller companies were generally unable
15

to borrow enough funds to acquire large firms.
As a result, sufficiently large businesses were
rarely taken over without the approval of the
acquired firms' management.
Now, with the development of original issue
junk bonds, which are rated "speculative" by
the rating agencies, smaller corporations can
obtain the funds to acquire large, inefficient
businesses and replace their management.
Some large corporations have noted this threat
and have—by increasing operational efficiency
and the firm's debt level—sought to reduce
their risk of being taken over. By increasing its
debt level, such a firm would become unable to
support any further increases in debt, thereby
forcing potential acquirers to rely on equity
financing. In either case, however, the likelihood
that corporations are underleveraged is lower
since both the proliferation of junk bonds and
the development of counterstrategies tend to
raise debt levels.

Why Corporations
May Be Overleveraged
The development of the junk bond market
may help reduce the concern of people who
think corporations are underleveraged, but this
development increases the concern of people
who think corporations are already overleveraged. The junk bond market provides another
mechanism for corporations to increase their
debt levels beyond the socially optimal level.
Some care must be taken in analyzing the
costs of excessive leverage. Public policymakers
need not consider the costs of failure suffered
by people positioned to demand compensation for an overleveraged firm's greater risk of
bankruptcy. For example, creditors and employees are two parties that are at risk in bankruptcy but who can make a company recognize
the costs of its leverage decisions. Creditors, for
example, can demand that businesses which
present a higher risk of loss or failure pay a
higher interest rate. Workers can push for higher
wages from financially weak companies or look
for alternative employment.
Not all parties, however, are able to influence
a company's leverage decisions. Financial weakness in the corporate sector could lead to a cut16




back in business activity which would weaken
the macroeconomy. In his 1933 analysis of the
interaction of debt and deflation, Irving Fisher
contends that deflation raises the real value of
debt and may cause companies to reduce their
output and employment. The reduction in output and employment further weakens the economy and leads to corporate failures, which in
turn reduce output more and strengthen the
forces of deflation.
Jack Guttentag and Richard Herring (1984)
provide another mechanism by which corporate
weakness could affect the economy as a whole.
In their model, investors (banks) are quite good
at estimating project-specific risk, but they systematically underestimate the possibility of a >.
major macroeconomic shock. Corporations respond to this systematic error by reducing their
capital ratios below those levels they would
maintain if the true probability of major shocks
were known. When a shock does occur, the value
of collateral backing corporate loans declines.
Banks respond by rationing, or restricting, credit, which further slows macroeconomic activity.
Concern about corporate bankruptcies because of excessive leverage may also adversely
influence monetary policy. The Federal Reserve
(1984) "attempts to ensure that growth in money
and credit over the long run is sufficient to encourage growth in the economy in line with its
potential and with reasonable price stability."4
This policy objective may occasionally require
restraining the growth of money in order to prevent an excessive rate of price inflation. However, the Federal Reserve may be reluctant to
follow appropriate anti-inflationary policies if
they might cause a wave of corporate bankruptcies that would weaken the economy even
more. Furthermore, even if the Federal Reserve
is confident that the macroeconomic consequences of a disinflationary policy can be controlled, failing corporations may attempt to
exert political pressure on monetary policy.
Another cost of leverage not fully borne by the
firm is the expected costs of bankruptcy when a
corporation successfully demands a government bailout. The U.S. political system allows
companies that have failed to appeal for public
support. In almost all cases, nonfinancial firms
are denied direct support for continuing operations, but in a few instances the government
has provided assistance.
E C O N O M I C REVIEW, MAY/JUNE 1988

Thus, the effect of excessive corporate debt
on government expenditures, the stability of
the macroeconomy, and monetary policy all
provide reasons for public concern about corporate debt ratios. However, current tax policy
provides the exact opposite incentive, favoring
debt financing over the use of equity.
Ideally, a theory could help determine the
optimal leverage ratio for each corporation, but
no such theory has been devised to date. Existing theory is not even sufficiently powerful to
allow us to specify the value-maximizing capital
level for individual corporations. Expanding the
analysis to consider the social costs of leverage
only complicates the problem.

Are U.S. Corporations,
in Fact, Underleveraged?
The arguments that U.S. corporations are
underleveraged are spurred in part by the problems the United States has had in competing in
international markets. U.S. firms appear to have
lower debt ratios than many of their foreign
competitors. Do the higher debt ratios in foreign countries suggest that U.S. businesses
are underleveraged?
In comparing domestic leverage ratios with
debt levels of West German and Japanese companies, Ellsworth (1985) concludes that U.S.
firms are indeed underleveraged. His research
indicates that the relative reluctance of domestic firms to use debt financing renders their cost
of capital higher, lowering return on equity and
reducing their ability to support rapid growth
while maintaining a constant capital structure.
The suggestion that Japanese corporations have
a lower cost of capital is supported by Irwin
Friend and Ichiro Tokutsu's (1987) findings.
Their analysis also lends credence to the claim
that the lower cost of capital resulted in part
from the higher leverage ratios of Japanese corporations. One limitation of Friend and Tokutsu's results to the current situation is that they
use average data from 1962 to 1984. Even if
Japanese firms no longer have a funding cost
advantage, Friend and Tokutsu's results could
be obtained if Japanese corporations had a sufficiently large advantage in the 1960s and 1970s.
The analysis below considers two counterarguments to the contention that U.S. com-

panies are underleveraged relative to foreign
firms, especially those in Japan and West Germany. First, several studies find that, properly
measured, U.S. leverage ratios are approximately the same as those in Japan and West
Germany. Second, any remaining differences in
leverage can be explained by foreign financial
systems that discourage firms from issuing equity
and encourage them to borrow from banks.
Measuring the Differences in Leverage
Ratios. U.S. companies appear to have significantly lower leverage ratios than Japanese and
West German firms if the ratios are measured
using unadjusted accounting data, but the
appearance maybe misleading. Ellsworth finds
that U.S. corporations have a ratio of total debt
to total capital that is approximately one-half
that of Japanese and West German firms. C.D.
Elston's (1981) research calculates that the
equity capital-to-asset ratio of manufacturers in
Japan was approximately 21 percent, which
compares with 35 percent to 40 percent for
those in West Germany and 50 percent to 60 percent for those in the United States. John D.
Paulus (1986) compares debt-to-equity ratios
for seven arbitrarily selected industries in the
United States, West Germany, and Japan.5 He
finds that the book values of the U.S. ratios are
the lowest in all but three of fourteen possible
cases.
Statistical analysis of leverage ratios confirms
simple examination of book data. Ravi Sarathy
andSangitChatterjee (1984),using 1979 balance
sheet data, compare balance sheet ratios for
573 large Japanese firms and 368 large U.S. firms.
A simple t-test, which gauges whether differences are merely a chance occurrence, showed
that the sample of Japanese businesses has
significantly lower equity-to-asset ratios. Allen
Michel and Israel Shaked (1985) use a more
sophisticated approach to compare a matched
sample of 130 Japanese and 130 U.S. firms. Thirteen companies from ten industries in each
country were selected, and two tests were used
to compare differences in the two countries'
capitalization ratios, which the researchers
defined as "the ratio of equity to equity plus
total debt." 6 Their results further bolster the
hypothesis that Japanese firms are more highly leveraged.
W. Carl Kester (1986) conducts an even more
sophisticated statistical analysis of U.S. and
17

FEDERAL RESERVE BANK O F ATLANTA




Japanese debt ratios, one which takes into consideration the fact that the profitability, risk,
growth, and size of a corporation may also influence its use of debt financing. However, even
after using regression analysis to adjust for all of
these factors, he finds that U.S. firms have
significantly lower debt-to-total asset ratios
than Japanese corporations when the ratios are
calculated with unadjusted accounting data.
Unadjusted accounting data, however, may
not paint a true picture in the case of Japanese
firms. Elston points out several reasons that
book values may understate Japanese equity:
( 1 ) Japanese companies probably take more taxfree deductions from earnings (and hence retained earnings) than corporations in other
countries, (2) large Japanese corporations tend
to provide more trade financing to smaller corporations than is typical in many countries, and
(3) the difference between the marketvalue and
the book value of the assets of Japanese corporations is probably greater than comparable
differences for foreign corporations.7
Elston reports official Japanese estimates
that the equity-to-assets ratio would have risen
from 18 percent to 35 percent in 1967 if these
three factors were included in the analysis. As
he mentions, unofficial estimates of an adjusted
equity-to-assets ratio ranged from 40 percent to
50 percent in 1975. Stephen Bronte (1982) reports that confidential analysis of adjusted
leverage ratios by the Japanese Ministry of
Finance and the Bank of Japan suggests that
Japanese and U.S. firms both have stockholders'
equity-to-total liabilities ratios of approximately 2:3. Thus, correcting differences in accounting data may eliminate most of the apparent disparities in leverage ratios across
countries.
The problems with adjusting accounting data
indicate that analysis of debt ratios using market values might be more appropriate. When
Paulus compares the ratios of debt to market
values of equity for the same seven industries
that he uses for book value comparisons, he
finds that the ratios fall dramatically: West Germany drops from 2.33 in book terms to 1.14 using
marketvalue of equity; Japan declines from 3.63
to 1.57. The U.S. figures are little changed, rising
from 1.22 using book value to 1.25 using market
value of equity. Paulus's figures may be somewhat deceptive in that he uses market values
18




for equity but not for debt His analysis, nevertheless, casts serious doubt on simple comparisons of book values, especially since more
sophisticated analysis appears to support his
findings regarding market value leverage ratios.
For example, Kester uses regression analysis to control for differences in profitability, risk,
growth, and size between U.S. and Japanese
firms. He concludes that businesses in these
countries have similar market value debt ratios.
Michel and Shaked also suggest that the overall
market capitalization ratios of Japanese and
American corporations appear to be similar.8
However, they find evidence that the shape of
the distributions of capitalization ratios is different.9 Specifically, Michel and Shaked find
that the capitalization ratios of the Japanese
sample contain more low-valued ratios than the

'ICJorrecting differences in accounting data may eliminate most of the
apparent disparities in leverage ratios
across countries."

sample of U.S. firms. Further doubt is cast on
discounting ratio comparisons by the fact that
the higher accounting leverage ratios have not
resulted in substantially higher bankruptcy
rates for Japanese and West German firms.
Although Edward I. Altman (1984) finds that the
Japanese failure rate may be somewhat higher
than that of U.S. firms, he also notes that "just as
we discovered in the comparison of Japanese
and U.S.A. rates, the West Germany-U.S.A. ratios
are quite similar."10
Although West German and Japanese companies have leverage ratios comparable to U.S.
firms', they also operate in environments which
give greater encouragement to debt. West German and Japanese financial markets are thought
to be far weaker than the U.S. markets, which are
among the most developed in the world. Charles
Smith and others (1987) contend that Japanese
E C O N O M I C REVIEW, MAY/JUNE 1988

corporations continue to avoid issuing all types
of securities in Japan because new issues are
"so red-tape-tied" by government policies. This
bureaucracy has encouraged Japanese firms to
rely on bank debt. W. Friedmann, D.H.A Ingram,
and D.K. Miles (1984) also note that West German governmental restrictions discourage small
firms from becoming public limited companies—
the only type of firm that can raise equity in the
share markets. In particular, all public limited
companies must allow their employees to
nominate at least one-third of their supervisory
board members.
West German and Japanese corporations are
also encouraged to have higher leverage ratios
by financial systems that help reduce conflict
between owners and creditors. Japanese and
West German firms are able to issue more debt

"West German and Japanese corporations are also encouraged to have
higher leverage ratios by financial systems that help reduce conflict between owners and creditors."

because the agency costs associated with high
debt levels are reduced by those nations' financial structures. Banks in Japan and West Germany have historically been allowed to own
stock in nonfinancial corporations and participate in the management of companies. Such
involvement reduces the incentive to transfer
wealth from creditors to owners. Furthermore,
when Japanese businesses issue debt to the
market, they are generally required to provide
collateral. Rene M. Stulz and Herb Johnson
(1985) show that collateralized debt further
reduces a company's incentive to attempt to
transfer wealth to the owners. U.S. banks, in contrast, are severely limited in their ability to
purchase the stock of nonfinancial corporations.
Also, while U.S. corporations issue some collateralized bonds, Kester notes that a majority
of corporate debt is unsecured.
FEDERAL RESERVE BANK O F ATLANTA




The Japanese also encourage debt by reducing the costs of financial distress. Many Japanese corporations are members of large industrial groups, or families of corporations,
called keiretsu, in which stock ownership is concentrated in one or several parents. These
groups typically include a major bank that provides most of the necessary banking services to
the group." This ownership structure permits
temporary financial problems to be met with
assistance from other companies within the
group. If a company should encounter substantial financial difficulties, its bank will often take
the lead in arranging new loans or a merger. If
the firm becomes bankrupt, then the bank may
subordinate its position to that of other creditors,
eliminating the need for lengthy negotiations
and reducing legal costs.
Governmental guarantees can also reduce
the costs of financial distress. Japanese commercial banks have borrowed substantial sums
from and remained in debt to the Bank of Japan
for extended periods of time. The willingness of
the Bank of Japan to allow extended borrowings,
according to Sadahiko Suzuki and Richard W.
Wright (1985), reduces banks' concern about
liquidity crises and thus increases bank loans.
Elston also suggests that implicit government
guarantees have been provided to certain industries targeted for rapid growth.
Thus, corporate leverage ratios in some foreign countries appear higher than those in the
United States when measured in book value
terms. However, the differences are eliminated
when leverage is measured in market value
terms. Moreover, some foreign countries have
financial systems that are more supportive of
debt financing.

Analysis of Domestic
Leverage Ratios through Time
Aside from cross-national comparisons, another way of analyzing leverage rates in the absence of theoretical specification of optimal
leverage is to compare current levels with those
from prior periods. If operating riskiness of corporations is stable over time, an increase in
leverage ratios suggests that corporations are
19

Chart 1.
Book Value Debt-to-Equity Ratios for U.S. Nonfinancial Corporations
(1948-84)

Debt-to-Equity
Ratio

1948

1953

1958

1963

1968

1973

Source: C a l c u l a t e d b y the Federal Reserve Bank of Atlanta using data from Statistics of Income,
yearly issues, 1948-84, Internal Revenue Service, U.S. Department of the Treasury.

becoming financially weaker, and a decrease
implies greater strength.
Historical Trends. Several methods for calculating leverage ratios are available. The
strongest case for concern about corporate debt
levels arises from the analysis of leverage using
book values for debt and equity. Using 1926-79
data from the Internal Revenue Service's Statistics of Income, Robert A. Taggart, Jr. (1984) examines the long-term debt-to-asset ratio for all
nonfinancial U.S. corporations. Chart 1 presents
the total debt-to-equity ratio from 1948 through
1984 for all nonfinancial U.S. corporations and
shows consistent increases in the book value
20




1978
Corporate

Income

1983
Tax

Returns,

ratio of debt to equity over the post-war period,
with a maximum of 1.614 occurring in 1983.12
Corporate leverage ratios are less troubling
when measured using the market value of debt
to the replacement cost of assets as a measure
of leverage. Raymond W. Goldsmith and others
(1963) examine replacement cost leverage ratios from 1900 to 1958. Their results show that
corporations had much higher debt ratios prior
to World War II than after that war. George M. von
Furstenberg (1977) examines the period from
1952 to 1976 and finds that replacement cost
leverage ratios rose between 1955 and 1965 but
thereafter remained relatively stable. Roger H.
ECONOMIC REVIEW, MAY/JUNE 1988

Chart 2.
Market Value Debt-to-Equity Ratios for U.S. Nonfinancial Corporations
(1948-85)
Debt-to-Equity
Ratio

0.65

0.60
0.55

0.50

0.45

0.40

0.35

0.30

0.25

1948

1953

1958

1963

1968

1973

1978

1983

Source: C a l c u l a t e d b y the Federal Reserve Bank of Atlanta using data from Statistics of Income, Corporation
Income Tax Returns,
yearly issues, 1948-85, Internal R e v e n u e Service, U.S. Department of the Treasury; C o m p o s i t e A v e r a g e of Yields o n Industrial
Bonds, Moody's Industrial Manual 1986, vol. I (A-l); a n d Economic Report of the President, February 1986, Washington, D.C.:
U.S. G o v e r n m e n t Printing Office.

Gordon and Burton G. Malkiel ( 1981 ) extend von
Furstenberg's calculations to 1978 and determine that replacement cost leverage ratios rose
to their highest levels in 1977 and 1978. Paul
Bennett and others (1985) examine replacement cost leverage ratios over the period from
1958 to 1984. They find that leverage increased
over the period from 1958 to the mid-1960s, fluctuated until 1973, and then plunged. In 1974, the
replacement cost leverage ratio fell to the levels
of the late 1950s and early 1960s and remained
at low levels through 1984. Indeed, the lowest
leverage ratios appear to have occurred in 1981.
FEDERAL RESERVE BANK O F ATLANTA




Debt ratios are also less threatening when
leverage is measured by capitalizing dividend
and interest payments by corporations at market rates to obtain estimates of the market value
of equity and debt. Daniel M. Holland and
Stewart C. Myers (1979) use this approach to
analyze leverage ratios over the period from
1929 to 1981. They capitalize dividends using
the dividend yield on Standard and Poor's Composite Index and capitalize interest payments
using Moody's Baa corporate bond rate. Debtto-equity ratios computed with a modified version of their approach are presented in Chart 2;
21

dividends of all nonfinancial corporations from
the IRS's Statistics of Income are capitalized at
the rate of the Standard and Poor's 400 dividend
yield, and interest of all nonfinancial corporations from the IRS's Statistics of Income is
capitalized at the average yield for Moody's
Industrial Composite Debt Index for each year.13
Chart 2 shows that the debt-to-equity ratio in
1985 was higher than during the 1960s. However,
the 1985 ratio is in the same range as in the early
1950s and early 1970s. Moreover, the 1985 ratio
is well below the levels seen in the mid-1970s
and early 1980s.
Changes in Leverage and Changes in Risk.
Changes in leverage ratios may not always denote changes in risk. Leverage ratios shift over
time for a variety of reasons, with different
implications for corporate financial conditions.
For example, increased leverage resulting from
a tax policy that is more favorable toward debt
suggests reduced corporate financial strength.
In contrast, increased leverage caused by a
more stable macroeconomic environment may
suggest no change in corporate strength.
Based on the work done on determinants of
corporate financing policies, Taggart (1984)
delineates several factors that could influence
leverage ratios over time: business risk, corporate and personal taxes, inflation, federal
government borrowing, and the ratio of internal
funds to investment opportunities. Business
risk influences leverage through its effect on a
corporation's probability of bankruptcy. As
business risk increases, companies may reduce
their leverage to avoid increased bankruptcy
risk. Taggart examines the effect of business risk
by comparing changes in corporate debt-toasset ratios with the variability of returns for the
Standard and Poor's composite stock index. He
finds that ratios apparently plunged when business risk increased during the Depression and
rose with the reduction of risk in the period after
World War II.
Corporate and personal taxes influence
leverage ratios through their effect on the aftertax cost of debt and equity financing. To explore
this relationship, Taggart compares changes in
debt-to-asset ratios with a "debt incentive tax
ratio," which proxies the relative taxes on debt
and equity over the period from 1900 to 1980. A
graph of the two ratios implies that they were
unrelated, or even inversely related, prior to
22




World War II and only marginally related thereafter. Furthermore, the incentive ratio, which
has been relatively constant from 1950 to the
end of his sample period, could not explain
short-run variations in the ratio. However, reviewing the period 1935-82, Randall J. Pozdena
(1987) finds that tax policy has a significant effect
on aggregate corporate debt ratios.14 His results show that the corporate tax rate and rate
on capital gains have a significantly positive
effect. The personal tax rate and corporate nondebt tax shields have a significantly negative
effect on the ratio of liabilities to equity when
measured in book terms.15 Pozdena's analysis is
superior both in the variables used to proxy for
taxes and the methodology it employs to evak
uate the effect of taxes.
Inflation can affect debt ratios by increasing
the real tax advantages of debt financing. The
inflation premium in nominal interest rates is
primarily a return of the real principal of a loan.
Thus, an increase in the inflation rate in effect
allows a business to deduct from its taxable
income more of the real principal of its loan.
Taggart's graph of debt ratios and the change in
the GNP deflator fails to reveal a close, positive
relationship between movements in inflation
rates and debt ratios.
Federal government debt can influence corporate leverage by conditioning investors'
willingness to absorb corporate debt ratios. For
example, government debt may influence leverage ratios if government and corporate debt are
closer substitutes than government debt and
corporate equities. Taggart finds "a strong
inverse relationship" between government
debt and corporate debt-to-asset ratios when
the two are graphed over time.
The ratio of internal funds generated to
investment opportunities may be important in
determining corporate debt ratios in the short
run. Myers' pecking order implies that firms may
depart from their optimal ratios for extended
periods of time because of the costs of issuing
new securities. However, Taggart does not provide empirical analysis of this effect because
the pecking order theory does not suggest
permanent deviations of optimal ratios from
actual ratios.
Another factor that may influence leverage
ratios over time is found in Guttentag and
Herring's (1984) contention that firms sysE C O N O M I C REVIEW, MAY/JUNE 1988

tematically underestimate the probability of
major shocks to the economy. In their model,
individuals' subjective probability of a shock
declines over time as they forget about the last
shock. As a result, leverage ratios should have
increased in the period since the Great Depression. The researchers do not provide any
empirical evidence on this hypothesis.
Recent Trends in Corporate Debt Ratios.
Taggart's hypotheses, along with that of Guttentag and Herring, can be jointly tested through
linear regression analysis. Regression analysis
relates the value of one dependent variable to
the values of one or more independent variables. In the present study, separate regressions are run for two definitions of leverage: the
book value using the same definition as in
Chart 1, and the market value using the same
definition as in Chart 2. The independent
variables are those considered by Taggart and
Pozdena:

BVDE = a0 + a, *GOVNF +

+
a2*INFL

+
+ a3*RISK + a4 *CORP +
+

a5*INDIV

+ a6*CGAIN + a7*SHLD + e,

MVDE = b0 + b, *GOVNF +

(1)

+
b2*INFL

+
+ b3 *R1SK + b4 *CORP + b5*INDIV
+
+ b6*CGAIN + b/SHLD

+e2,

(2)

where BVDE equals the book value debt-toequity ratio as described above; MVDE represents the market value debt-to-equity ratio as
described above; GOVNF is the ratio of government debt to total domestic nonfinancial debt;
¡NFL is the percent change in the GNP deflator
for each year; RISK equals the standard deviation of monthly percentage changes in the price
for Standard & Poor's Composite Index; CORP is
the maximum tax rate on corporate income;
INDIV is the maximum tax rate on the ordinary
income of individuals; CGAIN equals the maximum tax rate on the capital gains of individuals;
SHLD is a measure of the non-interest tax
shields of corporations, defined as in Pozdena;
and e , and e2 are random error terms. Models are
estimated using annual data from 1948-84.
FEDERAL RESERVE BANK O F ATLANTA




The expected signs based on Taggart and
Pozdena for each of the coefficients are over the
variables. A "plus" sign indicates that an increase in the variable is associated with an
increase in leverage, and a "minus" sign indicates an inverse relationship. The tax variables
in the model are Pozdena's. The tax incentive
variable discussed by Taggart was substituted
for the tax variables Pozdena used, but those
results are not reported because the coefficient
on the tax incentive variable was not significant
Table 1 presents the results of estimating
both models. Each equation is estimated twice
because a potential statistical problem called
autocorrelation of the error terms was indicated
by the first estimation. The corrected equations
use the maximum likelihood ARI correction
method in the computer package RATS.16 With
the exception of the corrected market value
equation, all equations are significant at the
99 percent level of confidence, indicating the
odds that the same results could have occurred
by chance are only I in 100. The corrected
market value equation was not significant, even
at the 95 percent level.
The results of the book value of debt-toequity estimation are not substantially changed
by the correction. In both models, the coefficients on the ratio of government to total nonfinancial debt, corporate risk, inflation, and
individual taxes are significant with the correct
sign. The coefficient on the tax shield variable is
significant with the wrong sign, and the coefficients on the corporate tax rate and capital
gains are insignificant. These results imply that
government debt tends to crowd out corporate
debt issues, that corporations reduce their
leverage as their risk increases, and increases in
the inflation rate are associated with an increase
in leverage ratios measured in book terms. This
set of results does not appear to suggest that
taxes have a significant effect on corporate debt
ratios. However, this study uses a shorter sample period, with less variability in tax rates than
does Pozdena.
The results of estimating the market value
equation imply that none of the variables can
explain movements in debt-to-equity ratios
measured in market terms, perhaps because of
the difficulty in measuring the market values of
debt and equity. This outcome could also be
obtained if changes in the ratio were due primar23

Table 1.
Regression Model Estimates Debt to Equity without the Trend Variable*
(Annual Data, 1948-84)
Book
Value

Book Value with
AR1 Correction

Market
Value

Market Value with
AR1 Correction

-0.7057*
(-2.93)

-0.7606*
(-2.90)

0.2678
(0.95)

0.0960
(0.25)

INFL

0.0241*
(3.33)

0.0222*
(2.75)

0.0152
(1.81)

0.0045
(0.51)

RISK

-4.5074*
(-4.26)

-4.3858*
(-4.18)

-0.0483
(-0.04)

0.7099
(0.67)

CORP

0.0951
(0.23)

0.0388
(0.08)

-0.1210
(-0.25)

-0.1852
(-0.30)

INDIV

-0.6255*
(-2.81)

-0.6035*
(-2.55)

-0.1102
(-0.42)

-0.1985
(-0.63)

CGAIN

-0.1356
(-0.41)

-0.1404
(-0.38)

0.5483
(1.41)

0.5985
(1.12)

SHLD

-2.1376*
(-7.84)

-2.1333*
(-7.40)

-0.4629
(-1.46)

-0.3309
(-0.85)

3.3134*
(13.09)

3.3408*
(12.43)

0.5572
(1.89)

0.6110
(1.67)

GOVNF

Constant

rho

0.1010
(0.4643)

0.4186*
(2.15)

F-STAT (7,29)

172.9*

137.8*

6.756*

2.170

R-Square

0.977

0.977

0.620

0.647

Durbin-Watson
t t-statistics in

1.80

parentheses

* Indicates significance

at the 95 percent level (two-tailed for

ily to changes in the market value of equity that
are not expected by corporate managers.
As Guttentag and Herring contend, corporations' willingness to assume debt may have
increased over this time period. A simple way of
testing this hypothesis is to add a time trend
variable to the models. If corporations are willing to assume more debt as memories of the
Depression fade, then the coefficient on the
time trend should be positive. The revised
models simply add a trend variable, TREND, to
equations (1) and (2). TREND represents a time
trend which begins with a value of one in 1948,
increases by one per year, and has an expected
coefficient value greater than zero. The expected signs of each of the coefficients are the same
as before. The results of estimating the subse24




1.57

t-statistics)

quent equations are presented in Table 2.
Autocorrelation of the residuals may be rejected at the 95 percent level in the book value
equation but not for the market value equation.
Thus, the market value equation is also estimated using a correction. All equations are
significant at the 95 percent confidence level.
The coefficient on the trend variable is significantly positive in the book value equation,
suggesting that corporate debt ratios have risen
through time. The coefficients on the risk and
inflation variables are also significant with the
correct sign. The coefficient on the ratio of
government debt to total nonfinancial debt
changed signs and is significantly greater than
zero. This ratio is highly correlated with the
trend variable and apparently is serving as a
E C O N O M I C REVIEW, MAY/JUNE 1988

proxy for the trend variable in Table 1. All of the
tax variables in Table 2 have the correct sign,
and the coefficients on the individual tax rate
and capital gains rate are significant. Overall,
these results are more supportive of the tax
hypotheses than those in Table 1.
The correction does not significantly affect
the results of the market value debt-to-equity
ratios in Table 2. Three variables have significant coefficients in the market value of the debtto-equity model, the ratio of government debt
to total nonfinancial debt, the trend variable,
and the tax rate on capital gains. The coefficient
on the ratio of government to total nonfinancial
debt has the wrong sign, but the coefficients on
the trend variable and on the capital gains variable have the correct signs. These results are
less strong than those for the book value ratios,
perhaps because of the difficulties in measuring
market values or perhaps because managers,
failing to predict changes in market value or
regarding the changes as transitory, do not fully
adjust to changes in market values.
Overall, the analysis of the determinants of
domestic leverage ratios over time supports the
hypothesis that debt-to-equity ratios are increasing as managers forget the difficulties of
the Depression. The results also suggest that
debt-to-equity ratios measured in book terms
are a positive function of inflation rates and a
negative function of the riskiness of corporations. Some support is also provided for
the hypothesis that taxes have had a significant
effect on corporate debt-to-equity ratios, especially when they are measured in book terms.
Summaiy. Corporate leverage ratios are somewhat higher than they have been during certain
prior periods. When leverage is measured in
book value terms, the increase in leverage is
disturbing. However, if leverage is measured in
replacement cost or market value terms, then
current debt ratios do not appear to be unusually high. Regression analysis supports the
belief that leverage ratios measured in book
and market value terms are positively related to
a time trend. Leverage ratios measured in book
terms are positively related to the inflation rate
and negatively related to the amount of risk corporations are willing to assume. Some support
is also found for theories which contend that
taxes have a significant effect on corporate
leverage.
FEDERAL RESERVE BANK O F ATLANTA




Table 2.
Regression Model Estimates
Debt to Equity
with the Trend Variable*
(Annual Data, 1948-84)

Book
Value

Market
Value

Market Value
with AR1
Correction

GOVNF

0.9371*
(2.63)

1.4151*
(2.67)

1.4402*
(2.73)

INFL

0.0197*
(3.74)

0.0121
(1.54)

0.0126
(1-5)

RISK

-2.3617*
(-2.74)

1.4502
(1.13)

1.4506
(1.12)

CORP

0.1507
(0.50)

-0.0821
(-0.18)

-0.0861
(-0.20)

INDIV

-0.3918*
(-2.36)

0.0530
(0.21)

0.0617
(0.25)

CGAIN

0.6986*
(-2.43)

1.1309*
(2.64)

1.1357*
(2.69)

0.6369
(1.20)

0.6581
(1.23)

0.0207*
(2.48)

0.0211*
(2.53)

SHLD

-0.5628
(-1.58)

TREND

0.0297*
(5.29)

Constant

0.6096
(1.12)

-1.3310
(-1.64)

rho

-1.3698
(-1.69)
-0.3386
(-0.16)

F-STAT

295.5*

7.72*

8.17*

R-Square

0.988

0.688

0.688

2.33

1.94

DurbinWatson

t t-statistics in

parentheses

* Indicates significance
tailed for

at the 95 percent level (two-

t-statistics)

The positive relationship between leverage
ratios and the time trend is the most troubling
result because of its implication that corporations may be weakening their financial
structure as memories of the Depression fade.
However, the trend variable may be subject to
multiple interpretations since a number of
potential leverage determinants that are not
modeled, such as technology, may be correlated with the time trend.
25

Conclusion and Policy Implications
The results of this study of debt-to-equity
ratios of nonfinancial corporations in the United
States suggest that a variety of factors may
influence corporate leverage ratios and that
theory is not yet able to identify optimal ratios,
either for individual corporations or for nonfinancial corporations in the aggregate. Leverage ratios appear to be somewhat higher than
they have been in the past, but they are unusually high only when measured using the least
reliable indicator, book value. However, regression analysis controlling for the influence of certain other factors indicates that U.S. corporations
have tended to increase their leverage during
the post-war period.
Some studies suggest that U.S. corporations
are underleveraged relative to their foreign
competitors, but others contend that when
leverage is measured using market values, the
differences are insignificant. Regardless of relative leverage ratios, foreign countries do not

26




have significantly higher failure rates than the
United States. Moreover, the market structure,
tax policy, and regulation in some foreign countries tend to provide more support for high debt
levels than in the United States. One policy
implication of such cross-national comparisons
concerns banking and is discussed in the accompanying box.
The results of this study are limited in at least
two important ways. First, most of the analysis
focuses on aggregate debt ratios of the entire
corporate sector, whereas, for many purposes,
the debt ratios of individual corporations are
important.17 Second, the empirical examination
of domestic leverage ratios is constrained by
available data to the period prior to 1984,
although market value debt-to-equity ratios are *
presented for 1985. This study does not consider any changes in leverage after 1985.
Overall, the results do not reinforce the contention that U.S. firms are underleveraged and
provide only weak support for the argument that
U.S. firms are overleveraged.

E C O N O M I C REVIEW, MAY/JUNE 1988

Would Relaxing the Line between Banking and
Nonfinancial Companies Help Firms Support More Debt?
The e x p e r i e n c e of corporations h e a d q u a r t e r e d
in foreign countries c o u l d b e s e e n as encourage-

s h i p of nonfinancial corporations' stock is unlikely
t o reverse this trend.

m e n t for t h e United States t o remove restrictions

Moreover, J a p a n e s e c o r p o r a t i o n s a p p e a r a l s o

on banks' affiliation with nonfinancial corporations.

to b e reducing their reliance o n b a n k

Bank o w n e r s h i p of stock m a y h e l p r e d u c e t h e

Charles S m i t h a n d others (1987) report that while

debt.

agency costs of d e b t financing a n d r e d u c e t h e

b a n k lending accounted for a n average 84 percent of

costs of distress w h e n a firm encounters financial

corporate financing in 1970-74, t h e average s l i p p e d

p r o b l e m s . Thus, b a n k o w n e r s h i p c o u l d p r o m o t e

t o 60 percent b e t w e e n 1980 a n d 1984 a n d in 1984

efficient m a n a g e m e n t a n d allow s o m e b u s i n e s s e s

d r o p p e d t o 44 percent. In contrast, e q u i t y ac-

t o o p e r a t e with higher d e b t levels.

c o u n t e d for 36 percent of financing in 1985, ap-

However, b a n k ownership of t h e stock of non-

proximately d o u b l e its share in t h e 1970s. W. Carl

financial corporations raises a variety of issues in

Kester (1986) suggests that t h e r e d u c t i o n in b a n k

a d d i t i o n t o t h e effect of such ownership o n non-

l e n d i n g may b e occurring b e c a u s e m o r e of t h e

financial firms' financial policy. T h e

growth in J a p a n e s e corporations is concentrated

United

States has restricted b a n k o w n e r s h i p of nonfinan-

in firms that are n o t keiretsu

cial corporations for a variety of reasons i n c l u d i n g

i m p l i e s that t h e c h a n g e in financing policy m a y b e

m e m b e r s . H e also

(1} p o s s i b l e conflicts of interest at commercial

an a t t e m p t by J a p a n e s e managers t o m a x i m i z e

banks, (2) t h e potential for overconcentration in

their o w n utility rather t h a n shareholder value. In

b a n k s of e c o n o m i c a n d political power, a n d (3) t h e

particular, Kester n o t e s that heavy d e b t b u r d e n s

desire t o avoid extension of t h e federal safety net,

i m p o s e tight controls that managers m a y wish t o

i n t e n d e d t o protect banks, t o nonfinancial cor-

avoid. S m i t h a n d others p r o v i d e a different jus-

porations.

tification for t h e c h a n g e in financial policy, n o t i n g a

Bank ownership of corporate stock is b e i n g re-

B a n k of Japan study which states that t h e diver-

e v a l u a t e d in Japan a n d West Germany. The Jap-

sification of f u n d i n g sources m a y have cut t h e cost

a n e s e are m o v i n g t o restrict t h e o w n e r s h i p ties

of raising f u n d s from 6.4 percent in 1980 t o 6.2 per-

b e t w e e n b a n k s a n d o t h e r corporations by requir-

cent in J 985.

ing a reduction in b a n k o w n e r s h i p of o t h e r cor-

Thus, b a n k affiliation with nonfinancial corpo-

porations t o 5 p e r c e n t In West Germany, com-

rations m a y n o t p r o v i d e significant advantages t o

mercial b a n k o w n e r s h i p of n o n b a n k c o m p a n i e s

t h e n o n f i n a n c i a l sector. 2 C o r p o r a t i o n s in t h e

has b e e n criticized, though a c o m m i s s i o n estab-

U n i t e d States are m o v i n g toward market-based

lished t o investigate this issue f o u n d m o s t of t h e

financing

criticisms unsubstantiated. 1

Relaxing U.S. restrictions o n b a n k affiliation with

Relaxing U.S. restrictions o n b a n k stock owner-

a n d r e d u c i n g their reliance o n banks.

n o n b a n k s m a y n o t reverse t h e current trend.

s h i p m a y a l s o fail t o p r o d u c e h i g h e r l e v e r a g e
ratios here. J a p a n e s e a n d West G e r m a n comp a n i e s d o not have significantly higher d e b t ratios

¡1

when market values, rather t h a n b o o k values, are
used. Major U.S. corporations have b e e n steadily
reducing their reliance o n commercial b a n k loans,
partly b e c a u s e t h e information a d v a n t a g e that
b a n k s o n c e h e l d h a s b e e n e r o d e d a n d partly
b e c a u s e regulatory restrictions such as reserve
r e q u i r e m e n t s raise t h e relative cost of b a n k loans.
Merely relaxing t h e restrictions o n banks' owner-

FEDERAL RESERVE BANK O F ATLANTA




'See Krummel (1980).
Nash (1987) discusses arguments suggesting that the
mixing of banking and commerce would produce significant advantages for the commercial banking system.
The issues raised in that report are beyond the scope of
;
this study.

2

27

Notes
'A corporation's reliance on debt financing is typically
measured as the percentage of funds obtained through
debt. Firms that rely heavily on debt may be said to have a
high debt-to-equity
ratio or a high debt-to-total
asset
ratio or a low equity-to-asset ratio. Firms with high debt
levels are also said to have high financial leverage. This
study will refer to all three ratios and the term financial
leverage in discussing debt levels.

8

Market capitalization ratios were tested for the period
1977-81 using the nonparametric Mann-Whitney U tests.
^The Kolmogorov-Smirnov Two-Sample test.
,0
See Altman (1984): 177.
11
However, companies belonging to groups tend to borrow
only approximately 20 percent of their total needs at the
group's bank.
12

^ e e Haugen and Senbet (1978, 1988) for analysis suggesting that bankruptcy costs are irrelevant to corporate
leverage decisions.
^ e e the Board of Governors of the Federal Reserve System
(1984): I.
5
The seven industries are chemicals, steel, data processing, electrical and electronics, machinery and engineering, automobiles, and airlines.
6
The Mann-Whitney U test and the Kolmogorov-Smirnov
Two-Sample test

Adding to the concern about book value leverage ratios
are Tetlow's (1986) findings that Canadian book value
leverage ratios declined after 1982.
l3
The S&P 400 Index was chosen to isolate the behavior of
industrial dividends from those of financial, utility, and
transportation firms.
14
Pozdena also examines the relative issuance of debt and
equity and the issuance of junk bonds over the period
from 1908 to 1985.
1
''The only independent variable in Pozdena's model that is
not tax-related is the inflation rate. The nondebt-related "
tax shields include the depletion and depreciation allowances and the investment tax credit. According to
DeAngelo and Masulis, these are tax shields that may be
lost or reduced in value if the firm has excessive leverage.

7

l6

2

For example, suppose a firm issues debt and uses the proceeds to repurchase part of its outstanding equity. This
issuance and repurchase would increase the firm's total
interest payments to creditors and reduce the earnings
available for dividends.

The discrepancy between book and market values is
especially great for land values. A Japanese index of
industrial land prices rose from 100 in 1955 to 3,288 in
March 1981; see Elston (1981): 515.

The Durbin-Watson statistic for both equations is in the
inconclusive range.
17
See Titman and Wessels (1988) for a recent examination of
cross-sectional differences in corporate leverage.

References
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Baxter, Nevins. "Leverage, Risk of Ruin and the Cost of Capital." Journal of Finance 22 (1967): 395-404.
Bennett, Paul, Anne de Melogue, and Andrew Silver. "Corporate Debt-Equity Ratios." Federal Reserve Bank of
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Board of Governors of the Federal Reserve System. Federal
Reserve System: Purposes and Functions. Washington,
D.C.: 1984.
Bronte, Stephen, lapanese Finance: Markets and Institutions. London: Euromoney Publications, 1982.
DeAngelo, Harry, and Ronald W. Masulis. "Optimal Capital
Structure Under Corporate and Personal Taxation." Journal of Financial Economics 8 (March 1980): 3-29.
Ellsworth, Richard R. "Subordinate Financial Policy to Corporate Strategy." Harvard Business Review 61 (November-December 1983): 170-82.
"Capital Markets and Competitive Decline."
Harvard Business Review 63 (September-October 1985):
171-83.
Elston, C.D. "The Financing of Japanese Industry." Bank of
England Quarterly Bulletin 21 (December 1981): 51018.

28




Fisher, Irving. "The Debt-Deflation Theory of Great Depression." Econometrica 1 (1933): 337-57.
Fons, Jerome S., and William P. Osterberg. "Disinflation,
Equity Valuation, and Investor Rationality." Federal
Reserve Bank of Cleveland Economic Review (Fourth
Quarter 1986): 2-10.
Friedmann, W„ D.H.A Ingram, and D.K. Miles. "Business
Finance in the United Kingdom and Germany." Bank of
England Quarterly Bulletin 24 (September 1984): 36875.
Friend, Irwin, and Ichiro Tokutsu. "The Cost of Capital To Corporations in Japan and the U.S.A." Journal of Banking and
Finance 11 (June 1987): 313-27.
Goldsmith, Raymond W., Richard E. Lipsey, and Morris Mendelson. Studies in the National Balance Sheet of the
United States. Princeton: Princeton University Press,
1963.
Gordon, Roger H„ and Burton G. Malkiel. "Corporation
Finance." In How Taxes Affect Economic Behavior, edited
by H.J. Aaron and J A Pechman. Washington, D.C.: The
Brookings Institution, 1981.
Guttentag, Jack, and Richard Herring. "Credit Rationing and
Financial Disorder." Journal of Finance 39 (December
1984): 1359-82.
Haugen, Robert A, and Lemma W. Senbet. "The Insignif-

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icance of Bankruptcy Costs to the Theory of Optimal Capital Structure." Journal of Finance 33 (May 1978): 383-93.
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Holland, Daniel M., and Stewart C. Myers. "Trends in Corporate Profitability and Capital Costs." In The Nation's
Capital Needs: Three Studies, edited by Robert Lindsay.
New York: Committee for Economic Development, 1979.
Jensen, Michael C. "Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers." American
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Review 76 (May 1986): 323-29.
, and William H. Meckling. "Theory of the Firm:
Managerial Behavior, Agency Costs and Ownership Structure." Journal of Financial Economics 3 (1976): 305-60.
Kaufman, Henry. "Heavy Debt Poses Threat to Economic
and Financial Stability." American Banker 151 (September 22, 1986): 12, 13, 15, 16, 34,43.
Kester, W. Carl. "Capital and Owner Structure: A Comparison of United States and Japanese Manufacturing Corporations." Financial Management 15 (Spring 1986): 5-16.
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Long, Michael S., and lleen B. Malitz. "Investment Patterns
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Michel, Allen, and Israel Shaked. "Japanese Leverage: Myth
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Modigliani, Franco, and Merton H. Miller. "The Cost of Capital, Corporation Finance, and the Theory of Investment."
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, and
"Corporate Income Taxes
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Myers, Stewart C. "Determinants of Corporate Borrowing."
Journal of Financial Economics 5 (1977): 147-75.
"The Capital Structure Puzzle." Journal of
Finance 39 (July 1984): 575-92.
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Banks." New York Times, June 1987, 1, 14.
Paulus, John D. "Corporate Restructuring, 'Junk,' and Leverage: Too Much or Too Little?" Morgan Stanley Economic
Perspectives (March 1986): 1-21.
Pozdena, Randall Johnston. "Tax Policy and Corporate Capital Structure." Federal Reserve Bank of San Francisco
Economic Review (Fall 1987): 37-51.
Sarathy, Ravi, and Sangit Chatterjee. "The Divergence of
Japanese and U.S. Corporate Financial Structure." Journal
of International Business Studies 15 (Winter 1984): 75-89.
Smith, Charles, Bruce Roscoe, Richard Hanson, Brian Robins, and Daryl Gibson. "Japan Banking and Finance." Far
Eastern Economic Review 136 (April 9, 1987): 54, 63, 86.
Stulz, Rene M. and Herb Johnson. "An Analysis of Secured
Debt." Journal of Financial Economics 14 (December
1985): 501-21.
Suzuki, Sadahiko, and Richard W. Wright. "Financial Structure and Bankruptcy Risk in Japanese Companies." Journal of International Business Studies 16 (Spring 1985):
97-110.
Taggart, Robert A., Jr. "Have U.S. Corporations Grown Financially Weak?" National Bureau of Economic Research
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29

The Southeastern Forest Industry
after the Tax Reform Act of 1986
W. Gene Wilson

Forestry is a major economic activity in the
Southeast, and its potential importance is even
greater because of the future expansion possibilities, especially in the pulp and paper segment of the industry. In recent years the forest
industry has been subject to many new forces
that affect its future development. Particularly
important among these forces are the 1986 Tax
Reform Act, the Conservation Reserve Program,
and the behavior of the dollar. This article considers the performance of the southeastern
forest industry in the wake of the new tax provisions.
Like most new tax legislation, the Tax Reform
Act of 1986 led to fears about its potential negative impacts, particularly in capital-intensive
industries—such as forestry—that are dependent on a resource produced over several years.
Changes in capital gains taxation were considered especially important to the forest industry because of the possible impact on tree
planting and reforestation and, in turn, on the
supply of pulpwood and lumber. Another concern was that the loss of the investment tax

The author is an assistant economist in the regional
of the Atlanta Fed's Research Department.

30




section

credit would make the cost of investing in the
industry more expensive and thus possibly reduce capital expenditures. In view of the fact
that the declining dollar and the recently imposed Canadian export tax on lumber have
strengthened demand for U.S. forestry products, supply constraints could bode ill for
prices.
To foresters' relief, the final form of the 1986
Tax Reform Act and business conditions since
1986 have tended to lessen the original apprehensiveness. As booming domestic and export markets pushed the pulp and paper
industry to near-capacity production and rendered the lumber market robust as well, substantial new investment in mills and related
processing facilities has been occurring. While it
cannot yet be determined if tree plantings by
private owners have declined, the creation of
the Conservation Reserve Program will apparently help to offset any drop. In addition, the tax
reform legislation itself has so far proved much
less formidable than had perhaps been expected. However, these factors have not guaranteed future success for foresters. Before
examining the forest industry, though, an explanation of its structure and economic impact,
particularly in the Southeast, might be helpful.
E C O N O M I C REVIEW, MAY/JUNE 1988

Structure of the Forest Industry
The forest industry is composed of a wide
variety of companies that make products ranging from lumber and wafer board to pulp for
making paper. Essentially this industry can be
divided into two sections: forest
products,
which consists of pulp, paperboard, paper, and
similar products; and wood products, which
includes lumber, plywood, and other building
products.
Forest Products. The term forest products
refers basically to pulp. Whether derived from
wood or other materials such as wastepaper or
used rags, pulp is the material from which paper
and related products are made. The pulp, paper,
and board industry is composed of approximately 6,500 establishments and employs
roughly 670,000 people nationwide. For the
entire industry, total sales are estimated at
$75 billion.
Pulp and paper production has become increasingly concentrated in the South near abundant reserves of southern pine, which bears the
long fibers preferred for making heavy duty
paper and board. As a result, more than 50 percent of U.S. pulp and paper production now
occurs south of the Mason-Dixon line, continuing an industry relocation that has been underway for several years and for various reasons.
The South's large supply of commercial forestland and more rapid tree growth certainly are
two major factors. Also influencing the trend
have been lower costs for labor and resources
and an infrastructure suited to forest industries.
In 1987, total wood pulp production in the
United States reached an estimated 60 million
tons, some 85 percent of which is consumed by
the forest industry in making paper (see Table 1).
Pulp production is directly linked to the demand for paper products. For paper companies,
increased exports and higher domestic demand
made 1987 an outstanding year. The production
capacity utilization of paper and paperboard
manufacturers approached 96 percent, and paper
profits surged.1 The forest products industry
earned a record $4.6 billion on paper operations
last year as production of paper and paperboard
rose 4.5 percent from 1986.2 This year production
of paper and paperboard may set another record
as a weaker dollar, greater paper consumption,
FEDERAL RESERVE BANK O F ATLANTA




and energy prices, still well belowlevels of a few
years ago, continue to improve prospects.
In addition to strong domestic demand for
pulp and paper, the dollar's depreciation augurs
well for pulp and paper exports, particularly to
Japan, which absorbs one-fifth of the U.S. pulp
sold abroad, and to West Germany. Japan, West
Germany, Mexico, and South Korea together
receive half of U.S. pulp exports. The potential
for increased U.S. export of pulp may also improve as various countries—for example, Taiwanexpand their paper industries.
However, whether U.S. producers can effectively compete with expanding production from
a number of countries, primarily in Latin America,
remains to be seen. Notwithstanding the dollar's substantial decline over the past three
years, the U.S. pulp and paper industry is facing
intense global competitive pressures, largely
from countries whose currencies have appreciated relatively little vis-a-vis the dollar. Finland,
the leading force in process technology, is making progress in reducing energy, labor, and
chemical inputs per ton of paper produced.

Table 1.
Pulpwood Production
(billion

cubic

feet)

U.S.
Volume

South*
Volume

Percent of U.S.

1950

2.7

1.6

59

1955

4.0

2.4

60

1960

5.1

3.0

59

1965

6.7

3.9

58

1970

9.0

5.4

60

1975

8.8

5.4

61

1980

11.3

7.0

62

1983

11.3

7.2

64

1986

11.7

7.9

68

1987

12.0

8.3

69

* South includes the states of Alabama, Arkansas, Florida, Georgia, Kentucky, Louisiana, Maryland, Mississippi, North Carolina, Oklahoma, South Carolina,
Tennessee, Texas, and Virginia.
Source: Pulpwood Statistics, American Pulpwood Association,
June 1986. Data for 1986 and 1987 were provided
directly by the American Pulpwood Association.

31

Canada, one of the lowest cost producers, is
gaining market share against almost all competitors. Brazil, a long-term strategic threat, is
increasing exports at about 40 percent a year,
albeit from a small base, whereas the industry
worldwide is growing at an average rate of 1.5
percent per year.
Lumber and Related Products. Demand for
wood products used in construction rose 6 percent last year as both lumber and plywood sales
flourished. Roughly one-third of this country's
lumber output is produced in the South. From
1975 to 1987, southern pine lumber production
almost doubled, rising from 600 million cubic
feet to approximately 1 billion cubic feet. The
value of annual production at recent prices is
over $2 billion for southeastern timber owners.
Industries involved in producing wood products for construction have not generally enjoyed
the prosperity of forest product industries. Following a substantial recovery in 1983, conditions deteriorated in 1984 and 1985. The
industry just returned to profitability in 1987.
The mixed conditions in the lumber industry
result from fluctuating housing demand in the
United States, the export-dampening effects of
the high value of the dollar in 1984 and 1985, and
increased competition from Canadian imports.
Last year, though, the cheaper dollar, ample
demand from builders, and the effect of Canada's export tariff on relative lumber prices
helped to create a prosperous year for U.S.
producers.
This recent prosperity must be viewed in context, though. Improved technology, along with
import competition, created a surfeit of lumber
earlier in this decade. Consequently a substantial amount of industry restructuring has occurred.
In particular, a significant amount of productive
sawmill capacity has been discontinued.
U.S. lumber and logs should continue to be
competitive in world markets owing to the lower
dollar. Domestic prospects for lumber are
somewhat dimmer, though, as residential construction has decelerated from its pace earlier
in the expansion. Although the remodeling
market is consuming larger amounts of lumber
than previously, that market is closely related to
current economic conditions and can change
course quickly. It is also much smaller than the
market for new homes, apartments, and condominiums.
32




Forestry in the South
The Southeast is a major manufacturer of
pulp and paper. Georgia leads the nation in production of pulp, paper, and pulpwood, while
Alabama is a close second in pulpwood output.
With manypapermillscapitalized atnearly$500
mill ion and sawmills at $1 million to $25 million,
Georgia's 16 paper mills and 250 sawmills represent a major industry investment. In recent
years, Georgia and Alabama have supplied
about one-third of the approximately 7 billion
cubic feet of pulpwood annually produced in
the Southeast. Moreover, some industry sources
indicate that room for expansion still exists
throughout the region. Indeed, one study concluded that expansion of forest industries in
Alabama could create more economic growth
than comparable expansion anywhere else in
the state's manufacturing sector.3
Southeastern forests seem a likely source for
the nation's future pulpwood needs. In the
1960s, in a major industry shift to the Southeast,
roughly 2 million acres were purchased for the
purpose of growing trees. In the last decade,
southeastern forest industries continued to add
approximately one-quarter million acres to their
land holdings. As a region, the South possesses
more commercial forestland than any other area
in the country, though a greater share of commercial forestland in the Southeast is owned by
nonindustrial private owners.
Because of substantial demand for wood products, southeastern foresters are constantly
investing in reforestation and searching for ways
to improve productivity. In recent years, however, the future timber supply of the Southeast
and the nation has become a constant concern.
In this context, it is important to consider
whether the 1986 Tax Reform Act provides disincentives for investment in the future of the
forest industry.

The Tax Reform Act of 1986
and Its Impact on the Forest Industry
The Tax Reform Act of 1986 is a highly complex
piece of legislation that made numerous changes
E C O N O M I C REVIEW, MAY/JUNE 1988

in then-existing tax laws. The law was intended
to simplify the tax code and make it more efficient while being revenue-neutral. Major areas
of interest in the act are: (1) individual and corporate tax rates, (2) the investment tax credit,
(3) treatment of capital gains, and (4) deductions
for various development costs. With regard to
the forest industry, most tax changes fell into
two separate categories: changes that affected
commercial producers such as paper companies
and lumber manufacturers, and, perhaps more
important, changes that impacted the suppliers
of timber—largely non-industrial private owners.
The tax law change that will probably have the
greatest effect on timber supply, the basic
resource of the forest industry, is the elimination of preferential treatment for capital gains.
The proceeds from the sal e of or the val ue of cut
timber will no longer qualify for the long-term
capital gains deduction, that is, the exclusion of
60 percent of capital gains from taxation. As a
result, the income the owner receives from selling timber is nowtaxed as ordinary income. Prior
to the change, timber revenue of sole proprietors could be taxed at no higher than the maximum effective rate of 20 percent (40 percent
taxable gain times 50 percent maximum tax
rate). For instance, under the old law, a timber
owner who earned $10,000 from timber sales
could have excluded 60 percent ($6,000) from
taxation as a long-term capital gain. The remaining 40 percent ($4,000) would be taxed at the
appropriate tax rate for the owner's income tax
bracket. Assuming the maximum tax bracket of
50 percent, the tax obligation would have been
$2,000 (50 percent of $4,000). Consequently, the
effective tax rate on all timber revenue earned
was at most 20 percent.
The tax act's effect on individuals is relatively
modest. With the new law, capital gains tax rates
for individuals now match ordinary income tax
rates with a cap of 28 percent. Using the previous example, at the maximum rate of 28 percent, the tax obligation on $10,000 of timber
revenue would be $2,800. (Of course, for those
individuals in still lower income tax brackets,
the effective rate would also be lower.) This
change essentially raises the overall tax burden
and lowers the after-tax returns from investing
in timber. The effect, however, will vary relative
to each person's circumstances. At least partially offsetting the impact of changes in capital
FEDERAL RESERVE BANK O F ATLANTA




gains taxation, moreover, are increases in exemptions and the standard deduction.
The impact of the 1986 Tax Reform Act on corporations might be greater. Under the old law, a
corporation earning $100,000 from timber revenue could also exclude 60 percent or $60,000
from taxation. The remaining 40 percent would
be taxed at a rate of 28 percent, generating a tax
obligation of $11,200. Under the new law, the
entire $100,000 would be taxed at a rate of 28
percent, creating taxes of $28,000.
While the change in the capital gains tax is of
the greatest interest and possibly has the most
effect on foresters, another area of concern during development of the new tax legislation was
the investment tax credit. Though this credit
was eliminated for general business investment, the Act in its final form left unchanged the
investment tax credit for timber investment.
The impact is thus confined to industrial investment in paper mills and other manufacturing
facilities.
Even here, however, the loss of the investment tax credit seems far from dramatic. Indeed, despite the absence of the investment
tax credit, papermakers are likely to add capacity at a faster rate over the next three years
than they did over the past ten. In 1988, capital
spending is expected to increase 25 percent as
prospects remain favorable for the industry.4
The conclusion can be drawn that, while tax
policy can influence industries, overall business
conditions remain the final influence on investment.
Costs associated with growing timber continue to be deductible just as they were before
passage of the 1986 Tax Reform Act. Timber is
excepted from the requirement that costs be
capitalized. In addition, the provision allowing
taxpayers to amortize reforestation expenditures over a period of 84 months was not
changed by the 1986 act. This provision remains
applicable to not more than $10,000 of expenditures in any year.
Aside from the limited nature of tax reform
vis-a-vis the forest products industry, the impact
of tax changes may be at least partially offset by
various other considerations. For instance, the
weight that timber owners give to changes in tax
laws may be tempered by the frequency of
change in such laws. Tax laws commonly undergo substantial alteration over a period of three
33

or four years. Thus, people who are concerned
about a product that will not be harvested for at
least 15 years can be reasonably certain that tax
regulations will change more than once between planting and harvest. The possibility of
future, more favorable changes, may further
mitigate the Act's negative effects.

tually an additional 31.5 billion cubic feet of
wood will result over the life of the planting.
That figure represents enough wood to supply
the nation's total forest and wood product
needs for two years. Whether the Conservation
Reserve Program will result in a net increase in
reforestation cannot yet be determined, but
this program should certainly offset at least partially any negative impact of tax changes.

The Conservation Reserve Program
Is there potential for greatly increasing the
productivity of forestland and consequently
raising total after-tax revenue despite higher
taxation? For most Georgia timber owners, improving forest management would be one of the
most profitable investments available.5 Timber
production on unmanaged acreage is expected
to yield only about 40 percent of what could be
achieved with intensive land management.
One possibly important factor in offsetting
future timber shortages is the recent development of the Conservation Reserve Program,
which could serve to increase the supply of
forests in the South. Under this program, landowners receive an annual payment for idling farm
land on a long-term basis. At present, over
5 million acres nationally have been accepted
into the program; the goal over the next few
years is to engage 40 million acres in the Conservation Reserve Program. While not all the acreage will be planted in trees (grass is the other
option), 90 percent of Georgia's farmers enrolled in the program prefer trees. Perhaps as
much as 75 percent of the trees planted in this
program will be in southern states. The greater
interest in trees in the South reflects the marginal
productivity for crop production of much of the
idled acreage, the faster growing cycle for trees
in the South, and the existence of industries
with substantial demand for timber.
At least one-eighth of the land entering this
program is mandated by law to be planted in
trees. With a range of 40-45 million acres established for the Conservation Reserve Program, a minimum of 5 million acres will be
planted in trees from 1986 to 1990, making the
Conservation Reserve Program one of the most
ambitious tree planting programs ever established. If 5 million additional acres of trees are
indeed planted on diverted cropland, even34




Forestry Outlook
The ultimate economic well-being of the
forest industry hinges more on the uncertainties
of supply than on demand, which is more predictable. Demand for paper, lumber, and myriad
other wood products appears to be favorable
over the long run. The degree to which the
industry can meet market demand is limited by
the availability of the basic resource, timber. If
reforestation occurs at the rate needed and
modern timber management practices are
adopted, the future timber supply can be increased significantly.
Recent trends in planting and harvesting of
trees provide little good news, though. For
example, in 1986,61 Georgia counties were harvesting more pine timber than they were growing. Despite setting records for tree planting in
the mid-1980s, Georgia continues to experience
a net loss of timberland. In this decade, an
average 100,000 acres of pine forests have been
lost each year.
On privately owned land, less than 35 percent
of the timberland is replanted after harvest.
Considering that 64 percent of Georgia's commercial forests are privately owned, these figures do not have good future implications.
Changes in tax laws may have little negative
impact on tree planting, but they also provide
little assistance from a fiscal perspective in
alleviating the potential timber shortage. Sucha
shortage seems likely, given the predominance
of private forest land tenure arrangements in
the Southeast and the low ratio of reforestation
on such property.
The 1986 tax legislation's importance rests
not on what the act did as much as what it did not
do. The Tax Reform Act of 1986 may prove to be a
modest damper on forestry investment that
E C O N O M I C REVIEW, MAY/JUNE 1988

,

provides no additional encouragement to replant forests and make other needed investments. The overall effect of the law may not
significantly lessen timber supply in the future,
especially with the Conservation Reserve Pro-

gram in existence, but the Tax Reform Act of
1986 certainly will not assist in saving the timber
supply from what appears to be a growing
shortage.

Notes
'Anderson (1988): 922.
Levine (1988): 125.
^Trenchi and Flick (1982): 22.
4
Seskin and Sullivan (1987): 16.
5
Because Georgia is such a major part of the forest industry,
the remainder of this article uses the Georgia forest industry as an example on the assumption that developments
in this state are broadly representative of the industry
nationally Forestry in Georgia—as measured by salescomprises an $8 billion-plus industry that employs ap2

proximately 80,000 people. The annual timber harvest is
valued atroughly$400 million. For every dollar of these timber sales, the state's manufacturers produce final products worth more than ten dollars. For each dollar of income
received from timber sales, other Georgians earn an
additional six dollars transporting, processing, or marketing timber or timber products (Montgomery and Chaffin,
1982,7). On its own, Georgia would rank in the top ten of the
world's leading producers of pulp, paper, and paperboard.

References
American Paper Institute. Statistics of Paper, Paperboard,
and Wood Pulp. New York: American Paper Institute,
1985.
American Pulpwood Association, Inc. Pulpwood
Statistics.
Washington, D.C.: American Pulpwood Association, Inc.,
June 1986.
Anderson, Richard. "Paper and Forest Products Industry."
Valueline, lanuary 29, 1988, 922-23.
Birdsey, Richard A., and William H. McWilliams. Midsouth
Forest Area Trends. Resource Bulletin SO-107. New
Orleans, La.: Southern Forest Experiment Station, Forest
Service, U.S. Department of Agriculture, 1986.
Duerr, William A., ed. Timber! Problems, Prospects, Policies.
Ames, Iowa: Iowa State University Press, 1973.
Gunter, John, and Douglas C. Bachtal. Forest Resources:
Problems and Potentials for Georgia, vol. 2, no. I. Athens,
Ga.: University of Georgia, College of Agriculture, Cooperative Extension Service, November 1984.
Gunter, John, and Harry L. Haney, Jr. Essentials of Forestry
Investment Analysis. Corvallis, Oregon: OSU Bookstores
inc., 1984.
Gunter, John, Kim D. Coder, and Walker Rivers. Tree Planting
in Georgia under the Conservation Reserve Program, MP225. Georgia Forestry Commission and the Georgia Cooperative Extension Service, February 1986.
Levine, Jonathan B. "So You Don't Believe Money Grows On
Trees?" Business Week, January II, 1988, 125.
Maki, Wilbur R , Con H. Schallau, Bennet B. Foster, and Clair
H. Redmond. "Alabama's Forest Products Industry: Performance and Contribution to the State's Economy, 1970
to 1980." Research Paper PNW-361. Pacific Northwest

FEDERAL RESERVE BANK O F ATLANTA




Research Station, Forest Service, U.S. Department of
Agriculture, May 1986.
Milliken, Russell B„ and William H. Bradley. "How Will Tax
Reform Affect Timberland Investment?" Southern Pulp
and Paper, December 1986, 14-17.
Milliken, Russell B., and Frederick W. Cubbage. "Trends in
Southern Pine Timber Price Appreciation and Timberland Investment Returns, 1955 to 1983." Research
Report No. 475. Athens, Ga.: University of Georgia, June
1985.
Montgomery, Albert A. "The Pulp and Paper Industry and
Georgia's Forest Resources: An Economic Outlook."
Georgia Forest Research Paper 26. Georgia Forestry Commission, February 1982.
and Robert L. Chaffin. "The Economic Importance of Georgia's Forest Industry." Georgia Forest
Research Paper 27. Research Division, Georgia Forestry
Commission, April 1982.
Rudis, Victor A., and Richard A. Birdsey. Forest Resource
Trends and Current Conditions in the Lower Mississippi
Valley. Resource Bulletin SO-II6. New Orleans, La.:
Forest Service, Southern Forest Experiment Station, U.S.
Department of Agriculture, December 1986.
Seskin, Eugene P., and David F. Sullivan. "Plant and Equipment Expenditures." Survey of Current Business, vol. 67,
no. 12. U.S. Department of Commerce, Bureau of Economic Analysis, December 1987, 16-19.
Trenchi, Peter, III, and Warren A. Flick. Input-Output
Model
of Alabama's Economy: Understanding Forestry's Role.
Bulletin 534. Auburn, Ala.: Alabama Agricultural Experiment Station, 1982.

35

Book Review
Stock Market Activity in October 1987:
The Brady, CFTC, and SEC Reports
Peter A. Abken

To what extent did the October 19,1987, stock
market crash result from a malfunctioning of
market mechanisms? Analysts have grappled
with this question since last fall; the answer is
crucial to the development of future regulatory
policies for financial markets.
Three particularly influential reports focus on
the functioning of market mechanisms during
October 1987 and propose ways to avoid a
recurrence of such financial turmoil. These
reports are the Reports of the Presidential Task
Force on Market Mechanisms (the "Brady report"), the Final Report on Stock Index Futures
and Cash Market Activity during October 1987 to
the U.S. Commodity Futures Trading Commission (the "CFTC report"), and The October 1987
Market Break (the Securities and Exchange
Commission |SEC| report). The following review
concentrates on two major questions addressed
in each of these studies: (1) what role did program trading play in the market decline, and
(2) what, if anything, should be done about program trading?
This review focuses on the trading activity on
two of the most important financial exchanges:
the New York Stock Exchange (NYSE), where
most of the stocks for major corporations are

The reviewer, a specialist in futures and options markets, is
an economist in the financial section of the Atlanta Fed's
Research Department.

36




traded, and the Chicago Mercantile Exchange
(CME), where the S&P 500 futures contract is
traded. (More information on the S&P 500 futures can be found in this issue in the article by
Kawaller, Koch, and Koch, "The Relationship
between the S&P 500 Index and S&P 500 Index
Futures Prices," p. 2.)
The NYSE and CME use two different marketmaking systems to facilitate transactions between buyer and seller. The NYSE is organized
as a dealer market in which specialist firms are
obligated to "make a market" in stocks that the
exchange assigns to those companies. Their
market-making responsibilities entail risk because the firms must take the opposite side of a
transaction at a price close to the last transacted
price if no one else will do so. The specialist is
charged with maintaining an orderly market,
which requires holding an inventory of stock,
thus exposing the firm to price risk. Unlike the
NYSE, the floor traders on the CME are not
obligated to take positions in futures contracts;
these traders act as brokers, matching buyer
and seller. However, they also take positions in
futures contracts, albeit briefly, to profit from
price fluctuations caused by imbalances in buy
and sell orders. In this respect, CME floor traders
provide liquidity to the futures markets.
For markets in which price expectations are
not changing sharply, the provision of liquidity
enables stocks or futures contracts to be bought
or sold with low transactions costs and fast
E C O N O M I C REVIEW, MAY/JUNE 1988

execution at prices near the last transacted
prices. What happens in these markets when
broad-based uncertainty about price expectations is present, as in mid-October? Much of
the controversy surrounding program trading—
the institutional trading of all stocks in a program or index on which options or futures are
traded—centers on the adequacy of market
liquidity to accommodate trading when prices
are changing rapidly.1 Two relatively new program trading strategies at the heart of the
debate over market function or dysfunction are
stock-index arbitrage and portfolio insurance.
Considered both singly and jointly, they are
widely alleged to have exacerbated, and perhaps precipitated, the stock market collapse on
Monday, October 19.
Despite background research and exhaustive
reconstructions of events, the Brady Commission, the SEC, and the CFTC arrive at conflicting
conclusions regarding the culpability of program trading. The Brady and SEC reports find
program trading, and particularly portfolio insurance, significantly involved in both elevating
market uncertainty as well as directly and indirectly driving stock prices lower than they
would have fallen otherwise. The CFTC report,
on the other hand, concludes that the crash
resulted entirely from a massive change in
investor price expectations, and the claim that
program trading contributed significantly to the
market break is unsubstantiated. Each of the
reports details the mechanics of program trading. A brief overview here will lay the groundwork for a later discussion of the sources of
disagreement among the market reports. Also,
the November/December 1987 Economic Review included "An Introduction to Portfolio
Insurance," which gives a thorough discussion of
that topic, as well as references on stock-index
arbitrage.

A Review of
Program Trading Strategies
Stock-index arbitrage is the simpler of the
two basic varieties of program trading. Stockindex arbitrageurs attempt to make riskless
profits by exploiting price discrepancies between the S&P 500 index and S&P 500 futures
FEDERAL RESERVE BANK O F ATLANTA




prices. The flow of transactions on the CME and
NYSE will generally be different, often driving
index and futures prices away from their appropriate price relationship, known as the basis.
For example, a negative basis, in which the
futures price is below the index, indicates a
price misalignment, provided all component
stocks are being actively traded.
The activity of arbitrageurs tends to align
stock and index prices. Arbitrageurs buy futures
when futures prices are relatively low and simultaneously sell the stocks underlying the index
when stock prices are relatively high, and vice
versa. The arbitrageurs are said to be perfectly
hedged because their return depends only on
the relative movement of the futures vis-a-vis
the index prices, not on the absolute change in
their price levels. Their buy or sell orders for the
component stocks are sent to the specialists via
the NYSE's DOT (Designated Order Turnaround)
system. Separate buy or sell orders for hundreds of S&P component stocks (not necessarily
all stocks in the index) are routed to the specialists on the NYSE floor and are usually executed
within minutes. Rapid execution is critical, for
otherwise the arbitrageur is exposed to changes
in the absolute price level of the index, not just
the relative difference between the index and
the index futures price. During volatile markets,
the flow of arbitrage orders channeled almost
instantly to specialists through the DOT system
can be extremely heavy, leading to order imbalances that the specialists must try to absorb.
Portfolio insurance strategies involve systematic adjustments to a portfolio, typically an
index portfolio, to limit its exposure to stock
market fluctuations. The object of the strategy is
to guarantee a prespecified rate of return on a
portfolio over some predetermined time period.
The strategy places part of a portfolio in "cash,"
that is, Treasury bills, and the remainder in
equity. As the market rises, the equity component is increased by selling Treasury bills. When
the market falls, portfolio managers increase
the cash component. The same division of a
portfolio into equity and cash components can
be achieved using an equity portfolio and index
futures contracts. By selling (going short) an
appropriate number of index futures and holding the underlying stocks, any fraction of the
equity portfol io can be converted into a hedged
position that is equivalent to cash. In recent
37

years, most portfolio insurance has been implemented this way because the transactions costs
of using futures are generally lower. It is important to bear in mind that portfolio insurance is a
reactive, not speculative, trading technique: as
the market declines, futures are sold ; as it rises,
futures are bought.

The Reports' Findings
Before the mid-October decline, many analysts were concerned about the potentially destabilizing interaction between index arbitrage
and portfolio insurance trading. The SEC and
CFTC reports discuss concerns about a socalled cascade scenario that was originally
described in an SEC report following a sharp
market decline in September 1986. The scenario begins with a decline in futures prices, for
fundamental or other reasons, that triggers
stock-index arbitrage. Arbitrage selling, in turn,
depresses stock prices and affects the futures
market via portfolio insurance futures selling in
response to the stock market decline. Further
arbitrage is induced, which in addition to setting off more portfolio insurance futures selling
might also lead to stop-loss selling of individual
stocks, liquidations due to margin calls, and so
forth. The cycle intensifies and culminates with
a market collapse.
After October 19, the cascade scenario, in one
form or another, showed up in media accounts
of the crash.2 Each of the reports considers the
interaction of portfolio insurance, and stock
index futures trading generally, with stock index
arbitrage. Much of the analysis in the CFTC
report is devoted to disproving the cascade
hypothesis.
The main differences between the Brady and
SEC reports compared to the CFTC report regarding the role of program trading in the crash
stem from the emphasis they place on psychological factors. Two important examples will
be considered below. The different conclusions
are especially striking in comparing the SEC and
CFTC reports because the analyses in both
reports were based on two shared data bases:
(1) the special CFTC/SEC survey of the trading
activity, particularly involving index arbitrage
and portfolio insurance, of 16 firms that were
38




major participants in both the stock and index
futures markets in mid-October and (2) the
CFTC's daily large-trader position reports on
futures activity, which do not explicitly identify
program trading. Staff interviews with key market participants during the mid-October period
also supplemented the survey information.
Whether explicit or implicit, assumptions
regarding the impact of extreme price volatility
also contributed greatly to shaping each report's
eventual conclusions and recommendations.
The SEC report states that "li|n conducting our
analysis, we have adopted the fundamental
assumption that extreme price volatility, such as
occurred during the market break, is undesirable" (p. xi). They justify their viewpoint by '
pointing out that volatility reduces market liquidity, makes the provision of market-making

'The main differences between the
Brady and SEC reports compared to
the CFTC report regarding the role of
program trading in the crash stem
from the emphasis they place on psychological factors."

services more costly and less efficient, and
weakens investor confidence in equity investments. All of these adverse effects may ultimately reduce the rate of capital formation in
the long run. Although not directly stated, the
Brady report basically takes the same view of
volatility. Their focus on market mechanisms is
motivated by the "unusual frailty" that markets
demonstrated in mid-October; individual markets suffered from an "illusion of liquidity." The
CFTC report discusses episodes of short-term,
technical pressures on stock or futures prices
(that is, strained market liquidity), but, unlike
the other reports, does not consider their
potentially disruptive effects. To the CFTC,
extreme volatility is a neutral consequence of
extreme changes in market expectations.
The reports substantially agree on the fundamentals that appear to have set off the steep
E C O N O M I C REVIEW, MAY/JUNE 1988

decline in stock prices during the week before
October 19. These factors were: (1) a merchandise trade deficit figure for August that showed
less improvement than the market expected,
(2) a continued depreciation of the dollar,
(3) sharply higher short- and long-term interest
rates, and (4) prospective tax legislation in Congress that would increase the costs of financing
takeover activity. From Wednesday, October 14,
to Friday, October 16, the Dow Jones Industrial
Average (DJIA) closing changes from the previous day were -95, -58, and -108, respectively;
the broader market indexes experienced similar large declines. Volume was extremely heavy
and index arbitrage and portfolio insurance
activity were likewise at a high level, although
markets were not strained to the breaking point
as they would be early in the following week.

"The reports substantially agree on the
fundamentals that appear to have set
off the steep decline in stock prices
during the week before October 19."

Each report gives blow-by-blow details of intraday events in the various financial markets for
these three days and those of the following
week.
The October 14-16 period is of particular interest because the index arbitrage link between the CME and NYSE was functioning. Here
the CFTC saw events differently from the Brady
Commission and the SEC. Consider the thenrecord market decline on Friday, October 16.
The CFTC report found that portfolio hedge
activity, which includes portfolio insurance
futures selling, was more or less evenly distributed throughout the day, with the greatest
concentration of futures selling before 2:30 p.m.
Index arbitrage sales were executed during the
day in relatively concentrated intervals, especially toward the end of the day. At this time,
though, part of the arbitrage was related to the
FEDERAL RESERVE BANK O F ATLANTA




expirations of some futures and options contracts (during the so-called "witching hour").
In analyzing the day's trading, the CFTC concluded that "neither the magnitudes nor the
timing of this trading on October 16 is indicative
of any significant interaction between portfolio
hedging and index arbitrage sell programs"
(p. 78). Neither the SEC report nor the Brady
report focuses on portfolio insurance trading in
terms of the cascade scenario. The SEC report
states in a footnote that "this |cascade| scenario
is far more simplistic than the multitude of factors influencing trading during the October
market break. Nevertheless, the effects of futures selling on the stock market is relevant to
what occurred" (p. 3-11). The Brady report also
finds that during these days before October 19,
"heavy arbitrage activity was most often coincident with substantial intraday stock market
moves" (p. 29). This finding is not inconsistent
with the CFTC report; the CFTC was not specifically concerned about index arbitrageinduced market volatility (see CFTC report,
p. 79).
The Brady report goes further, asserting that
"the market's decline (from Wednesday to
Friday! created a huge overhang of selling
pressure—enough to crush the equity markets
in the following week" (p. 29). This overhang was
concentrated within two groups of sellers: portfolio insurers and a few mutual fund groups
needing to fulfill customer redemption orders.
The Brady report maintains that on Friday,
October 16, many market participants were on
edge over the threat of continued selling pressure.
According to the Brady report, a number of
aggressive "trading-oriented" institutions compounded the selling pressures by anticipating
the reactive selling of the portfolio insurers and
mutual funds and, concomitantly, selling ahead
of them before further market declines. Of the
$12 billion in stock that portfolio insurers
needed to sell to meet the directives of their
programs that week, only one-third had actually
been sold, according to the Brady report. Both
the CFTC report (p. 81) and SEC report (p. 3-12)
mention the existence of an overhang of selling
pressure, but neither give it the same emphasis
as the Brady report.
Selling pressure during the NYSE opening
on Monday, October 19, was in fact enormous.
39

Selling by institutional investors was the most
significant factor, particularly at the opening. Index arbitrage selling was also prominent at the
opening, although the CFTC states (pp. 91-92)
that even during the morning, index arbitrage
did not attain the concentrated levels of the
previous week. Gross selling of S&P 500 futures
for portfolio hedging purposes attained a record level of 20 percent of CME volume for the
day; 80 percent of that hedge selling can be
attributed specifically to portfolio insurance
strategies (CFTC report, p. 93). Furthermore, one
major pension fund, the largest portfolio insurance practitioner in the stock or futures markets,
supplemented its futures sales with very large,
periodic program sales of stock on the NYSE up
until 2:00 p.m.
Each report documents how selling pressure
was so powerful that the markets became congested. On the NYSE, in particular, the specialists were overwhelmed with sell orders. The
imbalances led to late openings for many component stocks of the S&P 500 and to trading
halts designed to give specialists time to work
out these order imbalances. The reported futures basis was negative (that is, the futures
price was below the index price) because the
computation of the index value included many
stock prices that were not current due to the disruptions in trading. The specialists' buying
power was strained and liquidity dried up. The
transactions costs of trading futures rose tremendously, making it difficult to match bids
with offers. By early afternoon, the index arbitrage link between the exchanges was effectively
severed because index arbitrage had become
too risky, despite its apparent profitability.
Trade execution times were highly uncertain. At
this point in the early afternoon, as the Brady
report puts it, both stock and futures markets
went into freefall. The DJIA was down 508 points
by the close; the broader indexes were likewise
down by record amounts.
The Brady report comes close to describing
the sequence of events on Monday in terms of
the cascade scenario: "Portfolio insurers sold in
the futures market, forcing prices down. The
downward price pressure in the futures market
was then transmitted to the stock market by
index arbitrage and diverted portfolio insurance (stockl sales. While index arbitrageurs may
not have accounted for a substantial part of total
40




daily volume, they were particularly active during the day at times of substantial price movements
ITJhey were the transmission mechanism for the pressures initiated by other
institutions" (p. 42).
The SEC report emphasizes the timing of
portfolio insurance and index arbitrage sales on
Monday: "The periodic sell pressure from
portfolio insurance related programs and more
concentrated arbitrage sell programs sometimes hit the NYSE simultaneously" (p. A-29);
"|t|he impact of the portfolio insurance stock
selling combined with the impact of index arbitrage trading was the dominating force in the
stock market during certain periods" (p. 3-12).
The CFTC report, in considering trading dur- ing the morning of October 19 before the arbitrage link broke down, found that "periods of

"Each report documents how selling
pressure was so powerful that the
markets became congested. On the
NYSE, in particular; the specialists
were overwhelmed with sell orders."

high volume portfolio hedge sales in S&P 500
futures do not correspond with the periods of
price weakness, nor do periods of low volume of
such sales correspond with price recoveries"
(p. 93). The report concludes that "the analysis
of intraday trading does not support the contention that on October 19 the stock market fell as
fast and as far as it did because of a continuously
intensifying interaction between index arbitrage stock sales and portfolio insurance selling
in the futures market" (p. 96).
The foregoing conclusions regarding the
impact of program trading highlight the difference in interpretation of events on October 19. The intraday pattern of futures and stock
price movements and their apparent correlation with intraday variations in trading of the
various market participants does not in itself
give convincing, clear-cut evidence about the
E C O N O M I C REVIEW, MAY/JUNE 1988

role of program trading. In each of the reports
the method of analysis of the survey data basically amounted to an evaluation of the correlation of price movements with trading activity and
evidently involved much subjective judgment.
Psychological Effects on the Market. In addition to studying the effects of program trading,
the SEC and the Brady Commission go further to
incorporate their evaluation of market psychology as a factor in explaining the market break.
An important example involving psychological
judgments concerns what the Brady report
termed the "billboard" effect As mentioned
above, on the morning of October 19, the futures
price was at a large discount to the index because many NYSE stocks were not trading. Was
this a real or spurious discount? If real, the
futures billboard would lead market par-

"T/ie Brady Commission makes the
most sweeping, comprehensive recommendations for changing the way markets work and how they are regulatedf."

ticipants to expect index arbitrage to drive stock
prices lower. Buyers might be deterred from
entering the stock market, and specialists might
be hesitant to take the buy side just when the
billboard is advertising a drop in the market.
The CFTC report contains a section that corrects the value of the S&P 500 index for the socalled non-trading effect, something market
participants had to do implicitly or explicitly. On
Monday morning, the CFTC finds, the index arbitrage link was keeping futures and index prices
aligned, and therefore the discount was spurious.3 The CFTC believes it improbable that
sophisticated broker/dealers "who conduct the
majority of index arbitrage transactions [would
respondl with massive futures/stock arbitrage
programs to an illusory discount of the futures"
(p. 19). In marked contrast, the Brady report
gives the following account: "Ironically, the
FEDERAL RESERVE BANK O F ATLANTA




large discount on Monday morning was illusory
Although the index arbitrageurs clearly
knew that many stocks had not yet opened |on
Monday morningj, they nevertheless believed
that a large discount existed. This belief led the
index arbitrageurs to conclude that the market
was headed much lower
" (p. 111-20). This
excerpt illustrates the emphasis that the Brady
report places on psychological assessments
about what market participants thought was
happening and what motivated them to act.
The Brady report's account of arbitrageur
actions on Monday morning does not have a
parallel account in the SEC report's detailed
intraday market chronologies. Evidently, the
Brady Commission based its evaluation of the
billboard effect and other matters on interviews
of market participants after the crash. The SEC
also relied on interviews, although the SEC was
more circumspect in their conclusions derived
from such information. In contrast, the CFTC report downplays psychological factors influencing investor and market-maker behavior, concentrating instead on analyzing questions using
the available data: intraday price movements,
trading volume, trader positions, and so on.
While the impact of investors' perceptions and
fears on market activity is hard to determine,
such evaluation appears to be an important and
relevant part of the explanation for the midOctober decline. Though the Brady report emphasizes the importance of psychological factors—for
example, the overhang and billboard effects—
the report in some instances states judgments
and conclusions with a certitude that seems
inappropriate. The SEC report generally gives a
more satisfactory account and analysis of market events because the report acknowledges
the uncertainties that temper its conclusions.

The Reports' Recommendations
The recommendations of each of the reports
are more difficult to compare than their analyses of the markets. The Brady Commission, the
SEC, and the CFTC had different scopes and
jurisdictions. The Brady Commission makes the
most sweeping, comprehensive recommendations for changing the way markets work and
how they are regulated. The CFTC, at the other
41

extreme, makes suggestions that involve the
fewest changes, particularly to the regulatory
structure.
The Brady Commission would like one agency
to oversee intermarket issues. That responsibility, in their estimation, could perhaps best be
carried out by the Federal Reserve. After the
release of its report, the SEC expressed interest
in taking over regulatory jurisdiction of stockindex futures trading, while, not surprisingly, the
CFTC strongly argues against such a reallocation
of responsibilities. In their respective reports,
both the SEC and the CFTC suggest ways to
improve interagency coordination, which, on
the whole, they believed functioned well during
the October crisis.
The Brady Commission recommends unifying
clearing and credit mechanisms, which nearly
disintegrated on October 20. Here, too, both the
SEC and the CFTC call for more moderate
refinements to the system. All reports agree that
market surveillance and market information
should be improved, especially in identifying
customer trades and their timing.
The Brady Commission's proposal for "circuitbreaker" mechanisms such as price limits on
futures and temporary trading halts on individual stocks are more or less consistent with
positions taken by the CFTC and the SEC. To be
effective, such circuit breakers need to be coordinated among markets. The Brady Commission
and the SEC consider the "harmonizing" (the
Brady Commission's term) of margin requirements across markets to be a useful step toward
reducing price volatility. The CFTC emphatically
rejects proposals to raise sharply the margins
required on futures contracts. This divergence
of views reflects, in part, differing assessments

of what happened last October. The CFTC regards margin on futures as a performance bond
to limit credit exposures, not as an extension of
credit. They are not as concerned about intraday
price volatility, nor do they believe that program
trading is a significant source of that volatility.
Although the Brady Commission and the SEC
recognize the distinct functions of margin on
stock and futures, both groups also are concerned about the concentration, size, and frequency of program-related trades and their
impact on market liquidity.
To alleviate some of the liquidity strains that
program trading may cause, the SEC recommends that the NYSE allow one or more wellcapitalized specialists to trade market baskets '
of stocks. In their opinion, this market basket
trading would add an additional layer of liquidity that would be more effective in dampening the price impacts of program trades than
simply increasing the capital of specialists in
individual stocks. This proposal, which had
been discussed by academics and others before the crash, is a good example of a relatively
small refinement of market mechanisms that
has the promise of doing much for market
liquidity and stability.
The appropriate course of action in the wake
of the October 1987 market break still remains
to be decided, and the various recommendations continue to stir controversy. In light of
the uncertainties, incremental reforms appear
to be prudent. Legislators and regulators
should not rush to restructure either the market
mechanisms or the regulatory system without
much more compelling evidence that such
changes would help markets and society at
large.

Notes
1

John Dowries and Jordan Elliot Goodman, Dictionary of
Finance and Investment
Terms, 2nd. ed. New York:
Barrons, 1987, 311.
2
Two examples are Anise C. Wallace, "A Suspect in Market's
Plunge," New York Times, November 30,1987; and George

42




Melloan, "The Market Meltdown Made Phelan a Prophet,"
Wall Street tournai, October 26, 1987.
^ h e SEC did a similar analysis that is consistent with the
CFTC's conclusion. See SEC, p. 2-13, footnote 49.

E C O N O M I C REVIEW, MAY/JUNE 1988

"TI
m
o
m

|

A Review of the Reports' Basic Findings

m
m

2
2

Diagnoses

Recommendations

o
-n
>

R o l e of Program

For Limits o n

£

Trading in Crash

Market Activity

SEC

Significantly involved in elevating market uncertainty and driving stock prices lower than they
would have fallen otherwise.

Price limits on futures.
Temporary trading halts for individual stocks.

Other Comments

For Regulation

Improve interagency
coordination.

Sees cascade scenario as oversimplified, but
concludes futures trading did contribute to
the crash.
Moderate refinement of clearing and credit
mechanisms recommended.

Make margin requirements more
uniform.

Improve market surveillance and information.
Allow a well-capitalized specialist to trade
market baskets of stocks.
CFTC

Not a significant factor in the
crash.

Price limits on futures.
Do not sharply raise margins
required on futures contracts.

Improve interagency
coordination.

Disputes cascade scenario.
Moderate refinement of clearing and credit
mechanisms recommended.
Improve market surveillance and information.
Use intraday margin settlements.

|Brady

Significantly involved in elevating market uncertainty and driving stock prices lower than they
would have fallen otherwise.

Price limits on futures.
Temporary trading halts for individual stocks.
Make margin requirements more
uniform.
Emphasize restraints on trading coordinated across markets.

-fc-




One agency, perhaps the
Fed, to oversee intermarket issues.

Emphasizes overhang of selling pressure
from October 14-16 and other psychological
factors.
Unification of clearing and credit mechanisms
recommended.
Improve market surveillance and information.

FINANCE

1

i r . l r l r l . .

MAR
1988

FEB
1988

JAN(r)
1988

MAR
1987

FEB
1987

ANN.

JAN
1987

I

CHG.(*)
$ Billions

„ , jff-yw

1[ , 7 5 2 , 0 9 2 1

,786,634

1,640,782

Ì ,643,266

i ,709,673

+

349,724

351,392

391,055

351,074

358,444

428,644

-

NOW

167,835

162,565

166,539

147,991

145,795

152,808

+13

Savings

515,006

509,358

509,270

506,150

504,327

507,689

+

Time

777,296

765,316

761,466

675,347

673,971

675,081

+15

Commercial

Bank

Deposits

Demand

8
0
2

215,075

211,874

213,743

196,b91

19b,14/

199,149

+

9

Demand

41,031

39,901

43,312

39,661

39,308

45,531

+

3

NOW

23,970

23,086

23,335

21,061

20,640

21,317

+14

Savings

57,767

57,196

57,245

57,647

56,976

56,686

+

Time

96,853

95,615

94,708

82,571

82,237

81,772

+17

21,926

21,457

21,476

19,840

19,563

20,034

+11

4,123

4,012

4,265

3,965

3,966

4,554

Commercial

Conmerci al

Bank

Bank

Deposits

Deposits

Demand

+

0

4

NOW

2,453

2,344

2,374

2,055

2,009

2,103

+19

Savings

4,816

4,720

4,708

4,567

4,335

4,266

+

11,071

10,790

10,621

9,744

9,663

9,706

+14

Time

5

PlfKTDA
85,181

83,696

84,396

76,876

76,139

77,603

+11

Demand

16,065

15,480

16,647

15,497

15,194

17,663

+

NOW

10,831

10,362

10,511

9,449

9,254

9,539

Savings

27,236

26,940

27,017

26,928

26,627

26,549

Time

32,787

32,454

32,139

26,771

26,866

Commercial

Bank

Deposits

4

+15
+

26,607

1

+22

Wmm^Êm.

•

M

M
+11

34,453

34,101

34,744

30,997

30,788

31,967

Demand

8,537

8,398

9,234

8,217

8,164

9,516

+

NOW

3,343

3,275

3,316

2,979

2,957

3,072

+12
-

Commercial

Bank

Deposits

4

9,015

8,972

8,939

9,119

9,080

9,130

15,087

14,986

14,911

12,141

11,881

11,992

+24

M
i
28,259

28,128

28,271

27,386

27,556

27,663

+

5,041

4,908

5,271

4,923

4,949

5,553

+

NOW

2,426

2,497

2,510

2,172

2,210

2,226

+12

Savings

8,024

7,979

7,956

7,948

7,927

7,729

+

1

13,224

13,091

13,058

12,779

12,863

12,756

+

3

Savings
Time

H
Commercial

Bank

H

Deposits

Demand

Time

M

1

3
2

^ssmsmmimmi®msm
14,928

14,614

14,560

13,812

13,659

13,645

+

Demand

2,310

2,266

2,454

2,307

2,327

2,609

+

NOW

1,580

1,473

1,434

1,411

1,320

1,327

+12

Savings

2,922

2,878

2,867

3,093

3,068

3,013

-

Time

8,442

8,247

8,081

7,295

7,241

7,058

+16

30,328

29,878

27,680

27,442

28,237

4,955

4,837

5,441

4,752

4,708

5,636

NOW

3,337

3,135

3,190

2,995

2,890

3,050

+11

Savings

5,754

5,707

5,758

5,992

5,939

5,999

-

16,242

16,047

15,898

13,841

13,723

13,653

Commercial

Commercial

Bank

Deposit

Demand

Time

30,29

8
0
6

+10
+

4
4

+17

NOTES:
All d e p o s i t d a t a a r e e x t r a c t e d
( F R 2 9 0 0 ) , and

from

the

Federal

Reserve

Report o f Transaction

A c c o u n t s , other Deposits and

a r e r e p o r t e d f o r t h e a v e r a g e o f t h e w e e k e n d i n g t h e 1st M o n d a y o f t h e

institutions with o v e r $ 3 0

month.

o f d e p o s i t s in t h e six s t a t e a r e a .

T h e total d e p o s i t d a t a g e n e r a t e d f r o m t h e R e p o r t o f T r a n s a c t i o n

eliminates interbank deposits by reporting t h e n e t o f deposits " d u e t o " a n d " d u e f r o m "
Report of Transaction

Cash
95«

T h e m a j o r d i f f e r e n c e s b e t w e e n this r e p o r t a n d t h e "call r e p o r t " are s i z e , t h e t r e a t m e n t o f

interbank deposits, and the t r e a t m e n t o f float.

not.

Vault

Most recent d a t a , reported

million in d e p o s i t s a n d $ 3 . 2 million o f r e s e r v e r e q u i r e m e n t s a s o f D e c e m b e r 1 9 8 7 , r e p r e s e n t s

A c c o u n t s subtracts cash in process o f collection

T h e S o u t h e a s t d a t a r e p r e s e n t t h e total o f t h e six s t a t e s .

from

demand

Accounts

o t h e r d e p o s i t o r y institutions.

The

d e p o s i t s , while t h e call report

does

S u b c a t e g o r i e s w e r e c h o s e n o n a selective basis a n d do n o t

a d d to t o t a l ,
r - revised
* - Most recent month vs. year-ago

44




month.

ECONOMIC REVIEW, MAY/JUNE 1988

FINANCE

HAY(p)

APR

1988

$

MAR

1988

HAY

APR

1987

1988

1987

MAR

ANN.
t
CHG.(*)

1987

Billions

1,779,310

1,792,663

1,660,331

1,677,942

1,640,782

+

Demand

358,866

357,752

349,724

351,237

358,994

351,074

+

NOW

170,376

170,782

167,835

152,850

159,216

147,991

+11

Savings

513,400

520,361

515,006

509,119

517,511

506,150

+

Time

780,435

779,940

777,296

678,900

676,670

675,347

+15

215,983

199,060

201,584

Commercial

Bank

Coiwnercial

Bank

Deposits

Deposits

1,771,229

7
2
1

217,791

215,075

196,591

+

9

Demand

41,045

41,866

41,031

40,350

41,491

39,661

+

2

NOW

23,721

24,197

23,970

21,759

22,633

21,061

+

9

Savings

57,959

58,891

57,767

57 , 643

58,813

57,647

+

1

Time

97,538

97,066

96,853

83,016

82,588

82,571

+17

21,914

22,255

21,926

19,954

20,265

19,840

+10

3,999

4,193

4,123

4,025

4,092

3,965

- 1

Commercial

Bank

Deposits

Demand
NOW

2,453

2,102

2,158

2,055

+20

4,813

4,906

4,816

4,579

4,658

4,567

+

11,057

11,154

11,071

9,700

9,738

9,744

+14

2,523

Savings
Time
FLORIDA

2,499

5

|
85,292

86,201

85,181

77,652

79,043

76,876

Demand

16,081

16,366

16,065

15,825

16,420

15,497

+

2

NOW

10,728

10,974

10,831

9,917

10,364

9,449

+

8

Savings

27,137

27,612

27,236

26,980

27,476

26,928

+

1

Time

33,049

32,867

32,787

26,523

26,552

26,771

+25

+11

Commercial

Commercial

Bank

Bank

Deposits

Deposits

+10

35,267

35,191

34,453

31,827

31,842

30,997

Demand

8,668

8,865

8,537

8,303

8,460

8,217

+

NOW

3,310

3,377

3,343

3,077

3,182

2,979

+

8

9,189

9,341

9,015

8,963

9,225

9,119

+

3

15,584

15,165

15,087

12,730

12,321

12,141

Savings
Time

28,089

28,366

28,259

27,404

27,758

27,386

Demand

5,002

4,987

5,041

4,931

5,035

4,923

NOW

2,392

2,434

2,426

2,221

2,299

Commercial

Bank

Deposits

Savings
Time

4

+22

' "

+

2

+

1

2,172

+

8

8,032

8,146

8,024

7,980

8,116

7,948

+

1

13,069

13,144

13,224

12,626

12,663

12,779

+

4

15,054

15,124

14,928

14,034

14,188

13,812

+

7

Demand

2,350

2,393

2,310

2,338

2,473

2,307

+

1

NOW

1,536

1,585

1,580

1,400

1,466

1,411

+10

Coirmercial

Bank

Deposits

Savings

2,972

2,992

2,922

3,102

3,161

3,093

-

Time

8,472

8,454

8,442

7,416

7,350

7,295

+14

30,367

30,654

30,328

28,189

28,488

27,680

+

4,945

5,062

4,955

4,928

5,011

4,752

+

0

4

WÊÊËÊÊÊÊSÊÊB.
Comnercial

Bank

Deposit

Demand

8

NOW

3,232

3,328

3,337

3,042

3,164

2,995

+

6

Savings

5,816

5,894

5,754

6,039

6,177

5,992

-

4

16,307

16,282

16,242

14,021

13,964

13,841

Time

+16

NOTES:
All d e p o s i t d a t a a r e e x t r a c t e d

from

the

Federal

Reserve

Report o f Transaction

A c c o u n t s , other Deposits and

( F R 2 9 0 0 ) , and are reported for t h e a v e r a g e o f the w e e k ending t h e 1st M o n d a y o f t h e m o n t h .
institutions with o v e r $ 3 0

million in d e p o s i t s a n d $ 3 . 2

o f d e p o s i t s in t h e six s t a t e a r e a .

The

million o f r e s e r v e r e q u i r e m e n t s a s o f D e c e m b e r 1 9 8 7 , r e p r e s e n t s 9 5 %

T h e total deposit data g e n e r a t e d from t h e R e p o r t o f Transaction

eliminates interbank deposits b y reporting t h e n e t o f deposits " d u e to" a n d " d u e f r o m "
not.

The

A c c o u n t s subtracts cash in process o f collection f r o m

Southeast data

Cash

m a j o r d i f f e r e n c e s b e t w e e n this r e p o r t a n d t h e "call r e p o r t " a r e s i z e , t h e t r e a t m e n t o f

interbank deposits, and the t r e a t m e n t o f float.
Report o f Transaction

Vault

H o s t recent d a t a , reported

r e p r e s e n t t h e total o f t h e six s t a t e s .

demand

Accounts

o t h e r depository institutions.

The

d e p o s i t s , w h i l e t h e call r e p o r t

does

S u b c a t e g o r i e s w e r e c h o s e n o n a s e l e c t i v e basis a n d d o n o t

a d d to t o t a l ,
p - preliminary
* - Most r e c e n t m o n t h vs. year-ago

FEDERAL RESERVE BANK O F ATLANTA




month.

45

EMPLOYMENT
ANN.

Civilian

Labor

Force

Total

Employed

Total

Unemployed

Unemployment

-

-

Rate

thous.

thous.
-

thous.

- %

MAR

FEB

MAR

1988

1988

1987

ANN.

%
CHG

119,957

119,942

118,353

+

1

112,867

112,460

110,229

+

2

7,090

7,482

8,124

5.7

6.5

40.9

40.7

40.9

412

404

403

16,397

16,349

15,134

+

8

15,360

15,219

14,872

+

3

1,065

1,131

1,250

6.3

6.5

7.5

Employment

- thous.

Manufacturing
Construction

-13

5.6

SA

Nonfarm

Avg.

Wkly.

Hours

Mfg.

Avg.

Wkly.

Earn.

Civilian

Labor

Force

Total

Employed

Total

Unemployed

Unemployment

-

-

-

Rate

Avg.

Wkly.

Hours

Avg.

Wkly.

Earn.

Employed

Total

Unemployed

$

Avg.

Wkly.

Hours

Mfg.

Avg.

Wkly.

Earn.

Government

1 7 ., 6 8 9

1 7 ,,575

1 7 ., 3 1 0

2 4 ., 8 4 2

2 4 ,,585

2 3 ., / 2 3

Fin.,

Trans.,

&

Real

Civilian
Total
Total

Labor

Force

Employed

-

13,815

13,747

13 , 3 2 0

+

2,364

2,359

2 ,322

+

2

776

768

755

+

3

Trade

3,383

3,363

3 ,313

+

2

Government

2,427

2,416

2 ,353

+

3

Services

3,110

3,084

2 ,947

+

6

820

818

791

+

4

758

757

738

+

3

1,515

1,511

1 ,473

+

3

372

371

356

+

4

+

&

Employment

Pub.

-

Util.

thous.

Manufacturing
Construction

41.8

41.8

41.7

+

0

Fin.,

375

373

370

+

1

Trans.,

Nonfarm

Ins.

1
3

thous.

137

144

168

SA

6.8

6.0

8.4

41.0

40.8

40.9

+

0

Fin.,

368

366

356

+

3

Trans.,

Unemployed

6,045

5,959

4,823

5,758

5,661

5,498

thous.

287

298

312

&

Real

Com.

&

Employment

Est.

Pub.

-

Util.

thous.

Manufacturing

73

72

71

Trade

332

332

322

+

3

Government

305

305

301

+

1

281

278

270

-

70

70

70

0

72

72

72

0

Construction

SA

4.9

5.3

5.6

-

Ins.

&

Real

Com.

&

Est.

Pub.

Util.

Rate

- %

Avg.

Wkly.

Hours

Mfg.

Avg.

Wkly.

Earn.

- $

7

5 ,100

5,062

4 ,823

542

543

528

+

3

8

Construction

346

346

337

+

3

1 ,397

1,383

1 ,313

Employment

-

thous.

Government
Services

Mfg.

3

Manufacturing

Nonfarm

Trade
Unemployment

3

5

+25

+
-

5

6 ., 4 7 8

+

thous.

3
2

5 ., 2 / 5

-

-

4

2
4

6 ,,623

1,865

thous.

4

3

b ,, 4 3 8

1,698

$

+
+
+
+
+
+
+
+

6 ., 6 6 4

Com.

Est.

%
CHG

b ., 4 6 2

Nonfarm

Ins.

1,873

-

1 8 ., 8 9 7
4 ., b 9 9

Services
Mfg.

8 1 ., 5 6 5

1 9 ,,287

2 3 ., 4 6 1

2

-28

8 3 ,,664

1 9 ., 3 1 9

4 ,,632

1,729

-

8 4 ., 3 7 9

2 3 ,,653

0

-15

1987

4 ,, 8 0 2

1,851

thous.

thous.

- %

+

MAR

1988

2 4 .,190

1,741

-

-

Rate

SA

-

Force

Total

Unemployment

thous.

- %

Mfg.

Labor

thous.

thous.
-

Mfg.

Civilian

$

FEB

1988

Trade
Services
Mfg.

MAR

44.4

46.0

45.6

-

3

Fin.,

392

398

402

-

2

Trans.,

Ins.

&

Real

Com.

&

Est.

Pub.

Util.

+

6

+

6

780

774

737

+

6

1 ,396

1,380

1 ,296

-

8

370

368

354

+

5

260

259

253

+

3

WM
Civilian

Labor

Force

Total

Employed

Total

Unemployed

Unemployment

-

Rate

Mfg.

Avg.

Wkly.

Hours

Mfg.

Avg.

Wkly.

Earn.

Civilian

Labor

Force

Total

Employed

Total

Unemployed

Unemployment

-

Rate

3,057

3,012

2,874

2,833

179

184

179

SA

5.8

5.7

5.9

thous.

- %

+
+

3,067
2,888

thous.

-

thous.
-

-

-

$

thous.

thous.
-

41.6

41.0

356

356

345

+
+

2,777

2 ,726

+

2

Manufacturing

573

573

564

+

2

Construction

148

146

147

+

1
1

2

Nonfarm

Employment

689

688

681

+

490

487

476

+

3

Services

546

546

526

+

4

156

155

152

+

3

175

174

171

+

2

1,495

1,490

1,465

+

2

167

166

159

+

1

Fin.,

Trans.,

1,910

1,966

-

3

1,676

1,690

-

1

Nonfarm

Ins.

8

Real

Com.

&

Employment

Est.

Pub.

-

Util.

thous.

Manufacturing
Construction

223

238

276

11.3

11.7

13.6

42.3

41.9

41.8

+

1

Fin.,

456

454

458

-

0

Trans.,

1,159

1,169

1,153

+

1

1,059

1,055

1,015

+

4

100

114

138

SA

thous.

Trade

3

1,900

-

Government
1

1,678

thous.

- %

41.4

2 ,784

2
0

-19

79

Avg.

Wkly.

Hours

Mfg.

Avg.

Wkly.

Earn.

Civilian

Labor

Force

Total

Employed

Total

Unemployed

-

-

-

$

thous.

thous.
-

thous.

363

356

315

314

315

328

327

Nonfarm

Ins.

8

Real

Com.

&

Employment

Est.

Pub.

-

Util.

thous.

Manufacturing
Construction

-28

Trade
Unemployment

Rate

- %

SA

Government

8.2

8.9

11.3

40.0

39.5

39.9

Services
Mfg.
Mfg.

Avg.
Avg.

Civilian

Wkly.

Hours

Wkly.

Labor

Earn.

Force

Total

Employed

Total

Unemployed

Unemployment

-

Rate

-

-

$

thous.

thous.
-

- %

307

310

303

+

2

Fin.,

+

2

Trans.,

2,375

2,381

2,315

+

3

2,236

2,224

2,138

+

5

Nonfarm

Ins.

&

Real

Com.

8

Employment

Est.

Pub.

-

Util.

thous.

Manufacturing

-21

Avg.

Wkly.

Hours

Mfg.

Avg.

Wkly.

Earn.

All

labor

NOTES:

Only
The

the

Southeast

data

46




represent

the

total

of

the

reports

185

180

+

3

199

199

193

+

3

141

140

137

+

39

39

38

+

3

43

42

41

+

5

2,041

2,029

1,978

+

3

498

499

494

+

1

2

402

+

3

94

+

7

105

105

99

+

6

Ins.

supplied

8

Com.

by

Real
&

Est.

Pub.

state

Util.

93

3

101

Trans.,

Statistics

6

186

417

3

Labor

4

+

101

+

of

4

+

31

413

361

seasonally

+

214

33

+

362

are

850

233

33

+

373

Bureau

877

233

461

Fin.,

data

880

105

4

330

2

from

1

477

+

rate

1

+

339

41.1

are

+

105

41.0

data

84
103

337

42.1

force

+

85
104

473

177
6.5

unemployment

314

85
104

Construction

157
5.7

$

2
0

Government

139
5.6

-

0
+

Trade

thous.
SA

Services
Mfg.

79

362

Government
Services

Mfg.

77

Trade

+13
3

agencies.

adjusted.
six

states.

ECONOMIC REVIEW, MAY/JUNE 1988

ü

GENERAL
ANN.
LATEST

Personal
($

ANN.

CURR.

PREV.

YEAR

PERIOD

PERIOD

AGO

3,844.8

3,749.3

3,589.2

N.A.

N.A.

N.A.

MAR

8,187.0

8,240.0

8,433.0

-

3

Broiler

Prices

U

per

lb.)

MAR

349.0

347.4

335.9

+

4

Soybean

Prices

($

per

bu.)

JAN

225.1

205.0

209.7

+

7

Broiler

Feed

Q4

468.1

465.7

439.0

+

7

MAR

N.A.

5,752.1

6,712.9

MAR

1,309.0

1,325.0

1,424.0

DATA

%
CHG.

Income

bil.

-

Pass.

Petroleum

Arr.

Prod,

Consumer

(thous.)
(thous.)

Price

+

7

Prices

Hours

Personal

Income

($

bil.

-

Broiler
Calf

Index

1967=100
Kilowatt

Rec'd

- mils.

(thous.)

Price

Prices

($

Personal

Income

($

bil.

-

Pass.

Petroleum

- mils.

Arr.

-

8

N.A.

N.A.

N.A.

JAN

35.1

31.2

33.1

+

6

Q4

49.2

48.6

46.4

+

6

Price

(thous.

MAR

181.3

144.4

185.2

(thous.)

MAR

54.0

55.0

55.0

Calf

Rec'd

Hours

Personal

Income

($

bil.

-

Pass.

Petroleum

-

N.A.

N.A.

N.A.

5.0

4.4

189.7

Price

1977=100

MAR
MAR

Q4

(thous.]

bil.

Soybean

Prices

($

per

Feed

Cost

Cash

-

mils.

JAN

- SAAR)

Pass.

Petroleum

Arr.

Q4

(thous.)

Prod,

Consumer

-

2

4.6

+

9

185.1

174.3

+

9

N.A.

3,112.0

3,512.1

19.0

22.0

23.0

-

JAN.,

Price

Income

($

bil.

-

($

Consumer

- mils.

Price

-

Pass.

Petroleum
Consumer

-

mils.

(thous.)

Prod,

(thous.)

Price

JAN

-13

MAR

Calf

Cash

Income

bil.

-

Pass.

Petroleum
Consumer

-

mils.

as
the
R =

-

of

bu.)

6.61
(Q2)163

6.16

5.04

(Ql)190

(Q2)173

-

6

153

+

3

ton)

5

+31

mil.
157

25.50

27.00

-

6.51

6.13

5.03

+29

158

194

177

-11

Receipts

ton)

4

($

- $ mil.

JAN.
(thous

per
($

per

178.4

+

4

Soybean

Prices

9.2

9.4

+

6

Broiler

Feed

Cost

Cash

Receipts

N.A.

N.A.

N.A.

N.A.

N.A.

N.A.

6.0

5.4

5.6

+

7

51.4

50.7

49.8

+

3

MAR

329.4

307.5

382.4

MAR

1,163.0

1,174.0

1,266.0

N.A.

N.A.

N.A.

4.9

4.3

4.8

+

2

Q4

26.9

27.2

25.5

+

5

Farm

MAR

45.3

35.1

38.5

+18

Broiler

MAR

73.0

74.0

80.0

-

Calf

Calf

($

JAN.,
($

6

2,402

+

76.30

+38

26.60

26.10

28.00

-

6.51

6.13

5.03

+29

158

194

177

-11

201

+

5

15,770

15,491

15,169

+

4

93.00

86.10

70.20

+32
-

)
bu. )
per ton)

0
5

mil.
210

(thous.

per

+

2,558
100.00

lb.

- $

584

2,405
105.00

JAN.

Placements

Prices

622

.)

cwt.

184.6

Farm

MAR

JAN

mils.

Income

Bureau

cumulative
total

-

26.00

10.0

cwt.)

Broiler

Prices

(i

per

lb.)

25.50

25.00

27.00

Soybean

Prices

($

per

bu.)

6.61

6.03

5.04

+31

Broiler

Feed

158

194

127

-11

Ill

+42

Farm

-14

Broiler

-

Calf

8

9

N.A.

N.A.

N.A.

2.4

2.1

2.3

-

4

62.3

63.7

58.9

+

6

358.2

288.7

285.8

Cost

Cash

($

per

Receipts
JAN.,

ton)

($

- $

6

mil.

JAN.

Placements

Prices

158

(thous.)

per

cwt.)

N.A.

N.A.

N.A.

93.00

92.00

72.50

Broiler

Prices

(i

per

lb.)

N.A.

N.A.

N.A.

Soybean

Prices

($

per

bu.)

6.65

6.30

5.06

+31

Broiler

Feed

185

N.A.

159

+16

149

+40

Cost

Cash

($

per

Receipts

N.A.

N.A.

N.A.

N.A.

N.A.

N.A.

6.8

5.8

6.4

JAN.,

ton)

Prices

($

per

+28

mil.
208

(thous.)

7,350

7,259

7,047

cwt.)

93.70

92.30

74.20

+26

lb.)

28.20

27.70

30.10

-

bu.)

6.63

6.10

5.05

+31

185

175

159

+16

151

+17

Broiler

Prices

(i

per

Soybean

Prices

($

per

Broiler

Feed

Cost

- $

JAN.

Placements

Farm

Cash

Broiler

+25

Calf

Index

Arrivals
by

27.67

lb.)

per

Broiler

(thous.)

Personal

Passenger

supplied

25.77

bu.)

(tf

5

Q4

(thous.)

Prod,

NOTES:

26.27

($

per

ton)

+

4
6

Agriculture

Arr.

Hours

lb.)

per

Prices

5

1967=100
Kilowatt

+3?

+39

Broiler

-

JAN

SAAR)

Price

72.73

+ 10

($

JAN.,

Receipts

Dates:
Plane

6

113
37,897

91.07

71.80

Placements

Prices

+

1967=100

($

4

+

115
39,819

91.80

185.5

Index

Personal

+

117
96.34

Agriculture

Arr.

Hours

4

100.00

per

84.1

JAN

SAAR)

Kilowatt

-

13,228

per

Cost

Dates:
Plane

(Q2)189

5

14,498

($

Farm

Index

Income

bil.

(QD195

14,517

(i

2,308.9

1967=100

($

(Q2)181

+30

(thous.)

Prices

90.4

Q4

(thous.)

Personal

-

4.90

Agriculture

Prod,

Hours

+27

29.60

5.93

cwt.)

Prices

1,864.4

JAN

SAAR)

Kilowatt

per

Feed

Dates:
Petroleum

75.10

27.50

6.36

40,041

- $

Soybean

Broiler

Index

Personal

ton)

per

Broiler

88.6

1967=100
Hours

92.30

28.00

JAN

Placements

Prices

2,199.6

MAR

(thous.)

Kilowatt

($

Receipts

Dates:
Plane

95.20

cwt.)

Broiler

Calf

MAR

MIAMI

Income

($

3

(thous.)

per

per

Broiler

Index

Personal

2

+

Farmers

(£

3

JAN

(thous.)

Hours

+

Agriculture

Arr.

Kilowatt

per

Prices

Broiler

mils.

SAAR)

Prod,

Consumer

($

by

($

Dates:
Plane

127
91,507

(1977=100)

Prices

Farm

Index

1967=100
Kilowatt

130
94,014

Agriculture

SAAR)

Prod,

Consumer

130

cwt.)

Cost

Dates:
Plane

%
CHG.

94,214

(thous.)

per

Placements

Broiler

1967=100
Hours

1987

Farmers

Placements

Prices

Broiler

Index

Kilowatt

APR

1988

Agriculture

SAAR)

Prod,

Consumer

by

(1977=100)

Index
Petroleum

MAR(R)

Agriculture

SAAR)

Index
Plane

APR
1988

for
the

are
of
the

six

data

supplied

collected
Labor

calendar
states.

from

by
26

Statistics.
year
N.

A.

U.

not

Department

the

month

available.

of

Petroleum

Agriculture

through
=

S.

airports.

+

data

Prices

177

cwt.)

N.A.

N.A.

N.A.

90.70

83.10

70.50

(tf

per

lb.)

N.A.

N.A.

N.A.

Prices

($

per

bu.)

6.18

6.60

5.01

Broiler

Feed

197

N.A.

205

data

annual

per

Prices

Taxable

Broiler

mil.

(thous.)

Soybean

Commerce.
by

($

- $

JAN

Broiler

Production

supplied

shown.
The

6

JAN.,

Placements

U.

S.

Sales

($

are

per

ton)

reported

by

U.

of

Agriculture.

change

are

an

S.

as

supplied

Department

placements

percent

Cost

average

calculation

is

Bureau
weekly
based

on

a

12-month

of

Mines.

Farm

Cash

rate.

The

most

cumulative

Price
data

recent

data

revised.

FEDERAL RESERVE BANK O F ATLANTA




47

+23
-

total.

Consumer
Receipts
Southeast

+29

data

over

4

Plane

Index
are

data

reported

represent

prior

year

CONSTRUCTION
ANN.

ANN.

(12-month

cumulative

Nonresidential
Total

FEB

MAR

1988

1988

1987

50,596

50,447

47,020

+

8

Value

7,275

7,264

8.424

+

0

Residential

CHG.

Building

Permits

- f

Bldgs.

Residential

Mii.

13,357

13,297

13,599

-

2

13,169

13,076

12,014

+

10

Hospi tal s

2,266

2,356

2,571

-

12

Schools

1,131

1,089

1,154

-

2

7,763

7,729

7,865

-

1

Value

867

849

1,120

-

23

Residential

Building

Permits

- $

Nonresidential

Industrial

Multifamily
Total

- $

Residential Building
- $

Permits

1,853

1,755

1,858

-

0

2,439

2,395

+

1

Multifamily

Hospitals

483

523

472

+

2

Schools

274

274

151

+

81

507

588

-

13

Value

29

65

-

54

Residential

10

Building

Permits

- $

Total

511

30

Bldgs.

- $

Residential

Mil.

Nonresidential

158

160

176

186

182

182

+

2

16

16

19

-

16

31

16

3,722

3,776

3,854

-

3

Value

Residential

Hospitals
Schools

29

Building

Permits -

$

Nonresidential

8

Single-family

1,098

1,122

1,155

-

5

Multifamily

173

219

312

-

45

95

95

37

Bldgs.

526

Stores

565

Hospitals

124

Schools

104

Nonresidential
Total

Residential

264

Offices

Building

Permits

-

$

+ 3
- 25
+ 29
+ 4
+520
+154

398

459

-

16

Value

Residential

Value

- $

71
38

Single-family

Stores

163

169

135

+

21

Multifamily

Hospitals

106

104

39

+172

14

14

41

-

66

215

217

234

-

8

Building

P e r m i t s -- $

Building

Value

- $

Residential

27

25

23

+

17

51

52

56

-

9

Stores

62

62

78

-

21

Hospital s

16

18

23

-

30

Schools

13

13

7

+

86

1,038

1,018

970

+

7

Value

Residential

Industrial

Nonresidential
Total

Bldgs.

Building

Permits

147

158

224

-

34

Offices

246

231

235

+

5

Stores

Industrial

Bldgs.

339

304

+

14

47

45

59

-

20

18

17

9

NOTES:

Data

Nonresidential

supplied

data

by

exclude

the
the

U.
cost

S.
of

Bureau

of

the

construction

Census,
for

Total

Housing

publicly

Units

owned

Authorized

buildings.

-

3.9

3.9

6.5

-40

1,131

1,134

1,259

-10

9,029

9,038

8,630

+

5

115.4

110.3

107.7

+

7

71.5

72.7

80.9

12,751

12,814

12,484

3,599

3,527

3,724

- 3

17.6

47.0
16.2

51.2
21.7

- 9
-19

5,491

5,340

5,485

+ 0

401

411

521

-23

6.4

6.6

7.8

-18

0.5

0.5

2.0

-75

787

809

941

-16

288

294

328

-12

4.8

4.9

5.4

-11

0.9

1.0

1.8

-50

503

510

561

-10

1,740

1,753

1,889

-

8

22.0

22.1

23.5

-

6

-42

-12
+

2

Permits

Permits

Mil.
-

Thous.

units

units

7.7

8.2

13.2

2,749

2,742

2,747

Permits

Mil.

By B u i l d i n g

The

7

Thous.

units

Permits

- $

8

+

Permits

Building

Building

Value

+100

-

Thous.

Mil.

Multifamily

347

Schools

-

units

Single-family

Hospitals

671
11.5

Permits

units

Permits

- $

627
10.2

- Thous.

Mil.

Building

Residential

-

Nonresidential

619
10.0

Permits

Building

- $

0

Permits

Multifamily
Value

-

units

Single-family
Total

23,477

Mil.

- $

Offices

23,349

- Thous.

Permits

Residential

Mil.

23,411

Mil.

-

Nonresidential

-20

Thous.

Building

- $

-

Total

126.1

Permits

41

Nonresidential

102.5

Mil.

102

Value

1

102.0

units

Building

13

Total

1

-

units

65

Schools

-

207.1

Permits

Permits

12

Bldgs.

15,763

201.1

Mil.

63

Industrial
Offices

-

Building

Residential

386

15,648

205.4

Permits

Multifamily
Value

15,677

units

Single-family
Total

2

Mil.

- $

Residential

Mil .

Nonresidential

- $

1,761
350
407
541
20
41

-

units

Building

1,813
266
454
565
122
104

143,672

Permits

Permits

7

Mil.

140,829

Mil.

-

1,820

140,944

-25

Thous.

Building

- $

-

- $

626.8

units

882

Value

476.4

Permits

417

Total

8

467.9

CO
ID
«3-

Industrial

Residential

+154

3

-

Mil.

793

Schools

Permits

- $

358

Hospital s

-

units

387

Offices

Nonresidential

Permits

808

Bldgs.

Building

81

Mil.

Stores

Total

+

96,640
1,088.8

Mil.

Building

Value

-

Building

Multifamily
Total

93,676
1,010.7

Permits

Single-family

Stores

Nonresidential

Ï
CHG.

93,642

units

Mil.

- $

Offices

Industrial

1987

1,007.0

units

Building

Value

-

Total

1988

Hermits

Mil.

2,420

Nonresidential

1988

Permits

Stores

Industrial

MAR

Thous.

Mil.

Offices

Total

-

units

units

Building

Value

Mil.

Bldgs.

Permits

Single-family

Nonresidential

FEB

Permits

Mil.

Single-family

Stores

Total

Building

- $

Offices

Nonresidential

MAR

rate)

Nonresidential

Industrial

%

MAR

Southeast

Permits
data

and

Public

represent

the

Contracts,
total

of

+

0

C-40.

the

six

states.

48




E C O N O M I C R E V I E W , M A Y / J U N E 1988

Newsletters To Keep You Up-To-Date
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49

Federal Reserve Bank of Atlanta
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