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E C O N O M IC R E V I E W

Additional copies of the ECONOMIC REVIEW may
be obtained from the Research Department, Federal
Reserve Bank of Cleveland, P. O. Box 6387,
Cleveland, Ohio 44101. Permission is granted to
reproduce any material in this publication providing
credit is given.

JANUARY 1971

DIFFUSION INDEXES AND
ECONOMIC ACTIVITY
The Federal Reserve Bank of Cleveland, in connection
w ith its responsibilities in the area of monetary policy, is
concerned with national business and financial conditions
and keeps closely attuned to regional developments. Manu
facturing is generally regarded as exercising a pivotal role in
determining the pace and direction of overall economic
activity in the Fourth District, because manufacturing in
this region is dominated by durable goods industries.
Historically, production and employment in durable goods
industries— the Fourth District as well as in the nation—
in
have

been

volatile

than

nondurable goods

industries.
One means used by this Bank to keep abreast of actual

IN THIS ISSUE

and anticipated developments in the area's manufacturing
sector is a regular monthly survey of manufacturers. The
Diffusion Indexes and
Economic A c t iv ity .........3

results o f the survey were first brought to the attention of
the general public in the fall of 1969.1 Since then, there
have been various refinements of the survey returns,
including a new format for the monthly release beginning

Federal Laws Regulating
Bank Mergers and the
Acquisition o f Banks by
Registered Bank Holding
C om panies......................18

January

1971, and some investigation concerning the

reliability of the survey. This article describes the nature
and results of the survey and discusses certain analytical
tools

some

economists

use

evaluate current and

prospective business conditions.
1

Annual Index ....................28

See "The M onthly Survey o f Fourth D istrict Manufacturers—An

Early Warning Signal," Economic Commentary, Federal Reserve
Bank o f Cleveland, October 27, 1969.

ECONOMIC REVIEW
Nature of the Survey. The Federal Reserve

peak and started to decline, while other series are

Bank o f Cleveland, with the cooperation of many

still rising or experiencing plateau-like movements.

executives and economists of manufacturing firms

Similarly, mixed short-run trends are generally

in the Fourth District, began its m onthly survey of

found among groups of industries, among firms in

manufacturers in the summer o f 1964. Because

any particular industry, and among components of

current information on many aspects of industrial

an individual series.
Given

activity at the regional level is limited or not

the

crosscurrents

in the nature of

available at all, a number of key manufacturing

economic activity, it is extremely useful to know

series were selected to be included in the survey.

whether the forces of expansion or contraction are

For eight items, survey participants report whether

predominant. Diffusion indexes attempt to depict

their firms experienced an increase, no change, or

the pervasiveness of increases and decreases in

a decrease from the previous month (after allow

economic series over various time spans. Actually,

ance for normal seasonal variation) and what they

a diffusion index is not an index at all. It is,

anticipate for the month ahead.

instead, a measure of the percentage of: (a) a

The number of participants in the survey has

collection of time series that are expanding over a

varied, w ith the range o f 75 to 100 being the

given period; or (b) the components of an aggre

representative sample over the time period o f the

gate time series expanding over a given period; or

survey. In general, the composition of the survey

has consistently reflected the structure of manu

increases in some economic variable over a given

facturing in the Fourth District; that is, roughly

period.3 The periods generally used range from

three-fourths of the participants are engaged in

one to twelve months (or four quarters). Since

durable goods manufacturing; the remainder o f the

month-to-month, or quarter-to-quarter changes are

respondents

often

are

nondurable

goods

manu

the

irregular,

the

use

longer spans in

survey,

computing diffusion indexes avoids emphasis on

although confidential, are combined into conve

erratic movements and reveals cyclical elements

nient summary measures called diffusion indexes.

more clearly. A six-month span diffusion index,

Some background

for example, shows what is happening over succes

facturing.

Individual

replies

material on the nature of

diffusion indexes w ill, therefore, help to interpret

sive six-month

intervals,

but does not reveal

the results of the Fourth District m onthly survey

monthly movements w ithin the intervals. For that

of manufacturers.

reason, both one-month span and longer span

Nature of Diffusion Indexes. Business analysts
have long recognized that economic time series do
not all move uniform ly at any given stage of the
business cycle. Some series may have reached a
2

Much annual data pertaining to regional m anufacturing

diffusion indexes are often used simultaneously.
3

Examples o f a, b, and c, respectively, include the

Conference Board d iffu sio n index o f 20 economic tim e
series, the U. S. Departm ent of Commerce d iffu sio n index
of industrial p ro duction fo r 24 industries, and the First
National C ity Bank o f New Y o rk d iffu sio n index o f about

are available, after a lag o f several years, in the U. S.

1,000

Department of Commerce's publications. A nnual Survey

p ro fits. See the m on th ly p u b lica tio n, Business Conditions

o f Manufacturers and the quinquennial Census o f Manu

Digest, U. S. Departm ent o f Commerce, fo r additional

facturers.

examples o f d iffu sio n indexes.

m anufacturing

corporations

reporting

higher

JANUARY 1971

A diffusion index is similar to a rate of change,

Despite this lim itation, diffusion indexes have a

except that a diffusion index fluctuates between

reasonably good record of foreshadowing turning

100 percent (all components expanding) and zero

points in the corresponding aggregate series. In

(all components declining). A diffusion index at

other words, the proportion of expanding com

the 50 percent level implies no change in the

ponents in an aggregate series is at a maximum

aggregate series.4 There are two reasons why a

before the aggregate series reaches its peak; con

diffusion index merely implies a certain behavior

versely, the proportion o f declining components in

of the aggregate series. First, each component of

an aggregate series is at a maximum before the

an aggregate series is typically given equal weight

aggregate series reaches its trough.

in constructing a diffusion index, although there

The forecasting properties of a hypothetical

may be wide disparities in the relative importance

diffusion index are shown in Chart 1. (An actual

diffusion index, of course, does not trace out such

the

individual

Second,

index, generally

smooth, symmetrical curves.) A diffusion index

attempt is made to distinguish between differences

can be subdivided into four stages, each of which

in the magnitudes o f change in the component

corresponds to a certain behavior of the aggregate

items. Thus, a diffusion index at, for example, the

series.

80 percent level may im ply a 10-percent rate of

direction o f change in a diffusion

computing

the

components.

diffusion

Accordingly,

both

the

level

and

the

index are

increase in the aggregate series at one time and a

important considerations. Starting from an arbi

5-percent increase at another time.

trary 50 percent level, the first stage of a diffusion
index

4 ln

com puting

diffu sio n

index,

one-half

the

percentage o f components showing no change is added to
the percentage o f components expanding. Thus, fo r a

indicates that

more and

more o f the

components are expanding over a given time
period. When the m ajority of the components are

given aggregate series, if 30 percent o f the components are

expanding; that is, the diffusion index reaches its

rising, 40 percent are unchanged, and 30 percent are

peak, the implication is that the rate o f increase in

falling, the value o f the d iffu sio n index w ould be 50

the aggregate series has also reached a peak.

percent. The technique cited above, and used in this
article, is the most conventional method o f com puting a

During the second stage of a diffusion index, as

net

some of the components start to decline, the rate

percent

of increase in the aggregate begins to slow down

decreasing, w hich gives a possible range o f -100 percent to

(although the aggregate series continues to rise).

d iffusion

index.

Other

d iffusion

index

(percent

+100 percent, w ith

techniques

include

increasing

minus

the

zero im plying no change in the

aggregate series) and the cumulative net diffu sio n index
(percent increasing minus percent decreasing—
cumulated

When the diffusion index returns to the 50 percent
level (at the end of stage II), the aggregate series

over tim e, which gives a possible range o f -100 percent to

reaches a peak; that is, the rate of change has

in fin ity , w ith the co n tou r o f the cumulative net d iffusion

declined to zero.

index resembling the contour o f the aggregate series). For
illustrations of the three types o f d iffu sio n indexes, and

The third stage of a diffusion index indicates

fo r additional technical in fo rm a tio n , see A rth u r F. Burns,

that declining components of an aggregate series

"N ew Facts on Business Cycles" and G eoffrey H. Moore,

are outnumbering increasing components, which

"D iffu s io n Indexes, Rates of Change, and Forecasting," in
Business Cycle Indicators,
Analysis o f Current
N a tio n a l

Bureau

V ol. I, "C o n trib u tio n s to the

Business Conditions”
of

Economic

(Princeton:

Research,

1961).

implies that the aggregate series has begun to
decline. The rate of decrease gathers momentum as
more of the components move into declining
5

ECONOMIC REVIEW

CHART 1
.

PROPERTIES

OF f D I F F U S I O N
l

INDEX

AG G R EG AT E SERIE S

D I F F U S I O N INDEX

Stoge

a diffusion in dex th a t is

im plies th a t the a g g r e g a te series is

rising (50% — 100% )

in creasin g a t an in creasin g rate

fa llin g (100% - 50 % )

in creasin g a t a d e creasin g rate

fa llin g (50% - 0)

d e clin ing a t an in creasin g rate

rising (0 - 50 % )

declin ing a t a d e creasin g rate

SOURCE:

FEDERAL RESERVE BANK OF CLEVELflNO

phases. When the majority of components are

diffusion

declining; that is, the diffusion index is at its

performance of an actual diffusion index and its

lowest point, the implication is that the rate o f

corresponding aggregate series. Chart 2 shows the

decline in the aggregate series is at a maximum.

index of industrial production and its six-month

As the diffusion index moves into its fourth
stage, the rate of decline in the aggregate series

index

span diffusion

can be approximated by the

index,

based on 24 industries

included in the index of industrial production.5

begins to slow. The end of the fourth stage of the
diffusion index implies a trough for the aggregate

A lthough Business C onditions Digest centers m on th ly

series. A further rise in the diffusion index, above

plots of d iffu sio n indexes in the middle o f the periods

the 50 percent level, is indicative of an upturn in

over w hich changes are measured, an equally acceptable

the aggregate series.
The four different stages of a hypothetical

procedure of

p lo ttin g

d iffu sio n indexes and rates of

change on the term inal months o f the span is used in this
article.

JANUARY 1971

CHART 2.

I N D E X OF I N D U S T R I A L P R O D U C T I O N A N D
6 - M O N T H S P A N D I F F U S I O N I N D E X OF I N D U S T R I A L
P R O D U C T I O N - 24 I N D U S T R I E S
INOUSTRIRL
INDEX:

PRODUCTION

19 57 -5 9 = 100

INDUSTRIAL

PRODUCTION

DIFFUSION INDEX

SOURCES: U.S. DEPARTMENT OF COMMERCE AND BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM

The table
production

lists rates o f change in industrial

(associated

during periods that correspond to

activities in Southeast Asia) that was superimposed

different stages of the diffusion index.

w ith

the

escalation

m ilitary

on a capital goods spending boom. A fter March

Stage I of the diffusion index underscores the

1966, the rate of increase in industrial production

accelerating phase of industrial production from

began to subside, as gains in output among the 24

late 1965 to early 1966. As the diffusion index

industries became less pervasive (stage II). When

rose to

the diffusion index dropped below 50 percent

100 percent, the rate of increase in

industrial production almost tripled between the

(stage III), industrial production entered into a

two six-month periods ending in September 1965

declining phase that began in early 1967. The

and

1966 (see table). The accelerated

upturn in the diffusion index (stage IV) signaled

increase in industrial production partly reflected a

March

the bottoming of the decline in industrial produc

sharp upswing in the output of defense industries

tion. Finally, movement of the diffusion index

ECONOMIC REVIEW
Diffusion Index of Industrial Production*
Changes in Industrial Production
over Related Periods
1965-1968

eight items relating to manufacturing activity: new
orders, shipments, backlogs, inventories, delivery
time, employment, hours, and prices paid. D iffu
sion indexes fo r each of those items were con

Six-m onth Span
D iffusion Index
(term inal m onth
o f span)t

Seasonally Adjusted
Percent Change in
Industrial
Production

79.2% (9/65)
100.0% (3/66)

+ 2.3%
+ 6.7

100.0% (3/66)
70.8% (1/67)

+ 6.7
+ 0.7

70.8% (1/67)
27.1% (6/67)

+0.7
-2 .4

indicators is not a diffusion index, it has properties

27.1% (6/67)
41.7% (9/67)

-2 .4
+ 0.1

peaks and troughs in the composite leading index

41.7% (9/67)
83.3% (3/68)

+ 0.1
+ 4.1

Diffusion
Index
Stage

structed, and the results were consolidated into a
composite diffusion index (see Chart 3). Super
imposed on the composite diffusion index of

III

* 24 industries.
t Dates in parentheses refer to term inal months of
six-m onth spans over which changes in industrial
pro d u ctio n are measured.
Sources: U. S. Departm ent o f Commerce and Board of
Governors o f the Federal Reserve System

into stage I during late 1967 coincided w ith the

Fourth

D istrict

manufacturing activity

is the

national composite index of 12 leading indicators,
prior to trend adjustment.6
Although the composite index of 12 leading
that resemble those of a diffusion index; that is,
tend to be reached before peaks and troughs in
general

business activity.

A downturn in the

composite index of leading indicators preceded
each post-World War II recession or period of
business slowdown that did not qualify as a
recession, and an upturn in the leading indicators
preceded or accompanied each recovery from a
recession or a leveling in business activity.7
The generally good record of the national

recovery in industrial production.
Diffusion indexes can provide useful infor

composite leading index in foreshadowing changes

mation about the current and prospective behavior

in overall business activity can be taken as a crude

of an aggregate series (particularly if the aggregate
series itself cannot be measured in a practical

°The composite index o f 12 leading indicators, p rio r to

way— is the case w ith many economic series at
as

trend

the

regional

level).

Using

the

concepts just

described, this article focuses on the diffusion

adjustm ent, has a relatively

fla t trend

and is

adjusted upward (by 0.35 percent per m onth) so th a t its
trend is equal to th a t o f the national composite index o f 5
coincident indicators. For fu rth e r details on the compos

indexes of Fourth District manufacturing activity

ite index of 12 leading indicators, see "Leading Indicators

and their reliability, as reflected by rates o f change

o f Econom ic A c tiv ity ," Econom ic Com mentary, Federal

in counterpart national series. The actual rates of

Reserve Bank of Cleveland, August 10, 1970, and the
references cited therein.

change in Fourth District manufacturing series, of
course, can only be inferred from the behavior of

7 For an analysis o f the correlation between changes in the

the diffusion indexes.

composite index of leading indicators and subsequent

Composite Indexes. As mentioned earlier, a

changes in gross national product, see G eoffrey H. Moore,
"Forecasting Short-Term Econom ic Change," Journal o f

selected sample of manufacturers reports to the

the Am erican Statistical Association, March 1969, V ol.

Federal Reserve Bank of Cleveland each month on

64.

JANUARY 1971

CHART 3.

C O M P O S I T E D I F F U S I O N I N D E X OF F O U R T H D I S T R I C T
M A N U F A C T U R I N G A C T I V I T Y AND C O M P O S I T E INDEX
OF 12 L E A D I N G I N D I C A T O R S , P R I O R TO T R E N D
ADJUSTMENT (UNITED STATES)

LAST ENTRY; 1/71; 11/70
SOURCES: U.S. DEPARTMENT OF COMMERCE AND FEDERAL RESERVE BANK OF CLEVELAND

benchmark against which to judge the reliability of

this Bank's m onthly survey is to gauge the actual

the composite diffusion index o f Fourth District

performance

manufacturing activity. Although the scales of the

facturing activity in the Fourth District and to

selected

indicators o f manu

two series in Chart 3 are different, short-run

keep abreast of manufacturers' anticipations, or

contours and turning points are similar. During the

more generally, the trend of business sentiment.

subcycle

both

Subordinate purposes o f the survey are to gain

composite indexes reached their peaks in March

some insight on the behavior o f national counter

1966.

parts o f the items included in the survey.

The

1966-1967,
trough

for
the

example,
Fourth

District's

composite index was realized in February 1967,

Generally, there is no feasible way to measure

while the trough of the national index came one

how accurately

month later. During the subcycle of 1969-1970,

indexes reflect the behavior of the corresponding

both the Fourth District and the national indexes

aggregate series. Apart from partial coverage of

reached their peaks in April 1969.

manufacturing employment and

Evaluating the Survey. The primary purpose of

the

Fourth

District diffusion

hours in the

Fourth District, data on the items in the survey do
9

ECONOMIC REVIEW

CHART 4.

M A N U F A C T U R E R S ’NEW ORDERS
FO UR T H DI ST R I C T
DIFFUSION INDEX

UNITED

STATES

LAST E N T R Y : 1/71;11/70
SOURCES: U.S. DEPARTMENT OF COIWERCE AND FEDERAL RESERVE BANK OF CLEVELAND

not exist. National data are, therefore, taken as the

phase. Conversely, when the diffusion index is

reference points to judge the reliability of the

recovering and moves above the 50 percent level,

survey results.

the national series should also begin to recover. Of

The Fourth District diffusion indexes are eval
uated on the basis o f how well they conform to

course, the

Fourth

District diffusion

indexes

should not always be expected to m irror the

the contours traced by rates of change in counter

national series, mainly because there is a larger

part national series. The higher the level of the

proportion of durable goods industries in the

diffusion index, the greater the implied rate of

Fourth District than in the nation as a whole.

change in the corresponding aggregate series for

Among the items discussed and shown in the

the Fourth District (and the greater should be the

charts, some diffusion indexes and rates of change

rate of change in the national series). Timing is

are inherently smoother than others. All display

also an im portant criterion. When the diffusion

irregular month-to-month movements. For the

index falls below the 50 percent level, one would

sake o f consistency, each Fourth District diffusion

expect to see the national series begin a declining

index

is smoothed by a three-month moving

JANUARY 1971
average, and the rate of change in each national
o
series is computed over three-month spans.

beginning in the spring of 1967 and continuing

Among the eight items being evaluated, new

tapering in the rate o f increase, and finally a

until the spring of 1969, followed by a gradual

orders is a fairly smooth series. The correspon

decline beginning in late 1969 (see Chart 5). The

dence between the Fourth District diffusion index

moderate

of new orders and the national rate o f change in

summer of 1970 reflected the rebound in many

new orders tends to be good. For example, during

industries following the end of the teamsters'

recovery

shipments

during

the

the 1965-early 1966 buildup in new orders, both

strike, while the subsequent decline can be traced

series peaked in December 1965 (see Chart 4).

to the recent auto strike and softening in the

When the Fourth

capital goods sector.

below

District diffusion index fell

50 percent in November 1966, manu

Manufacturers' backlogs (also called unfilled

facturers' new orders in the United States began to

orders) serve as a buffer between new orders and

decline significantly at the same time. Troughs in

shipments. When the flow of new orders exceeds

the national rate of change and the Fourth District

the volume of shipments, backlogs accumulate;

diffusion index, occurred in January and February

conversely, when shipments begin to exceed new

1967, respectively. The auto strike in the fall of

orders, backlogs are drawn down. Business analysts

1967 temporarily interrupted the recovery in new

pay close attention to the behavior of backlogs as

orders that lasted until 1969. The Fourth District

an indicator of demand pressures on human or

diffusion

1969, and a

physical resource utilization. The change in back

sustained movement below the 50 percent level

index peaked in April

logs in durable goods manufacturing industries,

began in December 1969. Meanwhile, the 1969

where most backlogs exist, is also an officially

peak in the national rate of change in new orders

recognized leading indicator. As shown in Chart 6,

was reached in September; the declining phase also

there

began in December.

Fourth District diffusion index of backlogs and

The diffusion index of manufacturers' ship

is a close correspondence between the

the national rate of change in backlogs. The two

ments in the Fourth District tends to be the most

series have similar contours and turning points

erratic of the eight survey items. Nevertheless, the

d u rin g

broad contours of the Fourth District diffusion

1969-1970.

th e

subcycles

1966-1967

and

index seem to be in accordance w ith the alter

The Fourth District diffusion index of manu

nating phases of strength and weakness in United

facturers' inventories does not conform as well as

States manufacturers' shipments. Specifically, the

backlogs to the national counterpart series. There

Fourth District diffusion index suggests an acceler

is, however, some sim ilarity between inventory

ation in shipments during late 1965-early 1966, a

fluctuations in the Fourth D istrict and in the

deterioration beginning in late 1966, recovery

nation. One major exception is that the extremely

O
For the national series, m onth-to-m onth percent changes

States

were also com puted, placed on a three-m onth moving
average, and compared w ith the percent changes over

high rate of inventory accumulation by United
manufacturers in

1966 was not fu lly

reflected in the Fourth D istrict diffusion index

three-m onth spans. The results, in terms o f short-run

(see Chart 7). In the nation, the well-publicized

contours, are very sim ilar.

inventory adjustment of 1967 involved a sharp

ECONOMIC REVIEW

CHART 5.

MANUFACTURERS ’SHIPMENTS
FO UR TH DI ST R I C T
DIFFUSION INDEX

UNITED

STATES

PERCENT CHANCE OVER 3 MONTHS SPUN

LAST e n t r y : l/7l; 11/70
SOURCES: U.S. DEPARTMENT OF COMMERCE AND FEDERAL RESERVE BANK OF CLEVELANO
CHART 6.

MANUFACTURERS'

BACKLOGS

FOURT H DIS TR IC T
DIFFUSION INDEX

U NIT ED STATES
PERCENT CHANOE OVER 3 MONTHS SPAN

LAST ENTRY: 1/71; 11/70
SOURCES: U.S. DEPARTMENT OF COMMERCE ANO FEDERAL RESERVE BANK OF CLEVELAND

JANUARY 1971

FOURTH

DISTRICT

DIFFUSION INDEX

StvZ.
UNITED

3-MONTH Ml VINO AVERAGE
-

- ............. .................

_____________________

STATES

PERCENT CHRNGE OVER 3 MONTHS SPAN

LAST ENTRY: 1/711 11/70
SOURCES: U.S. DEPARTMENT OF COMMERCE ANO FEDERAL RESERVE BANK OF CLEVELAND

reduction in the rate o f increase in manufacturers'

accuracy of the Fourth

District series.9 Con

inventories, based on book value. (In view o f the

fo rm ity between the tw o series is generally good,

inflation

except that the amplitude o f delivery time is larger

occurring at that time, the physical

volume o f manufacturers' inventories probably

in Chicago than in the Fourth District (see Chart

declined.) In the Fourth District, by contrast, the

8 ).

diffusion index fell below 50 percent in January

For manufacturing employment, there is an

1967 and remained below that level until late in

excellent relationship between the Fourth District

the year, thus implying a reduction in inventories.

diffusion index and the rate of change in the

Delivery time, or vendor performance, is an

national data. The survey accurately depicted the

indicator of the time between placement of new

two declining phases of manufacturing employ

orders and actual delivery. Increases in delivery

ment during the

time

beginning in early 1967 and the second beginning

usually are symptomatic

of tight labor

markets and pressures on physical resources, as
suggested by high capacity utilization rates or a
rising backlog—
shipments ratio. Because there is
no national series on delivery time, vendor perfor

1965-1970 period, the first

in late 1969 (see Chart 9).
9

"V e n d o r performance, percent o f companies reporting

slower

deliveries,"

from

the

Purchasing

Management

Assocation o f Chicago, is shown as a diffu sio n index in

mance reported by firms in the Chicago area was

Business Conditions Digest and is classified as a leading

selected

indicator.

as the

benchmark

for

gauging

the

ECONOMIC REVIEW

CHART 8.

DELIVERY

TIME

FO UR TH DIS TR I C T
DIFFUSION INOEX

CHICAGO

PURCHASING AGENTS

DIFFUSION INOEX

LAST ENTRY: 1/71? 11/70
SOURCESi FEDERAL RESERVE BANK OF CLEVELAND ANO PURCHASING MANAGEMENT ASSOCIATION OF CHICAGO

CHART 9.

EMPLOYMENT

IN M R N U F A C T U R I N G

FOURT H DISTRI CT
DIFFUSION INOEX

UNITED

STATES

PERCENT CHANGE OVER 3 MONTHS SPAN

LAST ENTRY: 1/71; 12/70
SOURCESi U.S. DEPARTMENT OF LABOR ANO FEOERAL RESERVE BANK OF CLEVELAND

Digitized for14
FRASER

JANUARY 1971
The contour of the Fourth District diffusion

District

survey

clearly

revealed the dramatic

index of the workweek is similar to that of

upswing in

manufacturing employment. The correspondence

temporary easing in the rate of inflation from

prices at that time.

Following a

between the Fourth D istrict and the national series

mid-1966 to early 1967, industrial prices moved

on the workweek, however, is less precise than for

progressively toward

employment. In the United States, the rate of

There were, of course, brief periods during recent

change in the workweek is more volatile than the

years when the rate of increase in industrial prices

higher rates o f increase.

rate of change in employment, because employers

eased for a few months at a time. But those lulls

customarily make their short-run adjustments to

were followed by renewed bursts of strength.

production by changes in the workweek rather
than in employment. Accordingly, the average

Summary. The nature o f economic activity is

workweek of production workers in manufac

such that at any given time, some economic series,

turing is an official leading indicator, and the rate

industries, and firms are likely to be registering

of change in the workweek precedes movements in

increases, others are showing no change, and

the workweek itself. For example, in the United

others are declining. An analytical tool, called a

States, the average workweek reached a post-World

diffusion index, has been devised that shows the

War II high in March 1966, three months after the

dispersion of changes that are occurring. Diffusion

peak in the rate o f change. In the Fourth District,

indexes can be used to infer the behavior of

the m onthly survey of manufacturers reflected a

certain aggregate series that may be d iffic u lt, if not

rapid rise and a high level in hours during late

virtually impossible, to measure at the regional

1965-early 1966 and the cutbacks that began in

level. This

Bank's m onthly

survey of

manu

late 1966 (see Chart 10). The survey also indicated

facturers uses diffusion indexes to help describe

another

the pace and direction of key economic variables

downward

phase

the

workweek

in the Fourth District's manufacturing sector.

beginning in late 1969.
The two price series shown in Chart 11 have a
strikingly

correspondence, despite some

The
survey

charts demonstrate that the
of

Fourth

District

m onthly

manufacturers has

conceptual differences. For the Fourth District,

generally reflected changing phases of manufac

the diffusion

refers to prices paid by

turing activity during the past six years. The major

manufacturers for materials and parts; the national

value of the survey is that it provides this Bank, in

series shows the rate of change in wholesale prices

addition to the survey participants and other

index

of industrial commodities and is based on prices

interested

charged fo r materials and finished producers' and

concerning the trend of actual and anticipated

consumers' products. (Often the Bureau o f Labor

regional

parties,

w ith

tim ely

business conditions.

information

The survey was

Statistics must resort to using list prices rather

exceptionally helpful in late 1966, when the signs

than actual transactions prices.)

suggested a rapid deterioration in business condi

From their

longstanding

period of relative

tions.

stability, industrial wholesale prices began to rise

More recently, the survey provided this Bank

noticeably in 1964, and the rise gained significant

w ith some evidence o f the slowdown in manufac

momentum in late 1965-early 1966. The Fourth

turing activity in the Fourth District by the latter

ECONOMIC REVIEW

CHART 10.

HOURS

IN M A N U F A C T U R I N G

FOURT H DIS TRI CT

DIFFUSION INDEX

UNITED STATES
PERCENT CHANGE OVER 3 MONTHS SPAN

LAST ENTRY: 1/71; 12/70
SOU R C E S > U.S. DEPARTNENT OF LABOR AND FEOERAL RESERVE BANK OF CLEVELAND

P R I C E S P A I D BY F O U R T H D I S T R I C T M A N U F A C T U R E R S
INDUSTRIAL WHOLESALE PRICES, UNITED STATES
FOURTH DISTRICT
DIFFUSION INOEX

3-nONTH nOVINO AVERAGE
_
_____________ I __________

UNITED STATES

PERCENT CHANGE OVER 3 HONTHS SPAN

6-0

SEASONALLY POJUSTEO — ANNUAL RATE

1965
LAST ENTRY:

’ 69

1/71; 12/70

SOURCES! U.S. DEPARTNENT OF LABOR ANO FEOERAL RESERVE BANK OF CLEVELAND

’ 70

’ 71

'7 2

AND

JANUARY 1971
half o f 1969. The survey also supported the view

ment beginning in

that inflation remained a matter o f serious concern

through 1970. Based on historical experience, the

in 1970 even though restrictive public economic

survey of Fourth District manufacturers should

late

1969 and continuing

policies had been pursued during the previous

provide some advance indications of the extent to

year. The survey also revealed the adverse effects

which

of reductions in manufacturing output on employ

unfolds during the months ahead.

recovery

the

manufacturing

sector

Future m o n th ly releases o f the Survey o f F ourth
D istrict

M anufacturers

m ay

obtained

from

the

Research Departm ent, Federal Reserve Bank o f Cleveland,
P. O. Box 6387, Cleveland, O hio 44101.

ECONOMIC REVIEW

FEDERAL LAWS REGULATING BANK MERGERS
AND THE ACQUISITION OF BANKS BY
REGISTERED BANK HOLDING COMPANIES
The Federal laws related to the expansion of

The postwar trend in banking toward increased
large

registered bank holding companies were written in

branch bank organizations or large bank holding

the same general manner. However, the Federal

concentration

financial

resources

companies has generated legislation designed to

Reserve System was granted exclusive jurisdiction

preserve competition in banking. The authority to

over cases involving the acquisition of banks by

administer

laws concerned w ith bank

registered bank holding companies. To date, the

mergers was divided among the three Federal bank

Federal

Supreme Court has not handed down any deci

regulatory agencies and each one was granted a

sions under these laws.
This article traces the development of Federal

substantial amount of autonomy. The wording of
law was sufficiently general to permit a

laws regulating the acquisition of banks by other

significant degree of fle xib ility in its interpretation

banks or by registered bank holding companies.

and administration. As a result, no consistently

Major legal points resulting from some important

uniform set of specific guidelines defining unwar

test cases decided by the Supreme Court are also

ranted or illegal bank mergers has emerged at the

discussed.

the

agency level. The

Department o f Justice has

developed quantitative

structural guidelines to

THE SHERMAN AND CLAYTO N ACTS

assist in determining whether or not to oppose

The Sherman A c t o f 1890 and the Clayton A c t

mergers between direct competitors (i.e., hori

o f 1914 are the cornerstones of Federal antitrust

zontal mergers). The banking agencies have used

legislation. The Sherman Act prohibits combi

additional criteria to take account of the perfor

nations in actual and unreasonable restraint of

mance aspects o f banks in markets as well as the

trade, whereas Section 7 o f the Clayton Act

competitive aspects. The most common index of

prohibits

transactions

or acquisitions

pro

the competitiveness of banking markets used by

spective restraint of trade as well as those resulting

the supervisory authorities, the Department of

in actual restraint o f trade or substantial lessening

Justice, and the courts is the concentration ratio,

of competition. Neither act was used extensively

or the share of total commercial bank deposits of

all banks in a market accounted for by a few of

Sherman Act has been considered inapplicable to

the largest banks in that market.

all but the most serious restraints of trade. Section

Digitized for 18
FRASER

prevent

bank

mergers

before

1963.

The

JANUARY 1971

11 of the Clayton Act granted the Board of
TABLE I
Development of Bank Merger Legislation

Governors of the Federal Reserve System the
authority to enforce the compliance of banks with
Section 7.

National Banking A ct o f 1918

This act required the advance approval of the Comp
tro lle r o f the Currency before tw o or more banks
could merge under the charter of a national bank.

The applicability of the Clayton Act to bank
mergers was greatly limited, however, since the
original Section 7 applied only to consolidations
and mergers accomplished by stock acquisition.

Federal Deposit Insurance A c t o f 1950

This legislation divided a u th o rity to approve or deny
certain mergers involving tw o or more insured banks

Since provisions of Federal law prohibit member

among the three Federal bank regulatory agencies. No

banks of the Federal Reserve System, with few

specific regulatory standards were set fo rth .

exceptions, from directly purchasing corporate
stocks, most mergers are accomplished by an

Bank Merger A ct o f 1 9 6 0

This act fo r the firs t tim e made all bank mergers
involving insured banks subject to the jurisd ictio n of

acquisition of assets and assumption of liabilities
or an exchange of stock. In effect, before 1960,

one o f the three Federal agencies. Furtherm ore, it

bank

contained specific regulatory standards unlike previous

exclusively through state laws that provided for

legislation. These standards were almost identical to
those incorporated in the Bank Holding Company Act
of

1956, and both

acts were equally

ambiguous

mergers were subject to control almost

regulation by a state agent or agency according to
varying standards.

regarding the relative weights to be attached to each of
the three groups o f factors.
This act made m andatory advisory reports evaluating

BANK MERGER LEGISLATION
PRIOR TO 1960

the com petitive factors fro m the banking agencies not

The earliest Federal laws relating specifically to

having ju risd ictio n over the particular marger and the

bank mergers assigned regulatory duties to the

Departm ent o f Justice. The question of the applica
b ility o f the a n titru st laws to bank mergers was le ft
open.

various Federal banking agencies w ithout setting
forth any specific standards for the exercise of
their authority (see Table I). For example, the

Bank Merger A ct of 1 9 66

This legislation was enacted fo r the same purpose as
the Bank Holding Company A ct o f 1966. It dealt w ith

agencies were not explicitly granted permission to
consider the probable effects of the acquisition of

the issue o f the a p p lica b ility of the a n titru st laws to

a bank upon competition. The National Banking

bank acquisitions by merger in identical language.

A c t o f 1918 required the advance approval of the
Comptroller of the Currency before two or more

It appeared to give a free hand to the Departm ent of
Justice in challenging bank mergers by requiring a

banks could merge under the charter of a national

30-day w aiting period after an approval by a Federal

bank. Section 18(c) of the Federal Deposit Insur

bank agency during which the Government could

ance A c t o f 1950 provided that before an insured

organize its case.

bank could merge w ith another insured bank, prior
written consent would have to be obtained from
the Comptroller of the Currency if the resulting
bank was to be a national bank, the Board of
Governors of the Federal Reserve System if the
19

ECONOMIC REVIEW

resulting bank was to be a state member bank, or

The Bank Holding Company A c t o f 1956

the Federal Deposit Insurance Corporation (FDIC)

(BHCA) represented the first significant attempt

if the resulting bank was to be a nonmember

by Congress to subject the formation and expan

regulatory

sion of bank holding companies to Federal regula

standards were set forth. A more serious short

insured

bank.1

Again,

no specific

tion. It required a holding company to register

coming of the Federal Deposit Insurance Act was a

w ith the Board of Governors if it owned 25

provision that made the approval of these agencies

percent or more o f the stock o f each of two or

unnecessary unless the capital stock and surplus of

more banks. The act gave the Board o f Governors

the resulting bank was less than the aggregate

the authority to approve or deny applications for

capital stock and aggregate surplus of the partici

the formation of new registered bank holding

pating banks. This provision appears to reflect a

companies as well as applications fo r acquisitions

traditional concern of bank regulators w ith the

of additional banks by existing bank holding

adequacy of a bank's capital to protect its depos

companies.

itors from losses arising out of shrinkages in asset
values. The majority of bank mergers, in which the

Unlike the previous legislation that unsuccess

capital stock of the resulting bank equals the

fu lly attempted to regulate bank mergers, this act

aggregate capital stock of the participating banks,

listed specific factors that the Federal Reserve

were exempted from Federal control.

System was to consider when evaluating a pro
posed acquisition of a bank. These factors were:

HOLDING COMPANY LEGISLATION
PRIOR TO 1960
The Banking A c t o f 1933 (Glass-Steagal Act)

(1) the financial history and condition of the bank
holding company and bank concerned; (2) their
earnings

prospects; (3) the character of their

granted the Board of Governors limited powers to

management; (4) the convenience and needs of the

regulate bank holding companies controlling the

communities to be served; and (5) the preservation

majority of the stock of at least one Federal

of competition in the banking industry. The first

Reserve System member bank (see Table II).

three

Supervisory powers over such an organization's

solvency, asset condition, capital, and operations,

financial

policies

(e.g., the setting of certain

reserve requirements) were intended to protect the

thus

factors

pertained

continuing

to the organization's

the underlying concern

fo r

depositors reflected in the Banking Act of 1933.

bank's depositors, and the Banking Act of 1933

The last two factors represented a significant

did not set forth guidelines fo r regulating the

departure from earlier legislation. The lawmakers

formation or expansion of bank holding com

concerned w ith the competitive health of the

panies.

banking industry appeared to recognize for the
first time that the acquisition of a bank also
involved

equally important nonsafety oriented

1 ln the Fourth D istrict states of K entucky, Ohio, and

considerations, such as competitive effects, the

Pennsylvania, the approval of the state banking depart

possible

ment is also required if the merger involves tw o state

introduction

new services at the

chartered banks. West Virginia is the only F ourth D istrict

acquired bank, and changes in its lending behavior

state that does not perm it branch banking.

and pricing policies. The safety of bank deposits,

JANUARY 1971
TABLE II
Development o f Federal M ultiple Bank
Holding Company Legislation
im portance o f factors (2) and (3) o f the criteria fo r

Banking A ct of 1933

This legislation granted the Federal Reserve Board

approval contained w ith in the Bank Holding Company

lim ited

A ct of 1956. The Board was directed not to approve:

powers

regulate certain

bank

holding

companies. In cases in which the Board had ju ris
d ictio n , it was authorized to examine the holding

1. Any acquisition...w hich would result in a m onop

company and its subsidiaries, to set certain reserve

o ly, or which w ould be in furtherance o f any

requirements and to supervise other financial policies

com bination

in the interest of protecting depositors. The Board had

atte m p t to m onopolize the business o f banking in

conspiracy

m onopolize

no a u th o rity to control holding company expansion

any part of the United States, or

and prevent any possible adverse com petitive effects.
2. A ny other proposed acquisition...whose effect in
Bank Holding Com pany A ct of 1956

any section o f the county may be substantially to

This act represented the first comprehensive bank

lessen com p e titio n , or tend to create a m onopoly,

holding company co n tro l legislation. Its m ajor objec

or which in any manner w ould be in restraint of

tives were to co n tro l the form ation and expansion of

trade,

registered bank holding companies (defined as owning

effects

unless it
of

the

finds

that the a nticom petitive

proposed transaction are clearly

25 percent or more o f the stock o f each o f tw o or

outweighed in the p u blic interest by the probable

more banks) and require divestment o f their non

effect o f the transaction in meeting the conve

banking interests. U nlike the Banking Act o f 1933, the

nience and needs o f the co m m u n ity to be served.

1956 law covered nonmember banks. The Board of

The first section o f the amendment tightened the prior

Governors was required to consider three groups of

law;

factors in deciding

m onopoly was merely one o f the com petitive factors

whether to approve o f holding

under the

1956 act,

any

tendency toward

company activities:

to be weighed along w ith other considerations. The

1. "B anking fa cto rs"

second section provided an exception to the strict

pertaining to the company's

application

solvency, earnings prospects, and management

a n titru s t

laws

determ ining

the

legality of holding company expansions. However, its
2. Convenience and needs considerations or the prob
able social benefits resulting from the transaction

wording

w ould

seem

indicate

th a t

Congress

intended any exceptions to be rare, although the
specific conditions governing whether the acquisition

3. The

prevention

excessive concentration

could still be considered in the public interest, despite
substantially adverse com petitive effects, were not

economic power in bank holding companies

specified in the statute.
Like the Bank Holding Company A ct o f 1956, the

The Bank Holding Com pany A ct o f 1966

This

legislation

Congressional

was

in te n t

enacted
w ith

p rim a rily

respect to

to
the

cla rify
relative

1966 act d id not apply to one bank holding com
panies.

although not diminished in importance, was no

solving the problem of regulating bank merger

longer to be the sole consideration.

activity

RECENT BANK MERGER AND
HOLDING COMPANY LEGISLATION

competitive effects o f a bank merger as the key

emerged

from

Congressmen who were

Congressional
inclined

debate.

to view the

issue involved generally favored reliance on anti

During the late 1940's and throughout the

trust laws to preserve competition. This group

1950's, when the pace o f bank merger activity was

advocated amending Section 7 of the Clayton Act

accelerating, two basically different approaches to

to make all bank mergers subject to the jo in t

ECONOMIC REVIEW

regulation o f the Attorney General and the Board

General and the banking agencies not having

of Governors. Proponents o f the second approach

jurisdiction

("public u tility approach” ) argued that banking

opportunity to render an advisory opinion on the

was already a highly regulated industry and,

competitive factors to the agency w ith responsi

over a bank

merger received the

therefore, deserving of special treatment under the

bility for approving or disapproving the merger.

antitrust laws and that any anticompetitive effects

The agency w ith jurisdiction over the case was not

of a merger could be compensated for by the

obliged, however, to base its recommendation on

several banking factors involved and the probable

this advice. The Bank Merger Act omitted any

extent to which the public's banking needs would

reference to whether the Attorney General could

be better met. They advocated amending the

make an antitrust attack on the merger if his

banking laws to require the prior approval of all

advice on the degree of adversity of the compet

mergers by the Federal banking agencies.

itive effects did not prevail. Such a course of

The Bank Merger A ct o f 1960, which amended

action was at least not barred by the Bank Merger

Section 18(c) of the Federal Deposit Insurance
Act, represented a partial victory for the advocates

Act.
The issue of the applicability of the antitrust

of the public u tility approach. This amendment

laws to bank mergers was settled in the courts (see

eliminated a serious obstacle to Federal regulation

Table III). The Supreme Court in the Philadelphia

of bank mergers by making all bank mergers

Bank Case (1963)2 and the Lexington Bank Case

involving insured banks subject to the jurisdiction

-(1964)3 ruled that bank mergers approved by

of one of the three Federal agencies, whether or

Federal

not the capital and surplus of the resulting bank

under antitrust laws. In the former case, the court

banking agencies could be challenged

was less than the aggregate capital and surplus of

held that the

the participating banks. The act also represented a

Philadelphia banks, which would have resulted in a
bank

proposed merger of two large

significant departure from past legislation regu

single

lating bank mergers, since it listed criteria (basi

deposits in the four-county area of Philadelphia,

controlling

percent o f

bank

cally the same as in the BHCA) to be used in

was of a sufficiently anticompetitive nature as to

evaluating applications for bank mergers. Neither

be in violation of Section 7 of the Clayton Act. In

act clearly stated

the

the relative weights to be

assigned to the banking factors (first three criteria

Lexington case, the court ruled that the

Sherman Act also applied to bank mergers.

BHCA of 1956), the

The Bank Merger A c t o f 1966, an amendment

convenience and needs factors, or the adverse

to the Bank Merger Act of 1960, was enacted in

competitive effects, if any, resulting from the

1966 to reconcile differences in interpretation

acquisition o f a bank. This ambiguity of the BHCA

between

listed

in discussion o f

of 1956 and the Bank Merger Act of 1960 was
somewhat resolved by amendments to both acts
six years later.
The Bank Merger Act of 1960 appeared to vest

the

courts,

which

emphasized

the

United States v. Philadelphia National Bank, et. at., 210

F .S upp 348 (1962); 83 S. Ct. 1715 (1963).
3

United States v. First National Bank & Trust Company

final authority to rule on all insured bank mergers

o f Lexington, et. a!., 208 F. Supp. 457 (1962); 84 S. Ct.

in the Federal banking agencies. The Attorney

1033 (1964).

JANUARY 1971
TABLE III
Key Supreme Court Decisions in Bank Merger Cases

monopoly or attempt to achieve that end in
banking in any section of the country. However, if
the proposed merger was likely to result in a

Philadelphia Bank Case (1 9 6 3 )

Court declared bank mergers to be

substantial reduction of competition, but not one

subject to the provisions o f the Clayton A ct. A merger

of monopolistic proportions, the agencies could

violating the a n titru s t laws could not be upheld on the

recommend approval under certain circumstances.

The Supreme

basis o f convenience and needs considerations.

Approval would be justified if the anticompetitive
effects were "clearly outweighed in the public

Lexington Bank Case (1 9 6 4 )

The Supreme Court ruled th a t bank mergers were to
be subject to the provisions o f the Sherman Act.

interest by the probable effect of the transaction
in meeting the convenience and needs of the
community to be served." In bank merger cases

Provident Bank Case and First C ity Bank Case (1 9 6 7 )

The Supreme Court, in a single opinion, ruled that the

involving less than substantially adverse competi

Department o f Justice need only challenge a bank

tive effects, the convenience and needs factors still

merger on the grounds of a violation o f the antitrust
laws. Furtherm ore, the decisions o f the regulatory

had to outweigh any anticompetitive effects to

agencies were not to be binding on the courts. The

warrant an approval. A merger's overall effect

defendant banks, in seeking to ju stify an a nticom pet

upon competition was to be evaluated in deter

itive

mining whether possible beneficial effects in some

merger, were

assigned

the

responsibility

showing that the convenience and needs consider
ations of the merger outweighed its anticom petitive

product markets could offset detrimental effects

effects.

in others.4 The agencies were directed to continue
consideration of the traditional "banking factors"

Th ird National Bank Case (1 9 6 8 )

The

Supreme

Court ruled

that a public

interest

defense o f an anticom petitive merger w ould not be

in all cases.
In 1966, the Bank Holding Company Act of

considered valid unless the defendants were able to

1956 was similarly revised. In both amended acts.

prove that the gain expected from the merger could

Congress affirmed the applicability of antitrust

not reasonably be attained through other means.

laws to bank mergers, but also softened their
impact by providing for possible exceptions. A

Phillipsburg Bank Case (1 9 7 0 )

The Supreme C ourt ruled th a t mergers involving tw o

30-day waiting period was required in the event of

d irectly com peting banks, regardless o f how small they

an approval during which the Department of

are, may violate the a n titru st laws.

Justice may sue to prevent the proposed merger or
acquisition. Both the 1960 and 1966 Bank Merger

competitive factors, and the regulatory agencies,

Acts required advisory reports on the competitive

which attached relatively greater weight to the

factors from the banking agencies w ithout juris

banking and convenience and needs factors than

diction over the merger and the Justice Depart

the

courts.

The

amended

Bank

Merger Act

assigned greater importance to the competitive

factors than the original act. Congress made liberal

large business loans while dim inishing it fo r small loans.

use of language found in the Sherman and Clayton

A merger, fo r example, m ight increase co m petition fo r

Furtherm ore,

merging

banks

could

argue

th a t th e ir

combined size w ould perm it them to enter new banking

Acts. The responsible agency was directed not to

markets by offering additional services (e.g., trust ser

approve any merger proposal that would result in a

vices).

ECONOMIC REVIEW

ment. Furthermore, the Department of Justice and

market (comprising a four-county area) in which

the courts were directed

the five largest commercial banks controlled 71

to apply the same

standards to bank mergers as did the bank super

percent of the deposits. In the latter case, the

visory agencies.

combined market share of the merging banks, the

Until very recently, Federal legislation regu
lating

the formation

and expansion

of bank

largest and sixth largest banks in Houston, was
estimated to be 32 percent of bank deposits in

holding companies has applied only to multiple-

Harris

bank holding companies. In general, these bank

accounted fo r 66 percent of the deposits.

holding companies were prohibited under the

County, where the five
both cases,

Federal

largest banks

district courts had

BHCA of 1956 from engaging in any business

dismissed the complaints o f the Department of

other than banking and managing banks. The

Justice. They were appealed to the Supreme Court

holding

and decided on March 27, 1967, in a single

companies were exempt from Federal regulation

opinion reversing the district courts. In its deci

under both the BHCA of 1956 and the 1966

sion, the Supreme Court answered two major
procedural questions. The court asserted that the

nonbanking

subsidiaries

one-bank

amendment to the act. A t the end of 1970, the
President signed into law a bill that extends

Department o f Justice need only challenge a bank

Federal

regulation to corporations and others

merger on the grounds o f a violation of the

owning 25 percent or more of one bank.5 This

antitrust laws. The Department o f Justice was not

legislation gives the Federal

Board a

required to prove a violation o f the Bank Merger

substantial amount of discretion in exercising its

Act of 1966. However, the court also recognized

authority to regulate one-bank holding companies.

that the Bank Merger Act o f 1966 provided a

Reserve

public

JUDICIAL INTERPRETATIO N OF THE
BANK MERGER ACT OF 1966

interest

exception

that

might

legalize

mergers which, if judged solely on a competitive
basis, would otherwise be illegal. It ruled that the

The Provident Bank Case (1967)6 and First

burden of proof to establish that the anticom

City Bank Case (1967)7 were the first cases to

petitive effects of a merger were outweighed by

come before the Supreme Court under the Bank

convenience and needs considerations rested with

Merger Act of 1966. The Comptroller of the

the defendant banks. Furthermore, the Supreme

Currency approved both of these mergers. In the

Court supported the contention of the Depart

former case, the merging banks accounted for 14

ment o f Justice that the opinion of the Comp

percent of the commercial bank deposits in a

troller of the Currency or any banking regulatory

agency was not binding on the courts. The courts,
See "Pending Federal Legislation Concerning One-Bank

Holding

Companies," Economic Commentary,

Federal

Reserve Bank o f Cleveland, August 31, 1970.

which had primary jurisdiction over bank merger
cases, were to make a fresh review o f all the
evidence presented in a case.

United States v. Provident National Bank,ef. at., 262 F.
Supp. 297 (1966); 87 S. Ct. 1088 (1967).

The Crocker-Anglo Citizens Bank Case (1967)8
involved a merger between the fifth and seventh
Q

^U n ite d States v. First C ity National Bank o f Houston, et.
a!., Supp. 397 (1966); S. Ct. 1088 (1967).

United States v. Crocker-Anglo National Bank, et. al.,
263 F. Supp. 125 (1966); 277 F. Supp. 133 (1967).

JANUARY 1971
largest banks in California. One bank operated

had been slowly declining since 1960, the court

primarily in northern California (San Francisco

held that merging it would have no adverse effect

Bay area) and the other operated in southern

upon competition. The district court termed this

California (metropolitan Los Angeles). However,

bank a stagnant or "floundering bank” rather than

the tw o banks had offices in Ventura County,

a failing one.

which is adjacent to Los Angeles. A California

The Supreme Court, in reversing the district

district court found that the defendant banks were

court's decision, reaffirmed its earlier decisions in

not in actual competition w ith each other. Fur

the Provident Bank Case and the First City Bank

thermore, the court rejected the contention of the

Case. In its decision, the court made it clear that

Department of Justice that the merger would have

both the regulatory agencies and reviewing courts

eliminated potential competition between the two

should give suitable weight to the convenience and

banks, a possibility

needs considerations to determine the overall

permitted

by California's

statewide branching laws. The district court based

effect upon the public interest o f a bank merger.

its decision upholding the merger partly on the

The court clarified and extended the position it

grounds that the Crocker-Anglo National Bank

had adopted in earlier cases concerning the burden

would be in a stronger position to compete with

of proving that a particular anticompetitive merger

the largest bank in the state after the merger that

could still be in the public interest and, therefore,

would

make it the fourth

largest bank. The

be exempt from antitrust laws. The court directed

Department of Justice did not appeal the decision.

the party (defendants) seeking to justify this

One of the landmark Supreme Court decisions

exception to be specific in describing and defining

in the enforcement history of the Bank Merger Act

the value of the benefits of the merger. The

of 1966 was handed down in the Third National

convenience and needs factors specifically men

Bank Case (1968).9 The case involved a merger

tioned

between the second and fourth largest banks in

capacity, providing an expanded range of banking

Nashville

services

(Davidson

County),

Tennessee. The

in
to

the
the

decision

were greater lending

community,

and solving the

merged bank would have held slightly less than 40

problem of weak management. More significantly,

percent o f the commercial

the court required the defendants to show that the

bank deposits

Davidson County in which, before the merger, the

gains

expected

from

the

merger

could

not

three largest banks controlled 93 percent of the

reasonably be attained through other means. The

bank deposits. The merging banks were direct

case was sent back to the district court to

competitors.

court had

reconsider the applicability of the Bank Merger

merger, reasoning that the

Nashville Bank and Trust Company, the bank to

Act of 1966.
The most recent major Supreme Court decision

be acquired, was not a vigorous competitor and

involving a bank merger was handed down in the

would not likely become one in the future. Since

Phillipsburg National Bank Case (1970).10 The

approved

Tennessee district

the

this bank's share of Nashville's banking business
1®United States v. Phillipsburg National Bank and Trust

q
United States v. T hird National Bank o f Nashville, et. at.,
260 F. Supp. 869 (1966); 88 S. Ct. 882 (1968).

Company, et. al., 306 F Supp. 645 (1969); 90 S. Ct. 2035
(1970).

ECONOMIC REVIEW

proposed merger was between the third and fifth

and the court defined the geographic market to

largest banks located in the two city area of

include most of the Lehigh Valley (Phillipsburg-

Phillipsburg, New Jersey, and Easton, Pennsylvania

Easton accounted for only one quarter of this

(the two cities are situated directly opposite each

defined market area), in which more than 30

other on the Delaware River). Although both

commercial banks were located and also evaluated

banks operate offices only in Phillipsburg, the

competition from a number of nonbank financial

Supreme Court defined the relevant geographic

institutions

market to include both cities because of their close

Justice had considered only commercial banking as

proxim ity. Phillipsburg has only one other bank,

the relevant product market.

which is smaller than either of the two involved in

that area. The Department of

The Supreme Court, in reversing the decision of

have

the district court, ruled that the antitrust stan

controlled approximately 23 percent of the total

dards were as applicable to mergers involving

the

merger.

The

merged

bank

would

commercial bank deposits in the two city area in

directly competing small banks as they were to

which the two largest banks held 56 percent of the

those in which large banks directly competed with

bank deposits. The deposit size of the banks

each other. In reaching its decision, the court

attempting

adopted the relatively narrow conception of the

merge

(each

one

under

$30,000,000) was significantly smaller than that

geographic and

of any of the banks involved in preceding cases in

Department of Justice. The court emphasized the

product market held

by the

which a bank merger had been contested before

preponderance of small deposit and loan accounts

the Supreme Court. Nevertheless, the banks were

at both banks involved in the merger to indicate

direct competitors, w ith

the narrow geographic scope of their competitive

main offices located

across the street from each other.

influence. The court reasoned that small bank
customers are generally more likely than larger

A New Jersey district court had ruled in favor

ones to establish their banking connections pri

of the merger, which had been approved by the

marily on the basis of convenience. The Supreme

Comptroller of the Currency, asserting that it

Court also rejected the district court's assertion

would have no measurable anticompetitive effect.

that competition should be analyzed in piecemeal

The other tw o bank regulatory agencies and the

fashion, on the basis of each of the submarkets

Department o f Justice had reported that the

(e.g., time and savings deposits, real estate loans)

merger would have a significantly harmful effect

in which a bank competed, at times w ith nonbank

on commercial banking competition in the rele

financial institutions. The Supreme Court ruled

vant geographic market that they defined as the

that commercial banks, were unique in providing a

Phillipsburg-Easton

disagreement

wide variety of financial products and services and,

regarding the competitive effects of the merger

therefore, were the only relevant financial insti

stemmed

conception

tutions that should be included in the analysis of

adopted by the Comptroller of the Currency (and

competition. The court concluded that the merger

later by the district court) of the relevant geo

would have substantially lessened competition in

graphic and product markets in which the two

the two city market area and would be in violation

banks competed. The Comptroller o f the Currency

of the Clayton Act.

from

the

area.
much

This
wider

JANUARY 1971
In returning the case to the district court fo r

the overall competitive effects of a merger, since it

further consideration, the Supreme Court directed

did not contain standards that could be used to

the lower court to reconsider the convenience and

evaluate the relative importance of each of a

needs factors in the relevant geographic market

bank's product markets. Another major source of

(Phillipsburg-Easton). The district court had origi

ambiguity in the law concerned the degree to

nally assessed these factors just in Phillipsburg.

which a merger's probable benefits had to exceed

The district court was also directed to examine

its potentially harmful anticompetitive effects to

the adequacy o f the attempts by the two banks to

justify an approval. Although the banking factors

cope w ith their loan, trust, and personnel prob

were listed in the BHCA of 1956 and both the
1960 and 1966 Merger Acts, the specific factors

lems by methods other than merger.
Concluding Comments. On the basis of an

relating to the convenience and needs o f the

analysis o f the bank merger cases that have come

community to be served by the merged bank were

before the Supreme Court since the passage of the

not spelled out in detail.

Bank Merger Act of 1966, it would appear that no

The Supreme Court has continued to apply the

substantial changes in the legal interpretation of

usual Clayton Act standards of competition to

bank mergers could be attributed to the 1966 act.

bank mergers and has also continued to rely

Basically, this act fused the Bank Merger Act with

heavily upon statistical guidelines such as concen

the Clayton Act.

tration ratios and numbers of firms in a market in

Although the Bank Merger Act of 1966 was

measuring the anticompetitive results. It has also

somewhat more explicit than the one passed in

continued to rely on commercial banking as the

1960, it still left a number of basic questions

only relevant line of commerce or product market

unanswered. For instance, the issue of the validity

by which to appraise bank mergers, excluding

o f employing the standard of changes in market

nonbank financial institutions from consideration.

concentration in assessing the competitive effects

To date, the court has not sustained a convenience

of all mergers was not settled.

1 1

In fact, no direct

and needs defense in a single case. However, the

reference was made to any specific factors to be

court has indicated its willingness to accept a

used in evaluating the competitive effects. Further

public interest defense if the defendants can show

more, the law did not facilitate a determination of

that any benefits clearly outweigh any adverse
competitive effects and that these benefits are not
attainable through

11 The

degree of co m p e titio n in markets may be in flu

enced

factors

other

than

m arket structure.

For

any feasible alternative to

merger. The court has traditionally evaluated the

example, the e lim ination o f an aggressive bank would

importance of the individual convenience and

have a stronger a nticom petitive effect than the e lim i

needs factors (e.g., greater lending limits, provision

nation o f a more passive com petitor. A merger in a small
tow n involving a weak bank th a t had been unable to

of trust services) according to the extent of

compete successfully m ight substantially increase market

unfulfilled need for them in the acquired bank's

concentration w ith o u t appreciably reducing com petition.

market.

ANNUAL INDEX TO ECONOMIC R E V I E W - 1 9 7 0
MONTH

JANUARY

ARTICLE T IT L E

U. S. Treasury Bills: Trends and New Developments, 1959—1969
Capital Spending in Major Areas of the Fourth District

FEBRUARY*

The Federal Funds Market Revisited
Inflation: Problems of the 1960's and Implications for the 1970's

MARCH*

The Eurodollar Market: The Anatomy of a Deposit and Loan Market

APRIL*

The Eurodollar Market
Employment Shifts Toward the Service Industries in Major Areas o f the Fourth District

M AY*

Economic Roundup
The Eurodollar Market
Commercial Paper, 1960—1969

JUNE

The St. Lawrence Seaway and the Fourth District
Capital Spending in Major Metropolitan Areas o f the Fourth District

JULY

Banker's Acceptances
A Note on the Current Decline in Corporate Profits

AUGUST*

The Pattern of United States International Trade
Direct Placement of Corporate Debt

SEPTEMBER

Trends in Productivity, Costs, and Prices
Registered Bank Holding Company A ctivity in Ohio, 1964—1969

OCTOBER

The Relationship Between Capital Appropriations and Expenditures
A Note on the Voluntary Steel Quota

NOVEMBER*

Patterns o f Federal Government Outlays and Revenues, 1960—1970
State and Local Revenues and Expenditures, 1960—1968

DECEMBER

Recent Trends in the Retail Trade Industry: United States and Fourth District
Capital Spending in Major Metropolitan Areas o f the Fourth District

* Out of print.