The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.
Prefatory Note The attached document represents the most complete and accurate version available based on original copies culled from the files of the FOMC Secretariat at the Board of Governors of the Federal Reserve System. This electronic document was created through a comprehensive digitization process which included identifying the bestpreserved paper copies, scanning those copies, 1 and then making the scanned versions text-searchable. 2 Though a stringent quality assurance process was employed, some imperfections may remain. Please note that some material may have been redacted from this document if that material was received on a confidential basis. Redacted material is indicated by occasional gaps in the text or by gray boxes around non-text content. All redacted passages are exempt from disclosure under applicable provisions of the Freedom of Information Act. 1 In some cases, original copies needed to be photocopied before being scanned into electronic format. All scanned images were deskewed (to remove the effects of printer- and scanner-introduced tilting) and lightly cleaned (to remove dark spots caused by staple holes, hole punches, and other blemishes caused after initial printing). 2 A two-step process was used. An advanced optical character recognition computer program (OCR) first created electronic text from the document image. Where the OCR results were inconclusive, staff checked and corrected the text as necessary. Please note that the numbers and text in charts and tables were not reliably recognized by the OCR process and were not checked or corrected by staff. Content last modified 6/05/2009. February 14, 1975 CONFIDENTIAL (FR) CLASS II - FOMC SUPPLEMENT CURRENT ECONOMIC AND FINANCIAL CONDITIONS Prepared for the Federal Open Market Committee By the Staff Board of Governors of the Federal Reserve System SUPPLEMENTAL NOTES The Domestic Nonfinancial Economy The wholesale price index for January fell 0.3 per cent, seasonally adjusted (not at an annual rate), This was the second consecutive monthly above that of a year earlier. decline in the total index. to a level 17.2 per cent It reflected lower prices for farm and food products which were partially offset by a rise in prices of industrial commodities. WHOLESALE PRICES (Per cent changes at seasonally adjusted compound annual rates)1/ Jan'74 Dec'73 to to Jan'75 Mar'74 Jtme'74 Sept'74 Dec'74 to Se Tpt'74 to Dec'74 12.2 35.2 13.4 21.9 * All commodities 17.2 Farm products 3.4 10.8 -29.3 59.2 23.8 32.3 16.6 26.9 20.2 22.7 18.9 21.5 13.6 88,7 32.6 23.1 13.2 28.3 40.4 11.3 35.7 10.4 28.3 29.1 43.7 25.9 27.2 32.2 22.7 31.8 25.3 30.9 15.0 18.5 10.6 19.1 15.6 17.4 8.8 17.3 -16.7 29.4 29.1 Industrial commodities Crude materials Intermediate materials Finished goods Producer Consumer Nondurable, excl. food Durable Consumer finished foods 24,5 Mar'74 to June'74 8.2 -14.8 8.2 13.3 18.7 7.7 Note: Farm products include farm products and processed foods and feeds. 1/ Not compounded for one-month changes. to Jan'75 -4.0 -30.5 6.3 -16.7 6.9 11.1 15.5 8.9 9.9 4.4 -10.8 The index of farm and food products decreased 2.5 per cent, seasonally adjusted, mainly as a result of declines for grains, soybeans, and manufactured animal feeds. -2- The index of industrial commodities rose 0.5 per cent, seasonally adjusted, with most of the rise accounted for by increases for machinery and equipment, fuels and power, woodpulp and paper products, chemicals, and nonmetallic minerals. The index is 23.8 per cent above the level of a year ago. Wholesale trade inventories. Book value of wholesale trade inventories fell at an annual rate of $2.8 billion in December, in contrast to the upward revised November growth rate of $6.8 billion and the fourth quarter annual rate of $5.9 billion. This fourth quarter rate of accumulation is below the third quarter rate of $$.6 billion. Data on retail inventories in December have just been received, and they show little change for the month. Merchant builder sales of new single-family homes dropped sharply in December to a seasonally adjusted annual rate of 364,000 units--a record low for the series which began in 1963. The December sales rate brought the fourth quarter 1974 average to nearly a fifth below the third quarter and the lowest in 8 years. Although builder backlogs of unsold homes at year-end were still quite large--13 months' supply at the current sales rate--they were a tenth below their yearearlier level. The median price of the mix of homes sold in December increased from that in November and continued above the rising median price of unsold units. In the market for existing homes, sales in December were below a year earlier for the third consecutive month. The median price of such units rose to $32,720--11 per cent above December 1973. -3- SALES, STOCKS AND PRICES OF NEW SINGLE-FAMILY HOMES Homes Home for sale 2/ (thousands of units) sold 1973 QI QII 726 680 QIII 566 QIV / Months' supply Median price of: Homes sold Homes for sale (thousands of dollars) 7.0 7.7 9.6 11.1 30.4 32.7 33.5 34.0 29.4 483 426 436 453 446 525 567 489 400 453 435 414 401 10.4 9.2 10.2 12.0 35.2 35.6 36.2 37.3 34.0 35.0 35.7 36.2 500 412 423 364 414 409 403 401 9.9 11.9 11.4 13.2 36.2 37.2 37.2 37.5 35.7 35.9 36.0 36.2 31.2 32.1 32.9 1974 QI QII QIII (r) QIV (p) Sept. (r) Oct. (r) Nov. (r) Dec. (p) Seasonally adjusted annual rate. Seasonally adjusted stock at end of period. -4- The Domestic Financial Situation Mortgage rates. According to the HUD(FHA) opinion survey, average interest rates on new commitments for conventional new-home mortgages fell substantially further during January to 9.15 per cent, while rates on commitments for existing-home mortgages fell to 9.20 per cent. Private secondary market yields on FHA-insured new-home mortgages were 8.99 per cent at the end of January--52 basis points below the December rate and 139 basis points below the high at the end of September. AVERAGE RATES AND YIELDS ON NEW-HOME MORTGAGES (HUD-FHA Field Office Opinion Survey) Primary market Conventional loans Spread 4/ Level 2/ End of Month 1974-Low High (per cent) (basis points) 8.55 (Feb.) 9.80 (Sept.) -66 (Sept.) 45 (Feb.) Level 3/ (per cent) 8.54 (Feb.) 10.38 (Sept.) Secondary market 1/ FHA-insured loans Spread 4/ Discounts (basis points) (points) - 8 (Sept.) 44 (Feb.) 2.3 (Feb.) 6.3 (July, Sept.) July 9.40 n.a. 9.85 n.a. 6.3 Aug. 9.60 -39 10.30 31 5.8 Sept. 9.80 -66 10.38 - 8 6.3 Oct. Nov. 9.70 9.55 -33 -13 10.13 10 4.6 Dec. 9.45 n.a. 9.51 n.a. 3.8 1975-Jan. 9.15 15 8.99 1/ - 1 3.8 Any gaps in data are due to periods of adjustment to changes in maximum per- missible contract rates on FHA-insured loans. 2/ 3/ Average contract rate (excluding fees or points) on commitments for conventional first mortgage loans, rounded to the nearest 5 basis points. Average gross yield (before deducting servicing costs) to investors on 30-year minimum-downpayment FHA-insured first mortgages for immediate delivery in the private secondary market (excluding FNMA), assuming prepayment in 15 years. 4/ Average gross mortgage rate or yield minus average yield on new issues of Aaa utility bonds in the last week of the month. - 5 INTEREST RATES 1974 Highs Lows Jan. 20 1975 Feb. 13 Short-Term Rates Federal funds (wkly. avg.) 8.81(2/27) 7.17(1/22) 6.28(2/12) 6.42 12.50(8/15) 6.93(2/6) 7.75(2/22) 7.75(2/26) 14.38(7/16) 8.25(2/18) 7.35 8.13 5.62 6.38 6.45 7.63 12.00(9/4) 7.88(2/20) 6.63(1/22) 6.25 12.13(7/10) 10.63(8/28) 6.80(2/19) 7.50(2/22) 7.16(2/19) 6.45 7.25 7.02 5.70 6.38 6.14(2/11) 11.90(8/21) 7.50(2/27) 7.00(1/22) 6.35 6.37(2/15) 7.01(2/19) 6.44 7.16 5.60 6.27(2/11) 9.75(7/17) 6.50(7/12) 7.00(2/27) 3.70(2/15) 7.00(1/22) 3.70(1/22) 6.00 8.79(8/23) 8.72(8/26) 6.72(2/14) 7.40(1/4) 7.44 7.82 7.09(2/11) 7.68(2/11) 13.55(7/3) 3-month Treasury bills (bid) Comm. paper (90-119 day) Bankers' acceptances Euro-dollars CD's (NYC) 90-119 day Most often quoted new 9.74(8/23) 12.25(7/17) 7.25 6-month Treasury bills (bid) Comm. paper (4-6 mo.) Federal agencies CD's (NYC) 180-269 day Most often quoted new 1-year Treasury bills (bid) Federal agencies 9.86(8/23) 9.65(8/23) 10.18(8/26) CD's (NYC) Most often quoted new Prime municipals 3.50(2/14) Intermediate and Long-Term Treasury coupon issues 5-years 20-years Corporate Seasoned Aaa Baa New Issue Aaa Utility Municipal Bond Buyer Index 9.40(10/8) 7.73(1/2) 10.53(12/2) 8.54(1/2) 10.61(10/2) 8.05(2/13) 7.15(12/12) 5.16(2/6) 8.78 10.63 8.63 10.45 9.45(1/23) 9.02p( 2 /13) 6.59(1/23) 6.27(2/13) 9.37(1/13) 8.98(2/10) Mortgage--average yield in FNMA auction 10.59(9/9) 8.43(2/25) -6- CORRECTION: Part II - Section III,page III-T-1. Data Table - Selected Domestic Financial In January, M1 declined at a 9.7 per cent annual rate, not the +9.7 per cent rate shown in the table. SUPPLEMENTAL APPENDIX A PROBLEMS OF THE ELECTRIC UTILITIES* Prospects for moving toward the President's goal of energy independence may have been impaired by the unfavorable set of developments that plagued the electric utility industry during 1974. These developments were brought to a head by the oil embargo of late 1973 which abruptly multiplied the cost of fuel. Even though most State utility commissions permit automatic adjustments for higher fuel costs, recovery of these costs is not complete and in any event tends to be delayed from two to four months. The sharp jump in fuel prices--along with the general inflation of other utility operating costs and steeply rising financing costs-forced substantial increases in utility rates during 1974. High utility rates and energy conservation measures led, in turn, to reduced demands for utility services. This increased the relative burden of the industry's heavy fixed costs, added to unit operating costs, and put further upward pressures on utility rates. With the utilization of existing plant being cut back by reduced demand,the utilities trimmed plans for capital expansion. Unfortunately, these cutbacks tended to center on programs for expanding nuclear generating capacity, since these require the largest initial capital investments and were adding most severly to the squeeze on the industry's financing capacity. Over the longer run these deferrals of nuclear plant expansion may prove costly, because nuclear facilities promise the most substantial savings in operating expenses. Most recently, financing difficulties of the utilities have been somewhat relieved by the development of easier conditions in credit markets. Moreover, the President is proposing a number of special programs to encourage business investment spending which--if adopted-should provide some stimulus to the electric utilities. Financial Status of Electric Utilities The recent unfavorable effects of high utility rates and reduced electricity sales on utility profits are shown in the following table. * Prepared by Margaret H. Pickering, Economist, Capital Markets Section, Division of Research and Statistics, and Stephen Roach, Economist, National Income, Labor Force and Trade Section. A-2 CORPORATE PROFITS BEFORE TAX AND INVENTORY VALUATION ADJUSTMENT (billions of dollars) Total Domestic Nonfinancial Electric, Gas and Sanitary Service Utilities 1972 1973 69.3 78.2 4.1 4.2 1973 - I II III IV 78.2 78.6 78.1 77.9 4.1 3.8 4.5 4.2 1974 - I II 73.8 77.0 2.5 2.6 76.4 3.0 III Source: Bureau of Economic Analysis, U.S. Department of Commerce. Even before this 1974 deterioration in earnings, the electric utility industry was suffering from illiquidity. Since 1966, current liabilities have exceeded current assets, and, the gap has widened over the past year, reflecting, in large part, the need to finance much more expensive fuel inventories. In contrast, other nonfinancial corporations during this period generally experienced moderate increases in working capital. During the 1974 period of peak financing pressure, the combination of weaker earnings performance and continued heavy bond financing substantially widened the spread of interest rates paid by electric utilities over those paid by industrial firms in the same bond-rating category. Thus, spreads between interest rates on new Aa utility bonds and industrial bonds in the same quality category rose from 20-30 basis points early in 1974 to 80-90 basis points during the summer. Most recently, with the general decline of interest rates, these spreads have narrowed to 30-40 basis points. The omission of its traditional quarterly dividend by the Consolidated Edision Company of New York in April played a large role in triggering the increased market sensitivity to the quality of electric A -3 utility debt and equity issues during the summer. This change of attitude was highlighted by actions of the bond-rating services which downgraded the bond ratings of an unusually large number of electric utilities during the months surrounding the Consolidated Edison omission. The general deterioration in the financial position of electric utilities during 1974 was reflected in a rash of postponements of scheduled debt offerings, reductions in the size of issues being offered, switches from longer-term to medium-term maturities and lengthening of call protection, as well as in sharp increases in interest rates paid. These financing difficulties were compounded by the fact that electric, gas, and water utilities had to sell an estimated $13.5 billion in long-term debt and equity issues during 1974, compared to only $10.3 billion in 1973. The mix between new debt and equity financing was heavily skewed toward debt, because additional equity financing at the prevailing extremely low stock prices would have meant severe dilution of existing owners' equity, Capital Spending The electric utilities have played an increasing role in investment spending over the last few years, expanding their share of business plant and equipment expenditures from 11.8 per cent in 1969 to about 16.2 per cent in 1974. But since 1972, the growth in their capital outlays has been decelerating and is expected to decelerate further during 1975. PLANT AND EQUIPMENT EXPENDITURES OF PUBLIC UTILITIES (per cent change from prior year) Public utilities Electric 1/ 2/ 1970 1971 1972 1973 19741/ 13.2 19.1 16.4 20.8 11.1 12.6 10.1 9.9 10.1 10.7 1975 2/ 4.2 1.2 Anticipations reported in November Department of Commerce survey. Anticipations reported in December Department of Commerce survey. The erosion of anticipated expenditures became particularly evident during 1974. Early in the year, there occurred a slight stepup of investment plans, but as 1974 progressed, and the ramifications of the energy crisis became apparent, demand for power slowed. This, together with increased fuel costs and significantly tighter financial markets, led to sharp cancellations of planned outlays. A- 4 Altogether, cancellations, delays and stretch-outs announced during 1974 aggregated more than $20 billion, including about 60 per cent of planned outlays for nuclear-related facilities. A McGrawHill survey conducted in October 1974 indicated that 89 per cent of electric utilities had cut back capital expenditures during the year. Of those cutting back, 34 per cent cited inadequate demand as the principal reason, while 24 per cent cited high interest rates. A poor stock market and material shortages were also cited as factors contributing to reduced outlays, though by fewer respondents. The cutbacks in capital spending programs may have unfavorable future impacts on customer utility rates and the goal of energy self-sufficiency, because the bulk of the reductions have been in nuclear plants. While these plants require huge initial investments, they provide tremendous cost savings once they become operational. Some industry observers estimate that average operating costs of a nuclear facility may be less than one-third the cost of an In curtailing their nuclear programs, utilities have oil-fired plant. thus opted for lower construction costs at the expense of higher future operating costs, which they will then pass along to users. Even with the sharp cutback in capital expenditures, however, the level of anticipated outlays remains large. Thus, the back-log of unspent appropriations at the end of last September (the most recent date for which figures are available) still amounted to over 15 quarters of outlays at the September quarter rate. Even though some of this planned spending may never materialize, the amount of budgeted funds is still substantial. Program for Energy Independence In his State of the Union Address, the President outlined proposed legislative action designed to aid electric utilities, and in particular to stimulate investment in electrical power plants other than oil- and gas-fired facilities. The most important of these proposals include liberalized investment tax credits, preferred stock dividend deductions and mandated reform of State regulatory commission practices. The likely impacts of these proposed changes are summarized below: The President's proposals include: 1. Investment tax credit (legislative). The first of the proposed legislative changes would do the following: A - 5 (a) Permanently eliminate the current discrimination against utilities, raising the present 4 per cent credit to the 7 per cent applicable to other industries. (b) Temporarily increase the credit for all industries to 12 per cent for one year, retroactive to January 1, 1975. The 12 per cent rate also would be continued an additional two years for investment in electrical power plants other than oil- and gas-fired facilities. (c) Raise the limit on the maximum amount of credit against tax liabilities for utilities from the current 50 per cent to 75 per cent for 1975. Thereafter, the limit would decline in 5 per cent steps over the next five years, returning to the present 50 per cent general limitation in 1980. For those utilities paying taxes these proposals should be effective in arresting deterioration in financial positions as well as in stimulating investments designed to reduce reliance on oil and gas. The proposal to raise the limit on the tax credit from 50 to 75 per cent of tax liabilities should be particularly useful for the many utilities that have had credits they were unable to use even with only a 4 per cent credit. 1/ But, a substantial number of the weakest firms may be untouched by these tax reductions; indeed, an estimated one in five of all electric utilities currently pay no Federal income taxes and have substantial unused tax loss carry-forwards. For example, Consolidated Edison of New York has not paid Federal income taxes since 1969. 2. Preferred Stock Dividend Deductions (legislative). This change in the tax laws, first proposed in October, would permit all corporations issuing preferred stock to deduct the resulting dividends from taxable income, thereby encouraging equity financing. 1/ Weidenbaum, Murray L., Financing the Electric Utility Industry, Edison Electric Institute, New York, N.Y., 1974, p.94. A- 6 As with the investment tax proposals, the desired effects will be limited to those utilities that pay income taxes. Utilities taking advantage of this dividend deduction also would be confined to firms that have leeway under their indenture restrictions to undertake additional preferred stock financing. The overall impact of this proposal would be limited because corporate holders of preferred stock already enjoy an 85 per cent exclusion of dividends; with preferred dividends being wholly deducted by the issuer, the 85 per cent exclusion for stockholders would no longer be available. 3. Mandated Reform of State Utility Commission Practices (Legislative). The legislation would: (a) Set a five month limit for rate or service proceedings. (b) Require fuel adjustment pass-throughs, including taxes. (c) Require that construction work in progress be included in a utilities rate base. (d) Allow cost of pollution control equipment to be included in the rate base. Inclusion of construction work in progress in the rate base may be particularly important. As estimated by some industry observers, such actions would boost revenues by 10-12 per cent, with the largest increases obviously accruing to those companies with the largest construction programs. Frequently, such firms are in the poorest financial position simply because of their large capital outlays. This increase in revenues would considerably augment the potential effectiveness of the investment tax credit proposals, as indicated above. A five month limit on rate proceedings might also have a significant impact on earnings, since in the years 1971-73, 70 per cent of proceedings stretched beyond this time. 1/ 1/ Weidenbaum's, Op. Cit., p.108. A - 7 4. Energy Resources Council Study (Administrative). The Council will review the entire regulatory process and financial situation relating to electric utilities, in order to determine what further reforms or actions are needed. 5. Expedited Energy Facilities Siting and Improved Safeguards (Legislative). Laws designed to assure more rapid energy facility siting (and licensing in the case of nuclear plants) are proposed. An increase of $41 million also is requested in 1976 budget appropriations for nuclear safety, safeguards, and waste management. The benefits for the industry emanating from Proposals 4 and 5, however, would likely be limited.
@FedFRASER