savings provided 57 percent; conversion of assets, 16 percent; and the capital (and credit) markets, the balance of 27 percent. The extent to which the business doing the saving controlled investment varied with the types of companies. During 1930-38 the funds available from internal sources to 7 large automobile companies, including General Motors Corporation, were 31 percent greater than all their outlays for plant and equipment. Eleven large oil companies met 95 percent of their expenditures for plant and equipment from funds accumulated from internal sources. Nine steel companies, including the United States Steel Corporation, met 58 percent of these outlays from internal sources,22 despite the fact that some branches of the steel industry have undergone virtually a technological revolution in the last decade. Altman presented data summarizing the situation for all American business enterprises. From 1923 to 1929, business enterprises invested on the average 8.7 billion dollars each year in plant and equipment. Of this, 6.4 billion dollars, or 74 percent, came from funds accumulated from internal sources. After the depression, the ratio was somewhat higher. During the 5 years 1935-39, average outlays for plant and equipment were 5.8 billion dollars. Of this amount, 4.8 billion dollars, or 83 percent came from internal sources (see table 53).28 TABLE 53.-Financing business investments in plant and equipment, 1923-39 [In millions of dollars] ars nts er 323 1 Refers only to nonfinancial business enterprises. Net saving as reported by the Department of Commerce, Survey of Current Business, June 1940. Data for financial enterprises, and data for 1923-28 are unpublished. 2 All business enterprises. From Solomon Fabricant, Capital Consumption and Adjustment, New York, National Bureau of Economic Research, 1938, pp. 32-33, 38. Estimates for 1936 and 1937 are preliminary, and are used with permission of Dr. Fabricant and the National Bureau. Compiled by Moody's Investors Service. "Productive" issues are those adding to capital goods, by raising funds for new construction, additions, improvements, and purchase of new equipment. Estimates by George Terborgh. See Federal Reserve Bulletin, September 1939, and February 1940. 'Estimated. Source: Adapted from Hearings before the Temporary National Economic Committee, Part 9, p. 4041. 22 Hearings before the Temporary National Economic Committee, Part 9, pp. 3693-3694, 4046-4048. Ibid., pp. 3684, 3692. Data have been revised in accordance with the latest estimates of the Department of Commerce (June 1940). The amounts of funds available from internal sources are understated by the preceding calculation for four principal reasons, particularly in periods of depression and falling prices. (1) In many cases business expenditures for machines, implements, dies, small tools, and other plant additions are charged directly to the income account. (2) Every year business enterprises receive insurance settlements for property that has been destroyed by fire, shipwreck, flood, and other damage. The value of these settlements is not available, but a conservative estimate would indicate that business enterprises receive at least $150,000,000 a year for losses covered by insurance. (3) The establishment of contingency and other reserves, when charged to current income, reduces current undistributed profits or business savings. For example, when a reserve is set up in connection with a portfolio of market securities, or with accounts receivable, and these reserves are charged to current income, the profits of the business enterprise are reduced, but the enterprise has as much funds after the bookkeeping reduction of net profit as before. (4) Another source of understatement, particularly in periods of business recession and price decline, is the current accounting treatment of inventory. Inventory writedowns in such periods are substantial, but they present no similar problem in periods of prosperity and increasing prices. When prices remain constant or increase, goods are charged in and out at cost; and inventories at year-end are not revalued, because they are valued at cost or market, whichever is lower. During periods of falling prices, however, the application of the same accounting principle of cost or market, whichever is lower, has quite different results. Inventory charged out at one price may be replaced by inventory purchased at a lower price, but at the end of the fiscal year all of the inventory is revalued. All of the goods purchased at higher prices are revalued down to the prevailing price level. The amount of gross saving is not decreased, however, when inventory is marked down, for example, from $1,000,000 to $800,000 and the difference of $200,000 is charged to profit and loss. Internal financing, not security issues, provides the bulk of "venture capital" for American industry. For only in a financial sense are depreciation and depletion funds used for replacement. The new building is not the same as the old, and the new machine is the best, the most efficient that can be bought. Funds from all sources-from depreciation and depletion, from retained earnings, from new security issues, from sale and conversion of assets are commingled. They become one investment fund. All investment is financed from this one fund. The steel industry in the past decade has been revolutionized with its four-high strip mills, automatic operations, and shift to lighter steel products. General Motors Corporation has "ventured" into refrigerators, Diesel engines, and Allison liquid-cooled airplane motors. E. I. du Pont de Nemours & Co., Inc., stated that in 1937, 40 percent of their sales came from products which they had not begun to make in 1928.24 The Monsanto Chemical Co. reported that products which they began to manufacture after 1929 accounted for 39 percent of total sales in 1939.25 These and countless similar examples are all "ventures"; they were all made possible by investments using "venture capital." But the bulk of the "venture capital" came from internal sources. Annual Report, 1937, pp. 12-13. Annual Report, 1939, p. 4. When businesses invest their own funds it must not be assumed that the actual savers are identical with those who make the investment decisions. In legal theory the savers are the stockholders, though in practice it is the managers who decide how much should be set aside for reserves and expansion. They handle other people's money, though the corporation does not. In theory the stockholders have the right to determine whether investment of the earnings of their property should be made at all, and how much. Actually, in most cases, they play no effective part in the decisions. Private Placement. Where business concerns seek to invest funds other than those they have themselves saved, they have to go to a lender or broker. They then issue bonds or other securities and offer them for sale. If the buyer bypasses the investment banker by direct negotiation and direct sale, the process is known as private placement. During the 5 years 1934-38 the 26 largest legal reserve life insurance companies purchased 1.8 billion dollars of corporate bonds privately from the issuing corporations.26 The total amount of corporate bonds and notes privately placed with all purchasers during this period was 2.1 billion dollars. Their relative importance is indicated in table 54. TABLE 54.-Total corporate bonds and notes issued and amounts placed privately, Source: Hearings before the Temporary National Economic Committee, Part 9, p. 4065, as revised by the later tabulations of the Securities and Exchange Commission. The $2.8 billion of corporate bonds and notes placed privately during 1934-39 have meant a loss in gross profits of at least $60,000,000 to the investment banking industry. Private placement is undoubtedly dependent upon, if not caused by, the concentration of savings in savings institutions. If three or four insurance companies buy sections of a private placement amounting to $10,000,000, $20,000,000, or more, it is their size and concentration of savings which determines their proportionate shares. This concentration and the resulting magnitude of the investment problem as illustrated by the life insurance companies is dealt with in the next chapter. THE ROLE OF THE BANKER One of the major achievements of the Pujo Committee was the documentation, in part, of the controls exercised by investment bankers over railroads, public utilities, insurance companies, and 26 Hearings before the Temporary National Economic Committee, Part 10–A, p. 132. major industries.27 Extensive diagrams portray the spheres of influence of such well-known banking firms as J. P. Morgan, KuhnLoeb, etc.28 But the large volume of savings, the concentration of individual savings in savings institutions, and the relative importance of internal financing, particularly for the larger corporations, have left their impression upon the capital markets. They have changed the scope and the nature of commercial banking, and they have reduced the area of investment banking. The traditional field of the commercial banks has always been regarded as the making of short-term commercial loans. For two decades, however, commercial loans in particular, and short-term loans in general, have steadily been decreasing in importance. In 1921, short-term loans constituted 70 percent of all member bank loans and investments, and commercial loans by themselves constituted 52 percent. In 1929, short-term loans were 63 percent and commercial loans 36 percent of their loans and investments. By 1938, short-term loans were only 34 percent of loans and investments, and commercial loans had fallen to 23 percent of the total.29 The growing self-sufficiency of large business enterprises has made them for the most part independent of bank credit. It has been an important factor in the decline of the commercial and short-term loan. During the 1920's many corporations paid off their bank debts through the issue of bonds and stock, attacking the field of shortterm credit from another angle. As a result the character of commercial banking has changed radically. Two-thirds of all the loans and investments of commercial banks in 1938 represented United States Government, other securities, and real estate loans.30 In consequence, commercial banks now resemble investment trusts buying and selling fixed interest-bearing securities rather than traditional banks investing in commercial paper. Banks have openly recognized their function to provide the Nation's money and to furnish bookkeeping services. They have recognized their status as a service agency, instituting service charges. They have eliminated interest payments on demand deposits, and drastically reduced interest payments on time deposits. The banks have had to uncover new sources of revenue to replace the commercial business loan. They have established personal loan departments to make loans which are largely for consumption purposes; they furnish a large part of the capital for the finance companies, which make similar loans; they have begun to advertise their willingness to make loans on life insurance policies. In large part they finance Government lending activities. The commercial banks hold Government obligations, while ad hoc Government corporations make loans on urban and farm real estate, extend intermediate term loans to business enterprises, make crop and production loans to farmers, finance foreign trade, and engage in other banking activities. Faced with declining outlets for the profitable use of their funds in short-term commitments, commercial banks have been forced to 27 House Committee on Banking and Currency, Money Trust Investigations, pursuant to H. Res. 429, 504, 62d Cong., 2d sess. 28 National Resources Committee, The Structure of the American Economy, Washington, 1939. 29 Hearings before the Temporary National Economic Committee, Part 9, p. 4056. 30 Idem. make long-term investments. Their first attempts in this field bore maturities of 2 or 3 years; soon loans were made for 5 years; and at the present time loans for as long as 10 or 15 years are not unusual. Such loans are competing with and replacing short-term bond and note issues which were formerly handled by the investment banking machinery. Commercial banks recently invaded the prized investment banking field of equipment trust issues by making a 10-year term loan for the purchase of air transports. Most of these loans bear serial maturities. So important have term loans become that "in some weeks gains in commercial loans by banks in New York City have been accounted for almost entirely by increases in term loans." 31 A survey by the Board of Governors of the Federal Reserve System of the 400 reporting banks in 101 cities in April 1939 indicated that approximately 25 percent of their outstanding commercial, industrial, and agricultural loans had a term when made of a year or more. About 70 percent of the loans for a year or more had a term when made of 3 years or more. The size of these loans is evidence that they do not represent accommodation for small business. Fifty-six percent were for $1,000,000 or more, 32 percent for amounts ranging from $100,000 to $1,000,000, while the remaining 12 percent were for amounts smaller than $100,000.82 The role of the investment banker in supplying funds for the expansion of American industry is subordinate to internal financing and direct investment by individuals. Furthermore, investment banking has never financed more than a small segment of American investment. It is not now, nor has it ever been, concerned with the financing of small business enterprises, farms, and small homes. It has played little more than a minor role in the financing of new business enterprises and of large-scale real estate developments. Even in 1929, when the country was most conscious of its investment banking machinery, it is doubtful whether this machinery was directly concerned with as much as a fifth of the country's total investment in plant, machinery, and other capital goods. In recent years even this small share has been diminishing. Corporate financing has tended more and more to by-pass the investment banker. The major reasons for this development appear clearly from certain intensive studies which the Securities and Exchange Commission has made of the sale, redistribution, and mechanics of placement of several high-grade bond issues. These studies, together with a comparable study by an investment banking firm, indicate that, on the average, sales by the investment banking (distributing) group during the first week after public offering were made as follows: 33 Buyer and percent of issue bought Banks Insurance companies Charitable and educational foundations__ Security dealers- Individuals.. Total... New York Times, July 14, 1940. 46.5 38. 1 3.8 5. 1 6.6 100.0 Federal Reserve Bulletin, July 1939, pp. 560-562. 83 Hearings before the Temporary National Economic Committee, Part 24, exhibit 2074, p. 13005. |