August 10, 1973
The Second District directors and other business leaders who were contacted recently generally expressed doubts regarding the effectiveness of Phase IV in bringing about price and wage stability. Most respondents felt that the dollar-for-dollar cost pass-through provision would, with varying intensity, squeeze profit margins. Several directors reported that so far tightening credit conditions have had little effect on business spending plans of larger firms, but some noted it was having a dampening effect on smaller businesses. A marked tightening of the mortgage market was also indicated.
A note of skepticism marked the directors' initial assessment of the probable impact of Phase IV on the prospects for price and wage stability. Thus, one director characterized this part of the Administration's stabilization efforts as a "triumph of political expediency over economic reality". This view was shared by a number of other directors, who also felt that while the new controls might be partially effective as a "stop gap" measure in achieving price and wage stability, growing shortages—notably of agricultural products—would unavoidably lead to increases in the cost of living and in turn to heightened wage demands. The chairman of the board of one of the largest New York City banks stated that an assessment of the impact of the new measure was difficult, particularly because of the uncertainties surrounding the implications for wages of a prospective rapid rise in food and certain other prices. In this context, he felt that at this juncture the longer term outlook for wages and prices seemed closely linked to the extent of the increase in agricultural output and production and its stabilizing influence on the price level generally. The president of a large metal producing concern observed that the controls were causing severe domestic shortages of certain internationally traded key materials. He felt that the biggest problem associated with Phase IV was the 30-day pre-notification period for price increases applications by large firms, which he deemed much too long, making it "extremely difficult" for businesses to respond effectively to changing demand and/or cost considerations. The president of an upstate bank noted that, in contrast to the widespread support accorded Phases I and II, small businessmen in his area were "not at all pleased" with Phase IV, and that cooperation in the program was not likely to be forthcoming. On the other hand, an upstate manufacturer assumed there would be tolerance of and adherence to the Phase IV program for a reasonable period of time—at least through April 1974—and felt that the mandated controls were tough enough to enable a return to a more reasonable and acceptable rate of inflation.
With respect to the effect of the dollar-for-dollar cost pass-through limitation on profit margins, it was the consensus of the Buffalo branch directors that this proviso would result in some contraction of profit margins in the short run, at least as measured on a percent of sales basis. The reduction, however, was not expected to be significant, barring a substantial fall in demand. The New York banker felt, however, that this rule could create significant problems for certain firms and reported that his bank's research personnel estimated it would reduce after-tax profits by about $2 billion.
None of the respondents reported that the dollar-for-dollar pass-through would have an immediate effect on business spending plans. Views were mixed, however, regarding the impact of tightening credit conditions on such plans. The New York banker reported that he had not seen widespread evidence that capital spending plans were being deferred as a result of high interest rates and tightening credit conditions, although he felt that shortages of equipment and material could have a dampening effect on such outlays. A senior official of a large multinational firm said that not only have tightened credit conditions not had an appreciable effect on capital spending, but that there was evidence of a "spend-now" philosophy in the face of inflationary expectations. A similar view was expressed by the president of the large metal producing firm, while another director reported that executives of large firms with whom he had contacts had suggested to him that capital spending plans were not being materially affected by higher interest rates: cash flows were still sufficiently large to finance capital outlays and thus these firms were not especially sensitive to interest rate considerations. On the other hand, an upstate banker reported that in his area, the high levels of interest rates were starting to have a dampening effect on capital spending decisions. He reported that among smaller businessmen with whom he had contact, borrowing rates in the range of 7 1/2 percent or higher tended to have an immediate adverse effect on their willingness to commit funds. Similarly, most Buffalo branch directors felt tighter credit conditions were bound to have an impact on business spending plans. These directors cited instances where bank customers were postponing borrowing and spending plans, and reported that banks were rationing available funds by extending credit to their own customers first.
There has been a significant tightening in Second District mortgage market conditions according to the opinions expressed by a number of directors and major lenders in that market. Senior officials of thrift institutions reported that as a result of a net outflow of deposits, together with a sizable backlog of unclosed loan commitments, little or no funds were available for new mortgages in the 1- to 4-family home sector. A New Jersey savings bank thus reported it was making loans only to depositors, with a 40 percent down payment, and an official of a large New York savings bank claimed that at this time "there was no home mortgage market" and that his institution was entering into no new commitments for 1- to 4-family homes. Against this background, the respondents felt that the recent increase in the usury ceiling from 7.5 percent to 8 percent in New York and New Jersey (effective August 15 in New York) would have little or no effect at this time on the home mortgage market. Officials at the insurance companies, commercial banks, and mortgage companies who were contacted reported that construction loans and mortgages for commercial properties—apartments, shopping centers, office buildings—were available, but at very high rates. In this context, several respondents reported a drop in recent weeks in the demand for such loans, which they attributed in part to the high rates and in part to overbuilding in this sector.