The Year's Trend.
After three unsatisfactory months, the year 1938 brought so substantial a recovery of the security markets that even the war scare was able to shake it but briefly. Security prices rose rapidly during the summer, and a large volume of new issues appeared. Money rates and bond yields were low. Part of the stimulus to the market was artificial. The Government changed its policies with regard to gold and to member-bank reserves, the spending program was renewed, and gold poured into the country from abroad. Loanable funds were in abundance. A more conservative attitude in Congress modified the tax laws somewhat, and the Republican victories in the November elections doubtless encouraged business. The New York Stock Exchange itself suffered a shock in the spring when the defalcations of Richard Whitney were discovered. A reorganization of the government of the Exchange followed.
Securities Market.
During the first three months of the year the stock market continued the decline of the previous year. The New York Times stock-market average was 142 at its high point in March 1937 and 86 at the end of December 1937. At the end of March 1938, it was 71. The decline was not similar for different groups of stocks. Thus, industrials dropped 12 per cent during the first quarter; railroads, by 33 per cent utility stocks by 18 per cent. Bond yields declined similarly, corporated issues dropping from 81 in January to 74 in April. Again the amount of the decline was widened by the heavy decline of railroad bonds.
The recession in the prices of industrial stocks was to be expected in view of the low level of business activity and the consequent low level of profits. Railroad and public utility securities suffered from special causes. A third of the railroad mileage was in bankruptcy, and another 10 per cent near it. The situation of the roads was so apparent that the President asked for new legislation in their aid. However, the Interstate Commerce Commission granted only a part of the increase in freight rates asked by the railroads, while Congress failed to pass any legislation. A general railroad strike threatened during most of the year. Thus, not only was the financial condition of the roads bad, but it was being discussed publicly. Prices of public utility securities were affected by the uncertainty of the relation of private companies to the Government. The dismissal of Arthur Morgan from the Tennessee Valley Authority on March 22 and the validating of the Public Utility Holding Company Act by the Supreme Court a week later helped to increase the uncertainty. The discussions of the acquisition of properties of the Commonwealth and Southern Corporation by the Authority served to shake further the confidence of the public in the future of utilities. Throughout the year these causes served to keep the prices of these two groups of securities relatively low compared with the rest of the market.
The revival of general security prices was rapid. The market average moved up to 85 in May and 104 at its high point in August. Then followed the drop accompanying the war scare abroad. In September, a low point of 89 was reached. This reaction was very short-lived: in October, the average reached 109; in November, 110; and at the end of the year was again 109.
During this period of rising prices, the volume of trading was heavy. In the early months of the year, there was an average daily turnover of some 700,000 shares. In June, contrary to the seasonal tendency, it jumped to 1,932,302 shares and in July to 1,701,718 shares. In August and September, there were declines but, in the late fall, trading was nearly as active as during 1937. Accompanying the heavy trading went a large volume of capital issues. The average monthly offerings last year for new capital and refunding had been $323,000,000, while during the first 10 months of 1938 the average was $353,000,000. But the early months had been very low, about $175,000,000. In June, the total was $511,000,000 and in October $763,000,000. September was, of course, a low month. Of these issues, government offerings — Federal, state, and municipal — bulked large, and refunding issues amounted to nearly half. However, in the three months June, July and August, new corporate financing amounted to $456,000,000. This sum compares favorably with the amount of new capital raised by industrial corporations in the period before the depression. The almost complete absence of railroad and public utility financing which once was so important an element makes the totals seem insignificant.
Government Policies.
The buoyancy of the market was induced in part by artificial stimuli. The Federal Government embarked upon a variety of policies tending to make credit easy and funds abundant. In February, it modified its gold sterilization policy and in April abandoned it altogether. This restored to the monetary system $1,400,000,000 in gold and increased the reserves of the Federal Reserve System. It also provided the Government with funds for current expenses and for the next three months made borrowing unnecessary. The withdrawing of Government demand from the market allowed investment funds to flow freely into other channels.
Besides restoring the gold, the Federal Government added to bank reserves by changing the reserve requirements of the Federal Reserve System. The decrease amounted to some 13 per cent, and excess reserves were accordingly increased. Since the banks for the most part had had ample reserve margins before this change occurred, the effects of the policy were not obvious immediately.
Another aspect of the Government policy was the increase in spending. Expenditures for relief, public works and national defense were all increased substantially. As a result, the volume of orders for various types of business was increased, and profits rose to form the basis for higher security prices. Of course, by fall the $1,400,000,000 in gold had been used, and the Government debt began to rise again until, by the end of the year, it amounted to some $30,000,000,000. In the fall, the financing of the debt brought the new issues of Government securities mentioned above.
Abundance of Funds.
Another cause of additional funds coming into the market was the political tension abroad and even the war scare. This tension had very little direct effect in disturbing our markets. The stock market declined for a few weeks in September, and new issues of securities were cut off for a month. On the other hand, gold poured into this country for months in unprecedented amounts. The gold flows began early in the year. In the first two months, they had been negligible: but in March they reached $52,000,000 and remained at that level till August. Much of this came from Japan and from London. In August, the amount jumped to $100,000,000 and in September to $521,000,000. Although this marked the high point for the year, the movement of funds to this country continued throughout the rest of the year. The result was a further increase in the deposit accounts at the member banks. With these new funds, the banks might have increased their volume of loans. Such does not seem to have been the case. Even brokers loans remained at a low level. The banks did increase their holdings of securities. At the end of November, reporting Member Banks had $2,000,000,000 of securities more than at the end of November 1937. Most of this increase was in Government bonds. This increased demand on the part of the banks was a considerable factor in the bond market.
With the excess reserves and the general abundance of funds, money rates were naturally low. Prime bills dropped to per cent and bankers acceptances to 7/16 per cent. Treasury bills, which had averaged .45 per cent in 1937, stood at .02 per cent at the end of November; yet, the volume of loans did not expand.
Modifications of the Tax Laws.
One element in the financial situation was at least in part psychological. The attitude of Congress became much more favorable to business and financial interests. In spite of administration protests, the revenue bill in the spring carried modifications of the tax law. These modifications were not drastic, but they did give tangible evidence of goodwill toward business. The tax modifications were of two kinds: first, the taxes on undistributed profits were reduced. Under the preceding law they had been progressive with the amount of net earnings retained in a corporation rather than paid out to the stockholders. They could amount at a maximum to 27 per cent of net income. Under the new law, the maximum could not exceed 2 per cent and all businesses with net incomes below $25,000 were exempt. Since corporations had felt the old law a hardship, the new law made investment prospects better. The second tax modification conserved capital gains from the sale of securities. Here the old law had provided taxes on a scale adjusted according to the period for which these securities had been held. The new law lowered the rates and lengthened the periods. Again the investor was left freer in his operations.
In addition to modifying the tax law, Congress showed greater independence with regard to reform legislation than it had in many years. This independence did not lead to a cut in any of the appropriation bills. However, there were indications that Congress was beginning to share the doubts of business men with regard to the spending program.
Fraud Cases and More Stringent Laws.
The financial world was shocked by the discovery of two conspicuous cases of fraud during the year. The first was that of Richard Whitney. Long a leader in financial circles and a former president of the New York Stock Exchange, he had had great influence on the affairs of the Exchange. In recent years, while the Exchange had been undergoing a process of reorganization, partly in accordance with the provisions of the Securities and Exchange Commission Act and partly on its own initiative to prevent further public regulation, Richard Whitney had been the leader of the conservatives. He had effectually blocked many reform measures. In March, his firm failed because of the illegal practices of Whitney himself. Although the failure of this firm caused no flurry in security prices, it did shake confidence in the practices of members of the Stock Exchange. An organization which allowed such flagrant abuses to go undiscovered for so long a period obviously needed reform and this was made. The Exchange adopted a new form of government and changed many of its rulings. On June 30, a new president, William M. Martin, Jr., was elected. For the first time, the presidency became a full-time paid position.
The other case of fraud was discovered in December. It concerned the president of the wholesale drug firm of McKesson & Robbins, who called himself, Donald Coster. His defalcations, though large, were not important in the general financial world. The importance of the case lay in the fact that it exhibited dramatically the possibilities for deceit and fraud in business. Coster had had a long criminal career, yet leading bankers financed him. He defrauded his corporation of millions of dollars, yet the certified public accountants did not discover it. Obviously, our security laws are not yet stringent enough to protect the public.
No comments:
Post a Comment