EFFECTS OF WAR ON THE BUSINESS CREDIT
MARKET, 1940-45

AFTER 1940 THE BUSINESS credit market was dominated by the
enormous war production program. The most obvious effect was a
large expansion in the funds acquired by business to finance a dou-
bled physical volume of production. Among the less obvious conse-
quences were changes in the size and industrial composition of
borrowing businesses, alterations in the terms and conditions of
credit, and a redistribution of the business credit supply as between
governmental and private institutions, and as between commercial
banks and other private lending agencies. There was a striking in-
crease in the over-all profitability and liquidity of businesses,
traceable to the expansion in the money supply that accompanied a
vast increase in federal spending, financed in large part through
bank purchases of government securities.

MAGNITUDE AND NATURE OF WARTIME
ECONOMIC EXPANSION

The financial force behind the upsurge in production after 1939
clearly was the unprecedented money outlays of the federal
government. The amount of these outlays varied sharply in certain
roughly distinguishable phases of the war period. During the first
phase which ran from July 1940, following the fall of France,
through November 1941 the average annual rate of war expendi-
tures by the government was $9.0 billion. In the second phase, from
December 1941 through October 1942, and in the third, which ex-
tended through December 1943, the rate of war expenditures
amounted to $43.5 billion and $80.3 billion, respectively; while
during the fourth period, beginning January 1944 and ending with
the surrender of Japan in August 1945, the rate increased to $89.4
billion.



171



172 BUSINESS FINANCE AND BANKING

The vast disbursements by government for personal services and
commodities are reflected in the index of the physical volume of
industrial production of the Board of Governors of the Federal
Reserve System. This index (adjusted) rose from 114 in March
and April 1940 to a wartime peak of 247 in October-November
1943 an increase of 1 17 percent then receded to 230 in July
1944, stabilized during the remainder of that year, increased again
to 236 in February 1945, and thereafter decreased sharply. Other
measures of productive accomplishment, which do not rely so
heavily as the Federal Reserve index upon man-hours worked, give
much lower estimates of the growth in production. 1 As a measure of
the financial requirements of business enterprises, however, the
money value of production is more significant than the physical
volume. Gross national product the value of currently produced
goods and services flowing to government, to business for gross
capital formation, and to consumers is estimated at $97 billion in
1940, $187 billion in 1943, $198 billion in 1944, and $197 billion in

1945-

For the most part, the huge increase in production after 1940 re-
sulted from drawing upon unemployed manpower and facilities
and from utilizing human and physical resources more intensively.
In a rich nation with large unemployed and partially-employed re-
sources, it proved possible to superimpose most of the immense war
production program upon civilian output. Nevertheless, a growing
fraction of the output of war materials after 1941 owed its origin
to curtailments or stoppages in the production of particular types of
civilian goods, and to transfers of the personnel, materials, and
facilities to war production. During 1942 drastic reductions or
stoppages were ordered in the output of such important consumer
durable goods as housing, automobiles, radios, refrigerators, and
electrical appliances, and by March 1943 nearly two-thirds of all
manufacturing and mining output was for war purposes.

Manufacturers, distributors, and consumers widely anticipated
the mounting intensity of the war production program, and stocked
up with consumer commodities j inventories in the hands of distribu-
tors and consumers continued to expand for some time after the peak
of civilian production had been passed. Department store stocks

1 See, for example, Geoffrey H. Moore, Production of Industrial Materials in
World Wars I and II (National Bureau of Economic Research, Our Economy in War,
Occasional Paper 18, March 1944).



EFFECTS OF WAR ON CREDIT MARKET 173

increased during 1941 and the first half of 1942 to the highest point
in history} 2 but after July 1942 record-breaking sales caused by
continually mounting income payments to consumers brought a
sharp decrease in stocks. This curtailment, like that in the produc-
tion of consumer durable goods, had an important influence upon
demands by business for credit from banks.

An important development of the post- 1941 period was a decline
in the amount of credit used to finance the distribution of consumer
goods. The diminishing quantities of many types of consumer du-
rable goods flowing into consumption, combined with the tightening
of consumer credit under Regulation W of the Federal Reserve
System and the enlarged ability of the public to pay cash for its pur-
chases, reduced outstanding consumer credit from a peak of about
$10 billion at the close of 1941 to $5.4 billion at the end of 1943.
While small increases occurred in the next two years, the figure at
the end of 1945 was only $6.7 billion. Most of the reduction after
1941 was accounted for by instalment credit, and was closely geared
to production stop-orders for automobiles and other consumer
durables. While commercial banks were the direct retailers of only
a minor part of these loans, they "wholesaled" much of the balance
through their loans to consumer financing agencies} thus the com-
mercial loans of banks bore the brunt of this extraordinary with-
drawal of consumer credit. 8

The war brought about a 15 percent reduction in the business
population. Between late 1941 and the end of 1943 some i.i mil-
lion business enterprises 30 percent of all those in operation at
the close of 1941 closed their doors, while only about 572 thou-
sand concerns were organized, leaving a net decline of more than
500 thousand in the number of operating businesses. Beginning in
1944, however, increases were again reported, and by June 1945
about one-half of the 1941-43 loss had been regained.

The majority of businesses discontinuing in 1942 and 1943
were small concerns whose owner-managers entered the armed
forces, transferred to more lucrative employment in war plants, or
closed because of inability to obtain necessary labor and materials
for operations. As is shown in Table 14, two-thirds of the decrease
in the business population during this period was accounted for by
the retailing and service industries} but the relative contraction in
wholesaling and in contract construction was larger than in either
retail trade or the service lines. The disappearance of half a million
enterprises undoubtedly had some influence on the demand for
credit, by altering the size-distribution of the business population.

BUSINESS DEMAND FOR FUNDS: THE WARTIME
GROWTH OF ASSETS

The doubling of the gross national product between 1940 and 1944
was accompanied by a substantial increase in business assets, and by
a large concurrent increase in demand by businesses for funds to
acquire both fixed and current assets.

Until the early part of 1 942 private investment in new plant and
equipment was heavier than government investment} subsequently,
however, the largest expenditures on fixed assets were made by the
federal government. Such a high degree of uncertainty surrounded
the future value of most of the wartime plant that the Defense
Plant Corporation, War Department, Navy Department, Mari-
time Commission, and Reconstruction Finance Corporation built,
equipped, and operated vast arsenals} they also built, equipped, and
leased to business enterprises even larger amounts of fixed facili-
ties.

The cost of industrial facilities expansion initiated in the period
July i94O-June 1944 amounted to $33 billion. As indicated in
Table 1 5, the greater part of this investment was in manufacturing
industries, whereas investment in transportation (apart from the
huge merchant marine and air transport fleets), other public utili-
ties, and mining industries was only minor. Comprehensive data
covering the war period for trade and service industries are not
available, but it is likely that shortages of manpower and priorities
on materials reduced outlays very much below normal levels.

In view of the fact that the net book value of the fixed assets of
all nonfinancial corporations at the end of 1939 was approximately
$85 billion, it is apparent that the $33 billion of public and private
investment in war industrial facilities produced much less than a 50
percent increase in the magnitude of the nation's fixed plant. Such a
rough estimate indicates that the doubling of gross national prod-
uct between 1940 and 1944 was in large part achieved by a more
intensive use of plant.

Estimates of the Securities and Exchange Commission and the
Department of Commerce reveal that investment in plant and
equipment by private concerns, excluding agriculture, was greater
in 1945 than in any year since 1942 but less than two-thirds of that

in the peak year 1941, ad-
justment having been made
for differences in the price
level. As war controls were
lifted and materials became
available, expenditures in-
creased steadily, with those
in the final quarter of the
year substantially above
those in the first.

From the end of 1939 to the end of 1944 the current assets of all corporations, ex- cluding banks and insurance companies, on an unconsoli- dated basis are estimated to have risen by $44.2 billion, and a further rise of $0.5
billion took place in the first half of 1945. An expansion in holdings of United States government securities ac- counted for $20.0 billion of the increase after 1939, and cash for $12.9 billion . While cash plus government securities more than tripled in amount, in- ventories increased by only 43percent, or $7.7 billion.
Between the end of 1939 and June 1945 cash holdings more than doubled, holdings of gov- ernment securities increased ten- fold, and inventories rose by 43 percent.
This reflected both the accumulation by the federal government of
stockpiles of strategic materials and other inventories, which were
turned over to business concerns for fabrication, and the great re-
duction in inventories of consumer goods to which reference has al-
ready been made. While inventories of consumer goods accounted
for a major part of the increase in the current assets of business up
to the end of 1941, these stocks melted away rapidly thereafter.

Manufacturing concerns experienced a larger dollar expansion of
current assets between 1939 and mid- 1945 than did those in any
other industrial division, according to a tabulation of corporations
registered with the Securities and Exchange Commission (Table
1 6). While the dollar amount of the rise for railroads was dwarfed
by that in manufacturing industries, railroads had the largest per-
centage increase 242 percent of all groups. This performance
of the railroad companies reflects the relatively low prewar base of
their current assets, their high wartime earnings, the comparatively
less heavy wartime taxation of their profits, and large accumulations
of deferred maintenance.

An outstanding feature of the four-year period, 1941-44, was
the great expansion, in all fields except retail trade, in both fixed and
current assets of small and medium-sized businesses, compared with
large concerns; the increase was especially marked among those
enterprises engaged in war industries. 4 This behavior is traceable
to the fact that the percentage gains in sales volume, profit margins,
and net profits after federal income taxes were significantly greater
among small concerns j but it should be recalled that small busi-
nesses in general entered the war period with lower profit margins
than did large concerns. It may be inferred that the high mortality
rate among small businesses after 1941 was confined to very small

4 Securities and Exchange Commission data covering corporations whose securities
are registered with the Commission provide an adequate view of wartime changes in
the financial structure of large businesses. Wartime changes in the financial structure
of small and medium-sized concerns are revealed by an analysis, made by the Board
of Governors of the Federal Reserve System, of a sample of enterprises of all sizes
whose financial statements were assembled under a cooperative arrangement between the
Robert Morris Associates and the Board of Governors, beginning with the year 1941.
See Frederick C. Dirks, "Wartime Earnings of Small Business" and "Wartime Financ-
ing of Manufacturing and Trade Concerns, 5 * Federal Reserve Bulletin, January 1945,
pp. 16-26, and April 1945, pp. 313-30, for this analysis which covers the three
years 1941, 1942) and 1943- Additional data, covering 1944, also compiled jointly
by the Robert Morris Associates and the Board of Governors, have been analyzed by the
present authors j data for 1945 are not available.

SUPPLY OF FUNDS TO BUSINESS: WARTIME

GROWTH OF NET WORTH AND

INDEBTEDNESS

Business corporations financed the large wartime increase in total
assets both by expanding their short-term liabilities particularly
tax accruals and other items due to the federal government and
by retaining an unusually large part of their substantial profits. Be-
cause the net fixed assets owned by business appear to have declined
after 1941, some part of the large increase in current assets repre-
sented investment withdrawn from property account. When gov-
ernment-owned plant leased to private concerns is taken into
account, there was, of course, a large rise in the amount of fixed
assets operated by business.

Although the wartime increase in net working capital exceeded
the increase in net worth, as a result of the excess of depreciation and
depletion accruals over private expenditures on fixed property, the
war period nevertheless witnessed rapid growth in the net worth of
business. Between 1939 a year of depressed business and
1942 the net profits of all corporations more than doubled, even
after deduction of heavy income and excess profits taxes, and there-
after tended to stabilize. Business managements, probably antici-
pating a postwar period of uncertainty or reduced profits, followed
ultra-conservative dividend policies, disbursing only a minor frac-
tion of the wartime increase in net earnings in the form of cash or
property. 5

The distribution of wartime gains in sales and net profits was
quite unequal. The greatest percentage gains in business volume and
profits were enjoyed by small and medium-sized concerns, whose
relative profitability rose more than did that of large enterprises or
very small businesses. While net profits as a percentage of net worth
for small and medium-sized manufacturing concerns were lower
than for large manufacturing businesses in 1 940, they were defi-
nitely higher in 1943.*

The increase in the net working capital of business corporations
between December 1939 and June 1945 was relatively larger than
the increase in either cur-
rent assets or current liabili-
ties, since current assets rose
more rapidly than current
liabilities. As indicated
above, this increase in net
working capital was not, of
course, matched by an in-
crease in net worth because
of the growth of deferred
maintenance and the decline
in property accounts. Net
working capital rose by 95
percent, current assets by 82
percent, and current liabili-
ties by 71 percent, and a
slight increase occurred in
the ratio of current assets to
current liabilities. By far the
largest share of the increase
in current liabilities con-
sisted of short-term funds
owed the federal govern-
ment in the form of accrued
taxes and advances and pre-
payments on war produc-
tion contracts. In addition, a
substantial share of the $2.7
billion increase in notes and
accounts payable may be The net debtor-creditor relationship of corporations, excluding
banks and insurance companies, to the federal government changed
in favor of corporations. While the indebtedness of corporations to
government rose by $16.7 billion between December 1939 and
June 1945 on account of accrued taxes and advances and prepay-
ments by the government on war contracts (Chart 32), the indebt-
edness of the government to corporations rose $24.1 billion on
account of securities and receivables due to corporations.




1940 1941 1942 1943 1944 1945



Between the end of 1939 and
mid- 1 945 federal income tax ac-
cruals increased about thirteen
times, while other types of cur-
rent indebtedness remained com-
paratively stable.



182 BUSINESS FINANCE AND BANKING

Certain significant differences in wartime changes in liabilities of
small and of large manufacturing and trade concerns may be ob-
served. 7 Because of the greater percentage increases in net profits of
small concerns, referred to earlier, the increase between 1940 and
1943 in the net worth of small businesses ranged from 25 to 50 per-
cent, with the increases becoming progressively smaller among
medium-sized and large companies. This tendency persisted in
1 944. Net working capital also grew more among small than among
large concerns. Nevertheless, the rise in accrued federal tax liabili-
ties was more rapid among small concerns, and only about one-half
of this increase was covered by holdings of federal securities, as
against an almost complete coverage by the aggregate holdings of
large concerns.

FLUCTUATIONS OF BANK LOANS
TO BUSINESS, 1940-45

The behavior of bank loans to business in the war period was out-
wardly paradoxical. In 1940 and 1941 outstanding business loans
measured by commercial and industrial loans rose steadily, ex-
panding by 45 percent or approximately the same percentage as
that for the physical volume of production, when measured by the
Federal Reserve index (Chart 33). Then, in the face of strongly
increasing production, business loans declined sharply during 1 942
and up to mid- 1943. This decline was due entirely to a phenomenal
decrease, amounting to about $4.3 billion, in bank credit for civil-
ian business, only partially offset by an increase of $2.0 billion in
bank loans to finance production of war goods, which rose from
$1.3 billion at the end of 1941 to around $3.3 billion at mid-1943-
After mid- 1 943 commercial and industrial loans of banks again
expanded} between June 1943 and June 1945 the increase in loans
to civilian business was about $.9 billion. 8 The principal reason for
the expansion was the use of V and VT loans by businesses, whose
managements became more aware of the problems of "thawing out"
large amounts of working capital tied up in inventories and receiv-
ables connected with government work, and of the need for ample
liquid funds during the reconversion period.

The reduction in the rela-
tive importance of bank
loans as a source of short-
term funds for business is
revealed by a tabulation of
the current liabilities of the
sample of corporations dis-
cussed above. 9 Between the
end of 1939 and the end of
1941, these companies' notes
payable to banks expanded
at practically the same rate
as their total current liabili-
ties so that at the close of
1941, as in 1939, notes
payable formed about 15
percent of their short-term
debt. But by the end of 1943
this percentage had dropped
to 5.7 and by mid- 1945 it
was 6.7, reflecting princi-
pally the increased reliance
upon short-term federal
funds, primarily in the form
of tax accruals, but also the
reduction in inventories of
consumer goods and the
liquidation of outstanding
consumer credit. By the
middle of 1942 the rate of
inflow of government pay-
ments for war goods deliv-
ered or in process of produc-
tion had become so large
that it more than offset the
rate of outflow of cash to fi-
nance the expansion in pro-
duction.
WARTIME CHANGES IN THE USE OF BANK
FUNDS BY BUSINESS

Among the major industrial divisions of the economy, large manu-
facturing concerns, particularly producers of war goods, experi-
enced a sharp increase in the use of bank funds during the war
years, just as they experienced a spectacular expansion in assets
and in value of output. Trade and financial corporations in contrast
(judging from tabulations of notes payable to banks by corpora-
tions registered with the Securities and Exchange Commission) in-
creased their bank borrowings substantially in 1940 and 1941, and
then paid down this indebtedness during the next three and a half
years j in fact, by mid- 1945 financial corporations had liquidated
the greater part of their indebtedness to banks (Table 17). Railroad
and public utility companies reduced their bank borrowings during
the entire war period. In view of the fact that banks' outstanding
commercial and industrial loans rose by 1 8 percent between the end
of 1939 and mid- 1 945, it appears that there was a shift of bank
credit out of every major industrial division of the economy into
manufacturing and, to a lesser extent, into trade concerns.

Small and medium-sized businesses engaged in nonwar activities
showed little change between 1941 and 1944 (the period for which
data are available) in the amount of outstanding bank loans ; for
concerns in this size group engaged in war manufacturing, the per-
centage increase was considerably greater than that for large con-
cerns. 10 However, the use of accrued tax liabilities in financing the
current operations of small manufacturing concerns increased even
more markedly than did bank loans. Apparently the relative ex-
pansion in the assets of small manufacturing concerns during the
war was so large that it could not be met merely by a rapid growth in
net worth.

Changes in the geographical distribution of demand for bank
credit reflected changes in the location of productive activity; out-
standing bank loan balances increased most in those regions where
war industries grew most rapidly. As indicated in Table 18, the
percentage increases between the end of 1939 and June 1945 in the
commercial and industrial loans of Federal Reserve member banks
in the Seventh Federal Reserve District which includes two of

10 F. C, Dirks, of. cit. y Federal Reserve Bulletin^ April 1945, p. 321, and the pres-
ent authors' analysis of the Robert Morris Associates Federal Reserve sample for
1944.



186 BUSINESS FINANCE AND BANKING

the nation's largest war producing cities, Detroit and Chicago
and in the Twelfth Federal Reserve District which contained
the great shipbuilding and aircraft plants around Los Angeles, San
Francisco, and Seattle were considerably greater than the in-
crease for the nation as a whole. WARTIME SHIFTS IN BUSINESS CREDIT RISKS

Wartime changes in the kinds of credit demanded by business were
such as to reduce the extent to which these demands could be met
by private lending institutions under traditional arrangements.
An increase occurred in the average amount of credit risk. A large
part of the new plant facilities was so specialized to the production
of war materials that its value as collateral security for bank loans
was very doubtful. Estimates indicate that only about one-third



EFFECTS OF WAR ON CREDIT MARKET 187

of the government investment in war industrial facilities was suffi-
ciently convertible to lend itself to rapid postwar disposal} 11 and
even this convertible one-third of the plant was erected at such
levels of cost that the investment might not be fully recovered by
the government.

War production contracts also presented numerous risk-elevat-
ing forces. The managements of many enterprises had no demon-
strated experience or skill in producing the products which they con-
tracted to make for the government. Especially in the early stage
of the war production program there was grave risk that the
products would not pass government inspection and create good
accounts receivable which would form the means of repaying bank
loans, and uncertainty existed regarding federal standards of in-
spection and the promptness with which the contractor would re-
ceive payment for accepted products. Many concerns, especially
medium-sized and small manufacturers, demanded credit in
amounts far beyond their usual needs and well beyond those per-
mitted under standards that banks had been accustomed to apply.
The credit utilized by these manufacturers was often startling in
relation to their net worth. Many war plants operated with bor-
rowed funds several times the amount of their net worth, or with
current assets no larger or even less than their current liabilities.
Public interest in the expansion of war production caused tradi-
tional standards of creditworthiness to be thrust aside. Financial
considerations were not allowed to stand in the way of enlarged
production. Operating within a prescribed framework of law and
public regulation designed to prevent the assumption of large risks
and to protect depositors against loss, commercial banks could not
meet a very large part of the greater demand for credit. New insti-
tutions, new techniques, and new powers were therefore devised.

CREDIT FACILITATING ARRANGEMENTS
INTRODUCED DURING 1940-41

During the period immediately preceding the entry of the United
States into the war, the larger corporations first drawn into war pro-
duction financed their military orders with working capital on hand

11 A. D. H. Kaplan, The Liquidation of War Production (Committee for Economic
Development, New York, 1944) P- 99-



188 BUSINESS FINANCE AND BANKING

or by recourse to customary institutional sources. One of the earliest
devices for facilitating the flow of credit to businesses engaged in
war production was the Assignment of Claims Act of 1940. This
Act permitted all claims against the federal government for $ 1,000
or more to be assigned to "a bank, trust company, or other financing
institutions, including any Federal lending agency," 12 thus making
the claims available as collateral security for loans. Claims could
be assigned under contracts either for supplies or for plant facili-
ties.

Another early device was the Emergency Plant Facilities Con-
tract, which provided that a contractor could erect a plant, certified
as being necessary for the nation's defense, and could be reimbursed
for the entire cost by the federal government in sixty equal monthly
instalments following completion of the facilities. At the termina-
tion of this period, title passed to the government, unless the con-
tractor desired to retain the plant, in which event the contractor
might purchase the plant at cost less the depreciation specified in the
contract or at a negotiated price. The contract thus left to the con-
tractor the normal risks of production, but it required the govern-
ment to carry the risk of plant depreciation. By assigning the pay-
ments due from the government under such contracts, contractors
could secure funds from private financial institutions to finance
plant construction.

A third facilitating method was a ruling of the Treasury Depart-
ment that when a business expanded a plant, certified as necessary
for national defense, it could amortize the total cost over a period
of sixty months, deducting this amortization from its income for tax
purposes. 13 Such amortization could be allowed whether the plant
expansion was privately financed or financed under an Emergency
Plant Facilities Contract. This ruling stimulated investment in
those fixed assets which business concerns definitely intended to re-
tain after the war.

Legislation passed during 1941 permitted the War or Navy
Departments to advance from available appropriations sums not ex-
ceeding 50 percent of the contract price of supplies or facilities;
two-fifths of the advances might go to subcontractors participating

12 Public Law No. 811, 7 6th Congress, approved October 9, 1940.

18 Treasury Decision 5016 relating to Revenue Act of 1940, Sees. 23, 24, approved
October 23, 1940. If the war ended or the facilities became no longer necessary within
less than sixty months after construction was completed, amortization of cost could
be recomputed on the basis of this shorter period.



EFFECTS OF WAR ON CREDIT MARKET 189

in the completion of a government contract. The advances could be
authorized by Army or Navy officials, as could the so-called "prog-
ress payments" on government contracts.

The credit-granting powers of the Reconstruction Finance Cor-
poration were broadened in 1940. On June 25 of that year the Cor-
poration was empowered "to make loans to, or, when requested by
the Federal Loan Administrator with the approval of the Presi-
dent, purchase the capital stock of, any business corporation (a) for
the purpose of producing, acquiring, and carrying strategic and criti-
cal materials, as defined by the President, and (b) for plant con-
struction, expansion and equipment, and working capital to be used
by the Corporation in the manufacture of equipment and supplies
necessary to the national defense, on such terms and conditions and
with such maturities as the Corporation may determine." 14

This Act greatly expanded the powers of the RFC to lend to
businesses engaged in war production. There were no require-
ments in the 1940 law, such as were contained in the original 1934
legislation conferring business lending powers on the RFC, that
borrowers be "solvent," that loans be of such sound value or so se-
cured as "to assure repayment," that credit be "unavailable" at pre-
vailing rates for the class of loan applied for, or that the borrowing
businesses be "established" concerns. The existence of a national
emergency was deemed sufficient cause for relaxing credit standards
applicable to concerns whose production was considered vital to
national welfare. Under these powers the RFC had authorized to
business enterprises loans of $1.2 billion up to June 30, 1945,
and it then had $0.3 billion of such loans outstanding. These loans
represented credits extended, for the most part at the request of the
Army or Navy Department, to concerns producing urgently-needed
military supplies or services. In the beginning, many of the bor-
rowers were subcontractors who, unlike direct contractors, were un-
able to obtain an advance from the government to provide sorely-
needed working capital. The principal risks assumed by the RFC in
granting credit to these concerns were that their costs may have been
inadequately estimated and that the concerns might not be able to
perform satisfactorily under a contract,

The Export-Import Bank of Washington expanded its functions
in ways which had important implications for American commercial
banks and the business credit market. Up to 1940 the two major

14 Public Law No. 664, y6th Congress.



190 BUSINESS FINANCE AND BANKING

activities of this Bank were short-term financing of exports of agri-
cultural commodities and long-term financing of exports of indus-
trial products. In September 1940 Congress raised the amount of
obligations the Bank could have outstanding at any time, removed
the limitation upon the amount of credit extended to any one coun-
try, and extended the powers of the Bank. 15 Under this new author-
ity the Bank established large credits in favor of central banks in
Latin America to enable those countries to import essential prod-
ucts from the United States ; it loaned money to their govern-
ments for the improvement of highway and railway transportation
and to private interests for the production of strategic war mate-
rials. Apart from these activities, which were inaugurated as part
of the grand strategy of global warfare, the Export-Import Bank
also undertook to support the financial structure of foreign com-
merce during the emergency. For keeping open normal methods of
financing American exports to Latin America when shipping space
was short and delivery dates uncertain, it inaugurated a plan for
underwriting letters of credit of approved foreign banks, which
letters were opened in this country by American banks.

Outstanding obligations of the Export-Import Bank rose sharply
from the end of 1939 through 1943, but tended to stabilize during
1944. At the end of June 1945 the Bank had outstanding loans of
$0.2 billion and active commitments of $0.3 billion. It had pend-
ing many requests for credit to finance the exportation of railway,
electric utility, mining, and other equipment to Latin American and
other countries, as well as reconstruction in devastated areas. In
order to enable the Bank to engage more extensively in the financ-
ing of postwar foreign trade, the amount of loans and guarantees
it could have outstanding at any one time was raised to $3.5 billion
by the Export-Import Bank Act of 1945, approved July 31, 1945. 16

CREDIT FACILITATING ARRANGEMENTS
INTRODUCED DURING 1942-45

One of the most important measures introduced to facilitate the
flow of funds to enterprises participating in war production was what
became known as the V loan arrangement. 17 The War Department,

15 See Chapter 4, pp. 125-26. 16 Public Law No. 173, 79th Congress.

17 See Executive Order 9112 issued March 26, 1942 and Regulation V of the Board



EFFECTS OF WAR ON CREDIT MARKET 191

Navy Department, and Maritime Commission, under an Executive
Order of the President, were authorized to enter into contracts with
financial institutions under which loans to contractors for financing
war production could be guaranteed in whole or in part. The Fed-
eral Reserve banks acted as liaison agencies between the federal
agencies, the war contractors, and the banks. Wherever possible the
Federal Reserve banks attempted to arrange a credit extension
without guarantee. If this was not feasible, they arranged a guaran-
tee of a part of the loan by the federal agency concerned. As a last
resort, the federal agency might extend the funds directly, either
making the entire loan itself or taking a participation therein. Regu-
lation V, promulgated by the Board of Governors of the Federal
Reserve System, provided that rates of interest were to be specified
by the Board from time to time after consultation with the federal
departments and the reserve banks, and that the maturity of the
loans made or guaranteed under this plan should not exceed five
years.

The V loan was developed to assist war contractors who needed to
borrow more money than could be granted them under conservative
financial standards, and to aid in the problem of financing subcon-
tractors. However, government-guaranteed war loans offered an
advantage over straight bank credit even to companies of the high-
est credit standing to which adequate credit was available without
guarantee. Concerns financing with V loans might, in the event of
cancellation of one-quarter or more of their outstanding war con-
tracts, obtain a suspension of maturity for a proportionate amount
of the loan, and a waiver of interest thereon until settlement of
their claims on the government. Because of this provision, V loans
were extended in many cases where credit was otherwise procurable.
In practice, the great bulk of V loan credit went to large enterprises
and not to small contractors.

The VT loan arrangement, announced on September i, 1943,
was a direct outgrowth of the V loan. It provided for guaranteed
loans by private institutions to war contractors, not merely to supply
working capital needs for war production but also to enable contrac-
tors to obtain the use of their working capital upon termination of
government contracts. 18

of Governors of the Federal Reserve System issued thereto, effective April 6, 1942,
and revised, effective September n, 1944.

18 Federal Reserve Bulletin, September 1943, p. 849.



192 BUSINESS FINANCE AND BANKING

A further expansion of the purposes of bank credit for which
government guarantees could be issued was contained in the Con-
tract Settlement Act of I944- 19 Section 8(b) of this Act provided
for interim financing of war contractors through T loans, pending
payment by the government on their clahns, in amounts specified as
follows:

(i) 100 percent of the contract price of acceptable items com-
pleted prior to termination date of contract;

( 2 ) 90 percent of cost of raw material, purchased parts, supplies,
direct labor, and manufacturing overhead allocable to the termi-
nated portion of the contract;

(3) a reasonable percentage of other allowable costs, including
administrative overhead allocable to the terminated portion of the
contract, not included in the foregoing;

(4) such additional amounts, if any, as the contracting agency
deems necessary to provide the war contractor with interim financ-
ing.

This legislation was susceptible to a variety of interpretations,
but it clearly permitted government contracting agencies to ad-
vance or prepay to business concerns, whose war contracts were ter-
minated, not merely the bulk of their claims on account of such con-
tracts but also additional working capital for financing reconversion
or for other purposes. While the maturity date for such advances
was no later than the date of final settlement between the contractor
and the government, the period for which such credit could be used
might well be long. Alternatively, government contracting agen-
cies might guarantee loans made by banks and other private lending
institutions to provide such "interim financing." Both the procure-
ment services and the banks (under a government guarantee) were
placed by this Act in a position to finance the re-entry of war contrac-
tors into civilian business.

After September 1944, only T loans and 1944 V loans were au-
thorized. The 1944 V loans, which were similar to the VT loans
previously made, were to provide working capital for war produc-
tion purposes or to provide funds for both production and contract
termination financing. 20

By December 31, 1945, some 8,757 Regulation V loans had

"Public Law No. 395, y8th Congress, approved July i, 1944.
20 Federal Reserve Bulletin, March 1946, p. 244.



EFFECTS OF WAR ON CREDIT MARKET 193

been authorized for a total amount of $10.3 billion. There was
actually outstanding $0.5 billion of credit with $1.0 billion addi-
tional available to borrowers under the agreements. On the aver-
age 85 percent of each loan outstanding was guaranteed. Although
a large percentage of the number of guaranteed war loans author-
ized was in amounts of $50,000 or less, and the amount of such
credit available to small concerns appears to have borne roughly
the same proportion to their sales that held for larger businesses,
the greatest fraction of the amount of guaranteed war loans au-
thorized was represented by loans above $ I million.

The powers of the RFC to supply credit to business were further
broadened after December 1941. The Murray-Patman Act pro-
vided that the RFC and its subsidiary, the Defense Supplies Corpo-
ration, should assist dealers, finance companies, and banks in the
carrying and marketing of motor vehicles shipped on and after
January 16, 1942, when their sale was prohibited by the Office of
Price Administration except under rationing orders. On May II,
1 942 legislation was approved authorizing the RFC to buy from, or
make loans to, dealers in rationed commodities, on a basis enabling
dealers to secure amounts equal to the costs of the commodities. 21
The RFC approved about 2,903 loans aggregating $68 million
on automobiles, oil burners, tires, typewriters, and other rationed
articles up to June 30, 1945.

In the interest of small manufacturers who were believed to have
been overlooked in the early stages of war procurement, the
Smaller War Plants Corporation was established by Act of Con-
gress on June 1 1, 1942." One method of aiding small business was
to make loans and to lease equipment so that these manufacturers
might engage in war production or essential civilian output. Al-
though aggregate outstanding loans were limited in the original
Act to $150 million, the credit-granting powers of SWPC were
comprehensive and included loans to acquire land, buildings, and
equipment, to finance conversion to war production, to conduct war
production, to reconvert to civilian production, and to carry on civil-
ian production. On December i, 1944, the capital funds were in-
creased by $200 million.

21 See Report of the Secretary of Commerce Covering the Activities of the Recon-
struction Finance Corporation and, Its Subsidiaries in Connection October 31, 2942, pp. 32-33.

22 Public Law No. 603, 78th Congress.



194 BUSINESS FINANCE AND BANKING

SWPC made direct loans, participated in loans with other financ-
ing agencies, either public or private, and made commitments to
purchase part or all of the loans of other agencies. In all cases, be-
fore authorizing a loan it urged local banks to extend credit to an
applicant, either alone or with SWPC participation or stand-by
agreement. Loan applications were judged by SWPC mainly in the
light of the urgency of the national need for the goods to be pro-
duced and the ability of the applicant to produce them; the appli-
cant's financial statement was of secondary importance. 28 Terms to
maturity of loans to provide production facilities were geared to the
prospective ability of the borrower to make repayment, while the
maturity of production loans depended upon the dates of comple-
tion of the borrowers' contracts. When a bank participated by as-
suming a share of the risk, the interest rate on the bank's portion of
the loan was generally 6 percent, while that of the Corporation was
4 percent. The RFC, through the Defense Plant Corporation, acted
for SWPC in disbursing and administering the loans.

The number and amount of applications for financial assistance
rose slowly through 1942 and 1943, but the tempo of activity in-
creased measurably during 1944. Between September I, 1942 and
July 31, 1945 the Corporation approved a total of $431 million of
loans, of which $197 million were approved in 1944. More than
half of the approved applications came from concerns making iron
and steel and their products and transportation equipment. About
83 percent of approved loans provided working capital to the bor-
rower; 12 percent were for debt retirement, supplies, land, build-
ings, and miscellaneous purposes; and about 5 percent were for
plant equipment and machinery. The amount of credit actually
advanced by SWPC to businesses was much smaller than the ap-
proved total; it amounted to $33 million on September 30, 1945.

Another federal wartime legislative act broadening the scope of
government lending and loan-guaranteeing activities was the Serv-
icemen's Readjustment Act of 1944, as amended the "GI Bill
of Rights." 24 This Act, approved July i, 1944 and amended De-
cember 28, 1945, made available government-guaranteed loans to
discharged veterans of the armed forces who had had at least ninety

28 Public Law No. 42, 79th Congress, ist Session.

24 Public Law No. 346, 7 8th Congress. Amended by Public Law No. 268, 79th Con-
gress.



EFFECTS OF WAR ON CREDIT MARKET 195

days of service. Within ten years after the official termination of
the war, a veteran may receive from the Administrator of Veterans'
Affairs a guarantee of a loan not to exceed 50 percent of the loan,
or $4,000, whichever is smaller to purchase or construct a home,
farm or other real estate; or a guarantee of a loan not to exceed
50 percent of the loan or $2,000, whichever is smaller to pur-
chase machinery, equipment, and inventories, and to provide work-
ing capital; or a prorated portion of either of these amounts for
loans of both types or a combination thereof. The loans must carry
a rate of interest not over 4 percent. Farm real estate loans must
mature in not more than 40 years, home real estate loans in not more
than 25 years, and non-real estate loans in not more than 10 years.
Lenders may be persons, associations, corporations, or govern-
mental agencies, which presumably include every agency of busi-
ness credit supply. The loan guarantees under the "GI Bill of
Rights" may supplement insurance or guarantees of loans which
other governmental bodies such as the SWPC or RFC are
authorized to provide.

WARTIME SHIFTS IN THE RELATIONS BETWEEN
BUSINESS CREDIT INSTITUTIONS

The part played by government during the war years as industrial
owner and producer was given more attention than its enlarged
role as supplier and guarantor of credit to private enterprise. At
the end of 1939 the outstanding business loans of the RFC and
Federal Reserve banks amounted to less than $0.6 billion, whereas
the outstanding loans to business (short-term plus long-term) of
commercial banks, commercial finance companies, and insurance
companies amounted to almost $18 billion (Table 19). Five years
later, public agencies, including the war procurement departments,
had loans outstanding of about $2.5 billion, while the business loans
of the private institutions had advanced only to $20 billion.

The importance of public agencies in the business credit market
is incompletely measured by outstanding loans. At mid- 1945 no less
than $3.7 billion of credit was available to borrowers under out-
standing V loan agreements, in addition to the $1.4 billion of
guaranteed credit actually in use by business. And at the same time
the RFC had outstanding authorizations for loans and agreements to purchase participations in loans amounting to $0.3 billion. If it
were possible to divide the total risks of business credit between
those carried by public and by private institutions, the portion car-
ried by public agencies would be considerably larger than is sug-
gested Changes in the relationships among federal business credit insti-
tutions after 1939 were marked. By the end of 1944 the RFC and
the SWPC had emerged as the important wartime lenders to "mar-
ginal" businesses. The role of the Federal Reserve banks as direct
lenders in the wartime financing of business was insignificant, but
their services as intermediaries in arranging V, VT, and T loans
were considerable, 28 Conceivably, the Federal Reserve banks could
have developed into significant direct sources of working capital for
concerns in war work} but other methods of current financing,
especially V loans, advance and progress payments by federal pro-
curement agencies, and the RFC and SWPC loans satisfied the
demand.

So far as the legal authority to lend money to business was con-
cerned, there was duplication between the RFC defense loan pow-
ers and those of the SWPC. The SWPC received a mandate from
Congress to assist small business, but early in 1942 the RFC also
began to use its loan powers more intensively to spread war work
among smaller producers. On February 19 of that year the dis-
trict officers of the RFC were authorized to approve loans up to
$100,000 (up to $250,000 if there was participation by a bank) on
their own responsibility without reference to Washington. 26 In
operation, the SWPC and the RFC nevertheless differentiated their
functions in the following ways:

First, the SWPC loan program served businesses smaller than
those served by V loans or RFC defense loans. The average amount
of all loans authorized by SWPC up to early 1944 was $74,000,

25 During the five years ending December 31, 1944, the outstanding loans of Federal
Reserve banks decreased by $9.8 million. During the whole period only 700 applica-
tions were approved for loans totaling $337 million. See Federal Reserve Bulletin,
May 1945, p. 443.

2e Report of the Secretary of Commerce Covering the Activities of the Reconstruc-
tion Finance Corporation and Its Subsidiaries in Connection with the War y as of
October 57, /p^a, pp. 31-32. Up to October 31, 1942 some 2,908 of these smaller
loans amounting to $75 million had been approved by loan agency managers, includ-
ing 2,534 loans for the manufacture of products essential to the war effort.



19S BUSINESS FINANCE AND BANKING

compared with $1,265,000 for V loans and $340,000 for RFC
defense loans. 21

Second, as a group SWPC loans carried larger risks than V loans
or RFC defense loans. This resulted from the determined effort of
the SWPC to aid smaller enterprises, and from its announced policy
not to advance funds to applicants unless they had been unsuccess-
ful in obtaining them from other sources.

Third, a larger fraction of SWPC loans was used to provide
working capital, and smaller fractions to acquire fixed assets or to
retire debt, than was true of the other types of loans.

Within the realm of private finance, the war years witnessed a
decline of the commercial finance company and a rise of the life in-
surance company relative to the commercial bank. The larger life
insurance companies steadily increased their holdings of the mar-
ketable long-term bonds and notes of business, and they expanded
further their term loans and private purchases of debt securities.
At the end of 1944 life insurance companies occupied a more promi-
nent position than ever in the business credit market.

The importance of commercial finance companies as sources of
credit diminished sharply after 1941. In 1940 and 1941 their
outstanding loans rose rapidly, especially those arising out of the
financing of instalment sales of consumer durable goods. Begin-
ning in 1 942 finance company loans were repaid as the production
and distribution of consumer goods declined, consumer instalment
credit contracted, and new sources of funds opened up for con-
cerns engaged in war production. Many marginal enterprises,
formerly financed by commercial finance companies, were able to
win independence of outside aid as a result of large wartime earn-
ings. Other small business clients discontinued operations. The out-
standing loans of a sample of large commercial finance companies
were cut by more than three- fourths between the end of 1941 and
the end of 1944. Pressed with idle funds, commercial finance com-
panies purchased government securities and some of them acquired
manufacturing and other ventures, so that their function and char-
acter underwent substantial modification. After 1941 a severe re-

2T Figures relate to loans authorized and not amounts disbursed. See Federal Reserve
Bulletin, May 1944, p. 459$ also Report of the RFC to Congress, covering operations
from February 2, 1932 to March 31, 1944 (mimeographed), which indicates that
defense loans and participations amounting to $1,230 million had been made to 3,621
business concerns.



EFFECTS OF WAR ON CREDIT MARKET 199

duction occurred also in the outstanding consumer loans of indus-
trial banking companies, including the Morris Plan banks. Conse-
quently there was a more intense cultivation of the market for
business credit by industrial banking companies.

Factoring concerns, purchasing business accounts receivable with-
out recourse, sustained the volume of their operations more com-
pletely during the war years than did commercial finance compa-
nies. The explanation is that their business consisted largely of the
financing of textile concerns, which continued to require external
financing, whereas the commercial finance companies were heavily
dependent on the acquisition of instalment receivables arising from
the sales of consumer durable goods.



traced to accounts payable to trade creditors who were war contrac-
tors for whom the reporting business was a subcontractor.