Financial Crises: Understanding the Postwar U.S. Experience

By Martin H. Wolfson | Go to book overview

4
The Credit Crunch of 1966

The first financial crisis in the postwar period was called the "credit crunch" of 1966, as noted above. It came about when commercial banks were suddenly prevented from funding a strong demand for loans from the corporate sector. To understand how this crisis came about, it is necessary to understand conditions in the economy prior to the crisis in August of 1966.

As the year 1966 began, the U.S. economy was experiencing a strong surge in investment spending. Investment in plant and equipment by nonfinancial corporations, which had been quite low in the late 1950s and early 1960s, accelerated sharply in 1964 and 1965. Nonfinancial corporations financed this growth in investment through 1965 by relying mainly on internal funds, and, as a result, corporate borrowing through 1965 exerted little upward pressure on interest rates. In an unprecedented performance equaled neither before nor since in the postwar period in the United States, the bank prime rate remained constant, at 4.5 percent, for over five years (from 1960 to December 1965). Moody's AAA corporate bond rate also remained stable at slightly under 4.5 percent.

An increasing proportion of total debt through 1965 consisted of short-term debt. However, given the relatively low amount of total debt, the short-term ratio had less significance for overall corporate financial strength. Moreover, the total amount of short-term debt outstanding through 1965 was relatively low.

The liquidity ratio of nonfinancial corporations did decline steadily from 1963 through 1965. However, this level too was still relatively high for the period since 1961. 1 Thus, corporate balance sheets appeared not to have suffered too much damage from the surge in spending for investment in plant and equipment—at least through 1965. However, in addition to strong investment spending by business, government defense purchases of goods and services expanded sharply in 1965, particularly in the fourth quarter.

This rapid increase in spending in 1965 put pressure on the economy's scarce resources. The capacity utilization rate for manufacturing reached 91.6 percent in March 1966, the highest level in the entire postwar period; the unemployment rate fell in February 1966 to 3.8 percent. Compensation of employees in nonfi

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