1970: Penn Central
In June 1970, the surprise announcement of the bankruptcy of the Penn Central Railroad sent shock waves through the commercial paper market. The fear of a financial crisis—of larger proportions than the events of 1966—developed among market participants. To understand the background to this crisis, we will again trace developments in the corporate and banking sectors and in Federal Reserve policy.
The expansion of the economy resumed in 1968 after the growth recession that occurred from June 1966 to October 1967. Investment in plant and equipment contributed strongly to the expansion, beginning in mid-1968.
In addition, government defense spending continued at a high level. Because of these spending increases, and because the slowdown in the economic expansion in 1966-67 was relatively mild, the pressures on the economy during 1966 resumed relatively unabated in 1968. A 10 percent income tax surcharge that was passed in June 1968 did not slow the economy in the way that many had expected. The unemployment rate fell to 3.6 percent in 1968, and the capacity utilization rate was a high 87.1 percent. Compensation of employees in nonfinancial corporate business increased by 12.7 percent in 1968, and prices continued to rise.
Profits (as a percentage of the domestic income of nonfinancial corporations) continued to decline in 1968, as they had ever since 1966. In 1969, though, profits of nonfinancial corporations fell even further, dropping sharply and continuously throughout the year. The level of internal funds declined in 1969 as profits fell, dividends and foreign earnings held relatively steady, and depreciation increased slightly.
The decline in internal funds combined with an increase in capital expenditures to cause an increase in the financing gap of nonfinancial corporations during 1969. Investment in plant and equipment in dollar terms increased continuously from the third quarter of 1968 through the end of 1969, and inventory investment generally remained high. The financing gap rose steadily throughout the year, peaking at 18.6 percent of capital expenditures in the fourth quarter.