Economics and The Public Welfare

Chapter 80

Government versus Private Financing of War Production in World War II

First War Chiefly Private Finance; Second War, Government Finance. In 1941 a high official in the Government loan organization stated privately that the decision had been made that war production should be financed by Government money rather than by private money. This turned out to be the case.

In the first World War, the Government did very little. The War Finance Corporation was created for the purpose of assisting in financing war production where private credit was not available. But by October 15, 1918, the total of all credits provided by the War Finance Corporation was $43,202,592. The rest of the money which the war industries obtained in the first World War came primarily from retained profits, from the issue of new securities, and from the banks. Nonessential loans were held down, and nonessential capital issues were held down. But war production was adequately financed by private capital and by a carefully safeguarded expansion of commercial bank credit.

New Capital Issues Low in World War II. In the second World War, corporate security issues for new capital stood at a low level, as shown by the following table:

Corporate Security Issues for New Capital
1923	$2,635,000,000
1929	8,002,000,000
1934	178,000,000
1936	1,192,000,000
1937	1,225,000,000
1938	873,000,000
1939	383,000,000
1940	736,00 0,000
1941	1,062,000,000
1942	624,000,000
1943	374,000,000
1944	646,000,000
1945	1,255,000,000

A spurt will be observed in the year 1941, followed by a radical decline, and a spurt will be observed in 1945, but more than two-thirds of this 1945 figure came in the second half year after the war was understood to be over, and did not represent private capital for financing war production.

Bank Loans in World War II. Bank loans of the member banks of the Federal Reserve System, for commercial and industrial and agricultural purposes, moved as shown by the following table:

All Member Banks (000,000 omitted)
Year	Commercial Industrial Loans, Including Open Market Paper	Agricultural Loans
1938
Dec. 31	5,179	712
1939
Dec. 30	5.841	730
1940
Dec. 31	6,660	865
1941
June 30	7,807	738
Dec. 31	8,671	972
1942
April 1 (estimated) *	9,100
June 30	8,383	726
Dec. 31	7,387	1,089
1943
Dec. 31	7,421	1,023
1944
June 30	7,023	1,023
Dec. 30	7,531	1,198
1945
June 30	7,095	1,125
Dec. 31	8,949	855

* Judging by the figures of the Weekly Reporting Member Banks, the peak figure for all member banks for commercial and industrial loans was reached in late March or early April, 1942.

Bank Capital Inadequate—S.E.C. Restrictions. With the S.E.C. and other restrictions on the investment market and the stock exchanges, which we have discussed in connection with the stock market break of 1937, it was doubtless impossible for the private investment market to have financed the war industries adequately. The banks could do their part at the outset, and the foregoing figures show how rapidly bank loans went up in 1940-1941 and early 1942. But the time came when the war industries needed such great loans from the banks that banking capital was inadequate. National banks, when lending to anybody but the Government, must lend no more than 10% of their capital and surplus to one borrower, and the aggregate banking capital of the country for all insured commercial banks was only $6,673,000,000 on December 31, 1940, and for that matter, only $8,671,000,000 on December 31 of 1945. The credit of $1,000,000,000, which was made to the General Motors Corporation by a consortium of banks, would thus have been impossible under these limitations.

But Banks Could Lend to Government Without Limit. But the banks could lend to the Government without limit, and the Government could use bank money in financing war industries.

Cash Advances by Treasury. Very early the Treasury began making cash advances for working capital to industries which had adequate plant and equipment, but which were suddenly called upon to do five or six times as much work as they had ever done, and had no adequate basis for bank credit in the large amounts required.

“V” Loans. Speedily the Treasury grew concerned about this, not knowing how to do it and not knowing whether it was done properly, and felt the need of banking minds upon the transactions, and of banking machinery in the handling of the transactions. The solution was found in the “V” loans, loans arranged by the commercial banks but guaranteed by the Federal Reserve banks, the latter acting as fiscal agents for the Government and not putting their own funds at risk. These guarantees normally did not run above 90% of the loan.1 The banks took part of the risk, though in the case of certain weaker companies, the “V” loans were guaranteed up to 100%. This was a rarity. It came when the corporation was weak and when the Government desperately needed what the corporation could produce. Some “V” loans guarantees were only for 75%.

“V” Loans Chiefly for Working Capital. These “V” loans in general were not made for producing plant or equipment. They were primarily for wages and raw materials and other forms of working capital, occasionally including shortlived tools.

“VT” and “T” Loans. As the war went on, the fear of contract cancellations began to grow and “VT” loans came in. These were loans, guaranteed still by the Federal Reserve banks, designed not merely to facilitate war production but also to prevent a business from having its working capital frozen in the event contracts were suddenly cancelled. Finally came “T” loans, concerned primarily with freeing the working capital of industries producing war supplies for reconversion to peace activities.

On April 11, 1942, the Board of Governors of the Federal Reserve System announced the adoption of regulations to inaugurate the “V” loan system.2 The “VT” loans were inaugurated in a statement released by the Office of War Information on September 1, 1943, which appears in the Federal Reserve Bulletin of September, 1943 (pages 849-850). The “T” loans appear to have followed the passage of the George-Murray Bill.3

The table on page 569 4 gives the statistics of these “V,” “VT,” and “T” loans.

It will be observed that the loans authorized at any given time far exceeded the loans outstanding on that date. For example, the General Motors Corporation received a credit of $1,000,000,000, but the maximum use it made of this credit was $250,000,000. It will be further observed that the loans outstanding rapidly declined after V-J Day in September, 1945.

These loans were well handled, in the opinion of many bankers, and the results have been good—able men drafted from private business and finance, working at a financial sacrifice under wartime motives, with red tape cut through, did a job which bureaucrats could never do in peacetime.

Cash advances for working capital by the Treasury continued throughout under the supervision of the Army, Navy, Maritime Commission, and other Government agencies concerned with procurement of munitions, equipment, and supplies.

Throughout, moreover, the industries with good credit got regular bank loans for working capital.

Capital for Plant and Equipment. The problem of plant and equipment was solved for the most part in a different way. Tax legislation early in the war authorized rapid depreciation allowances for plant and equipment designed for war production. This was set tentatively at 20% a year, but the principle was that expenditures for plant and equipment should be amortized when the war was over. A great many industries used their own money first in building plant and equipment. The treasurer of one great company states that his company used $28,000,000 in this way, which, by September of 1946, had been amortized down to $2,400,000.

War Production Loans Guaranteed by War Department, Navy Department, and Maritime Commission through Federal Reserve Banks under Regulation V
(Amounts in thousands of dollars)
Date	Guaranteed loans authorized to date		Guaranteed loans outstanding		Additional amount available to borrowers under guarantee agreements outstanding
	Number	Amount	Total amount	Portions guaranteed
1942
June 30	565	310,680	81,108	69,674	137,888
Sept. 30	1,658	944,204	427,918	356,677	230,720
Dec. 31	2,665	2,688,397	803,720	632,474	1,430,121
1943
Mar. 31	3,534	3,725,241	1,245,711	999,394	1,865,618
June 30	4,217	4,718,818	1,428,253	1,153,756	2,216,053
Sept. 30	4.787	5,452,498	1,708,022	1,413,159	2,494,855
Dec. 31	5,347	6,563,048	1,914,040	1,601,518	3,146,286
1944
Mar. 31	5,904	7,466,762	2,009,511	1,680,046	3,615,963
June 30	6,433	8,046,672	2,064,318	1,735,777	3,810,797
Sept. 30	6,882	8,685,753	1,960,785	1,663,489	4,301,322
Dec. 30	7,434	9,310,582	1,735,970	1,482,038	4,453,586
1945
Mar. 31	7,886	9,645,378	1,599,120	1,365,959	3,963,961
June 30	8,422	10,149,315	1,386,851	1,190,944	3,694,618
Sept. 30	8,695	10,313,868	1,073,892	916,851	3,043,674
Dec. 31	8,757	10,339,400	510,270	435,345	966,595
1946
Jan. 31	8,761	10,340,275	427,278	363,048	764,093
Feb. 28	8,766	10,341,890	357,161	302,597	477,429
Mar. 30	8,768	10,342,690	271,793	230,110	363,010
Apr. 30	8,770	10,343,018	171,036	147,164	286,701
May 31	8,771	10,344,018	116,077	100,316	147,815
June 29	8,771	10,344,018	70,267	60,214	142,617

Note: The difference between guaranteed loans authorized and sum of loans outstanding and amounts available to borrowers under guarantee agreements outstanding represents amounts repaid, guarantees available but not completed, and authorizations expired or withdrawn.

Government Defense Plant Corporation. But when very rapid expansion of plant and equipment was called for, few industries could go far with their own funds, and with such additional funds as the very unsatisfactory investment market could provide. Government corporations stepped in. There was a Defense Plant Corporation under the Reconstruction Finance Corporation. It built plants and leased them to industries, giving the industries, in the lease contract, the privilege of buying the plant and equipment if they wished when the war was over. The Government corporations played a great role in our war finance. One speaks with diffidence of the figures of the Government corporations. These corporations were an unknown jungle, their number and functions were very inadequately known, and their figures were not subject to audit—until Senator Harry F. Byrd, late in the war, was able to compel disclosure of the main facts about them, and finally to bring them under the auditing system of the Comptroller General. The total assets of the Government corporations, as of October 31, 1939, were reported at $12,105,000,000, and the total assets as of September 5 30, 1945, were reported at $34,247,000,000.

Government Corporations Apparently Expand Over Twenty-two Billions During War. This would indicate an expansion of $22,142,000,000 in the assets of these corporations during the war. The Reconstruction Finance Corporation shows a swelling from $1,800,000,000 of assets on the earlier date, to $9,980,000,000 on the latter date. The War Shipping Administration, which did not exist in 1939, shows assets of $8,844,000,000 on September 30, 1945. On the other hand, the Home Owners Loan Corporation, which had assets of $2,976,000,000 on October 31, 1939, had disposed of virtually $2,000,000,000 of these assets by September 31, 1945. As against this, the Federal Land Banks, which do not appear in the figures for October 31, 1939, come into the figures for September 30, 1945 with $1,279,000,000 of assets. The United States Maritime Commission, which does not appear in the figures of the first date, had assets of $3,586,000,000 on September 30, 1945. It is probably impossible to give a precise figure for the contribution of these corporations to plant and equipment of war industries or to shipbuilding or other war activities. The Comptroller General may be able to do this in later years. But that their contribution to the war effort was enormous is certain. Such information as is available regarding specific transactions in which they have engaged would indicate that a very high order of intelligence and devotion to the public interest, at least where high ranking officials were concerned, was manifest in the war work of these corporations.

Reconstruction Finance Corporation. The figures for the RFC for September 30, 1945, include Defense Plant Corporation, Defense Supply Corporation, Metals Reserve Company, Rubber Reserve Company, and Disaster Loan Corporation, which previously were affiliates, but which as of July 1, 1945 (pursuant to Public Law 109, approved June 30, 1945), were dissolved and merged with the Reconstruction Finance Corporation. Also included is the War Damage Corporation, which continues as an affiliate.

The principal assets of the Reconstruction Finance Corporation on October 31, 1939, were loans and preferred stocks of $1,676,000,000, out of total assets of $1,800,000,000. The principal assets of the Reconstruction Finance Corporation on September 30, 1945 were:

Land, Structures and Equipment	$6,868,000,000
Loans Receivable	1,049,000,000
Commodities, Supplies & Materials	942,000,000

Prompt Settlement of Cancelled War Contracts. One further point is in order with respect to the Government’s dealing with the industries in prompt settlement of claims and freeing the working capital of the country for the problems of reconversion. The attitude of suspicion, of slow, meticulous negotiation, which characterized the relation of Government with business at the beginning of the war, gave way very largely to an attitude of mutual confidence as the war went on. The appreciation by the Senate Finance Committee, the Congress, the Federal Reserve authorities, the Government corporations, the Army and Navy, and other procurement agencies of the Government, of the need for rapid settlement of war contracts, if industry was to do its job in reconversion, led to the working out of very expeditious measures. The treasurer of one great corporation stated in September of 1946 that his company’s war contracts had been terminated and settled three months before, that the war was behind them, that they felt they had been justly treated, and that they were going ahead with new things.

Information was obtained in September, 1946, from representative bankers who had wide experience in dealing with companies with war contracts. All agreed that the experience of the corporation quoted above was typical. One stated that he knew no exceptions and that neither he nor his customers had any concern about the possible reopening of the settlements by the General Accounting Office. They could be reopened only in cases of fraud, and he had confidence enough in his customers to be sure that this would not occur.

Another stated that the experience was typical, but that in judging his customers as credit risks he was careful to make sure that they had completed their 1945 renegotiations and that in cases where they had not done this, he took that fact into account in determining their lines of credit. He had regularly sent to the General Accounting Office carbon copies of all contracts in which they had assigned their claims against the Government to his bank as a basis for loans, and he had always waited for an acknowledgment from the General Accounting Office at Washington before he advanced the money. These acknowledgments had always come promptly and there had been very little delay in making the loans.

One of the chiefs of another bank said that he had not troubled to wait for acknowledgment from the General Accounting Office before advancing money. He, too, had sent the carbon copy of the contract, but the General Accounting Office had authority only of review, it had no authority to prevent the loan, and its consent was not required for the making of the loan. He had not concerned himself about 1945 renegotiations. The General Accounting Office could reopen settlements only in cases of fraud, and he knew that his customers had not engaged in fraud.

Allegations of Fraud. Cases of fraud there have undoubtedly been. So great a volume of war business could not have been financed and put through without crooks coming in here and there. Allegations of fraud and excessive profits have been made before Congressional Committees. The Comptroller General has raised serious questions with a Congressional Committee regarding costs and profits. Charges of official favoritism have been freely made, and of the judgment of top armed forces officials being corruptly overridden by high civilian officials.

Charges also of great waste and extravagance have been made in connection with our war time expenditures in foreign countries, particularly in Latin America, but also in North Africa and elsewhere.

Woodrow Wilson and Charles Evans Hughes. It is worthwhile to recall at this point the episode recorded in Chapter 4 of this book. Faced with similar charges, President Wilson called upon Charles Evans Hughes, who had been his opponent in the Presidential election of 1916, and asked him to make a sweeping investigation. When Mr. Hughes made his report vindicating the integrity of the Government, the country was satisfied. Wilson knew that his own hands were clean and believed that the hands of his subordinates were clean. He knew also that he could depend upon the integrity and fairness of the great lawyer, his political opponent.

• 1This point will be discussed at length in Chap. 34.
• 2I have not been able to find that this article was ever published. However, the reader will find much of it in two books by Veblen: Imperial Germany and the Industrial Revolution, New York, 1915; and The Nature of Peace and the Terms of Its Perpetuation, New York, 1917.
• 3See my book The Effects of the War on Money, Credit and Banking in France and the United States, published by the Carnegie Endowment for International Peace, Oxford University Press, New York, 1919. For London, see the interesting articles by Mr. J. M. Keynes in the British Economic Journal in late 1914.
• 4O. M. W. Sprague: “Crisis of 1914 in the United States,” American Economic Review, September, 1915; H. G. S. Noble: “The New York Stock Exchange in the Crisis of 1914,” Garden City, N. Y., Country Life Press, 1915. These two papers are classics of permanent value.
• 5The figures of all the State and National banks and trust companies appear only once a year in the Comptroller’s report as of approximately June 30. For dates other than June 30, it is necessary to make estimates. During the war period these estimates are made on the basis of variation in the National Bank figures.