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The business situation.

the BUSINESS SITUATION

Corporate Profits

PROFITS from current production declined $12 1/2 billion in the third quarter after a decline of $8 1/2 billion in the second (table 1).(1) Hurricane Hugo, which ripped into the southeastern coast of the United States in late September, caused most of the third-quarter decline. The payment of almost $9 1/2 billion in storm-related benefits by domestic insurance companies lowered profits of domestic financial corporations by that amount; in addition, uninsured storm-related corporate damages reduced profits--mainly of domestic nonfinancial corporations--about $1 1/2 billion. (The October and November "Business Situation" described the sources used by BEA for estimating the impact of the hurricane, the types of property damage included in the estimates, and the effect of the storm on incomes other than corporate profits.)

Domestic nonfinancial corporations.--For domestic nonfinancial corporations, profits from current production declined $4 billion in the third quarter after a similar decline in the second. (Without the $1 1/2 billion of uninsured storm damages, profits of domestic nonfinancial corporations would have declined about $2 1/2 billion.) Real product of these corporations increased in the third quarter, but unit profits from current production declined. The decline in unit profits reflected a smaller increase in unit prices than in unit costs; both labor and nonlabor unit costs increased.

Profits before tax.--Profits before tax (PBT) declined $21 billion in the third quarter after a decline of about the same size in the second. The current production measure of profits includes two adjustments that are not included in PBT--namely, the inventory valuation adjustment (IVA) and the capital consumption adjustment (CCAdj); these adjustments convert the inventories and depreciation reported by business to those used in the national income and product accounts (NIPA's). The IVA increased $14 billion in the third quarter, somewhat less than in the second; the CCAdj declined $6 billion in the third quarter, somewhat more than in the second. The third-quarter increase in the IVA--or, equivalently, the decline in inventory profits--resulted from a slowdown in the rate of increase in inventory prices. For example, the Producer Price Index, the components of which are a major source of data on inventory prices, changed little in the third quarter after a 5-percent increase in the second.

Profits by industry.--The current-production measure of profits is not available by industry; PBT with IVA is the best measure available. For domestic nonfinancial corporations, PBT with IVA increased $2 billion in the third quarter after a slight decline in the second. Declining profits in manufacturing and in transportation and public utilities were more than offset by increasing profits in trade and in "other" nonfinancial industries.

Chemical and electric equipment manufacturers posted large declines that more than accounted for the $3 1/2 billion decline in manufacturing profits. For chemicals, the drop was the third in succession; for electric equipment, which had registered a modest increase in the second quarter, the third-quarter drop matched a large first-quarter decline. Profits of motor vehicle manufacturers remained negative in the third quarter, partly reflecting the cost of automobile sales-incentive programs. The only substantial increase in manufacturing profits was in petroleum; the increase reflected, at least in part, sharply lower expenditures for cleanup operations associated with the oil spill off the coast of Alaska in March.

The third-quarter increase in trade profits was widespread and reflected the deceleration in inventory prices. Both wholesale and retail trade registered increased profits, and, within retail trade, profits of food stores, auto dealers, and "other" retail increased substantially; only the general merchandise category of retail trade declined.

For domestic financial corporations, a steep third-quarter decline was dominated by property and casualty insurance companies. Without the impact of the hurricane on insurance companies, the third-quarter decline in financial profits would have been about $1 1/2 billion (mainly reflecting reduced profits of commercial banks).

Profits from the rest of the world increased $2 billion in the third quarter. Increased receipts from foreign subsidiaries of U.S. corporations accounted for 85 percent of the increase; reduced payments by domestic subsidiaries of foreign corporations accounted for the remainder. Like all NIPA profits, profits from the rest of the world exclude capital gains and losses. In the balance of payments accounts (BPA's), in contrast, receipts of income on U.S. direct investment abroad and payments of income on foreign direct investment in the United States include capital gains and losses. These BPA measures are discussed in "U.S. International Transactions, Third Quarter 1989" in this issue; the capital gains are shown in table 2 of the "Reconciliation and Other Special Tables."

NIPA Treatment of the "Bailout" of Thrift Institutions

The Financial Institution Reform, Recovery, and Enforcement Act of 1989 (FIRREA) was enacted in August to resolve the severe financial problems that besieged thrift institutions during the 1980's. (Thrift, or savings, institutions are depository institutions, such as savings and loan associations, that traditionally specialize in financing residential real estate.) This note briefly traces developments leading up to the passage of the act and describes the resulting organizational changes. Next, it describes the treatment in the NIPA's of the Federal agencies involved in the supervision of and provision of deposit insurance for depository institutions, with special attention to the transactions involved in the "bailout" of the thrifts. Then, it describes a change in treatment requiring a correction that was incorporated into the third-quarter estimates.

Background

Early in the 1980's, new Federal and State laws--particularly two Federal laws, the Depository Institutions Deregulation and Monetary Control Act of 1980 and the Garn-St Germain Depository Institutions Act of 1982--radically altered the activities of the thrift industry. The 1980 act phased out many of the restrictions on interest rates paid by both federally regulated commercial banks and thrifts, and it increased the limit on deposit insurance from the Federal Deposit Insurance Corporation (FDIC) for banks and from the Federal Savings and Loan Insurance Corporation (FSLIC) for thrifts from $40,000 to $100,000 per depositor. The 1982 act eliminated the statutory differential between ceilings on interest rates paid by commercial banks and those paid by thrifts and accelerated the phaseout of interest rate restrictions begun by the 1980 act. The 1982 act also broadened the investment powers for thrifts, authorizing them to make commercial, corporate, business, or agricultural loans up to 10 percent of their assets and to increase the percentage of their assets held in loans secured by nonresidential real estate, in consumer loans, and in State and local government obligations.

Although these laws did not directly apply to State-chartered thrifts that were insured by the FSLIC, these thrifts were indirectly affected. Various States, including Texas and California, had already given State-chartered thrifts similar, but even broader, authority to expand the types and extent of their investment activities. In the wake of the 1982 act, such legislation proliferated.

At the time of the passage of these two Federal acts, the thrift industry faced a divergence in interest rates. On the one hand, thrifts had to pay high rates to savers in order to avoid losing their deposits to competitors, such as money market funds, that had no regulatory limit on interest paid. On the other hand, thrifts' interest-bearing assets were concentrated in long-term home mortgages with low, fixed rates of interest. During 1981 and 1982, savers withdrew nearly $32 billion more than they deposited in FSLIC-insured thrifts. This disintermediation, coupled with bad management and investment decisions, laid the foundation for a crisis that began in the 1982-83 recession. Reflecting failures and mergers of solvent institutions, the number of FSLIC-insured thrifts dropped from 4,250 at the beginning of 1980 to 3,447 at the beginning of 1988. Of the remaining institutions, the FSLIC identified 259 as likely to need financial assistance to resolve their problems and another 252 that were considered insolvent under generally accepted accounting practices. In mid-1988, the FSLIC estimated that the cost of resolving these 511 insolvencies was $30.9 billion. A year later, when Congress passed FIRREA, the estimated cost of dealing with deposit payouts, financial assistance, and the interest on the funds borrowed for the bailout ranged from $150 billion to $160 billion.

The FIRREA dissolved the FSLIC (and the Federal Home Loan Bank Board, which supervised it) and replaced it with several new organizations. In addition, the act increased the premium to be paid by insured institutions for deposit insurance and increased the tangible capital requirements--that is, the ratio of capital to assets--that institutions must maintain to remain in business. The five new organizations dealing with thrifts and the one dealing with commercial banks are as follows:

The Savings Association Insurance Fund (SAIF).--The SAIF, a separate fund under the jurisdiction of the FDIC, insures deposits up to $100,000 per thrift depositor. The SAIF collects premiums but will not be responsible for any financial assistance or for any insured deposit payouts until after August 1992.

The Resolution Trust Corporation (RTC).--The RTC is to merge or liquidate thrifts that fail between January 1, 1989 and August 8, 1992. The RTC, which will automatically terminate operations at the end of 1996, is to provide all financial assistance and make all insured deposit payouts resulting from failures prior to August 1992. The RTC also is to manage and dispose of the assets and liabilities in its possession. When the RTC terminates operations, all remaining assets and liabilities will pass to the FSLIC Resolution Fund.

The FSLIC Resolution Fund.--The FSLIC Resolution Fund, a separate fund under the jurisdiction of the FDIC, is to assume and dispose of all the assets and liabilities of the FSLIC except those expressly transferred or assumed by the RTC. The FSLIC Resolution Fund will be financed in part by a share of the premiums paid by insured thrifts.

The Office of Thrift Supervision (OTS).--The OTS, an office in the Department of the Treasury, will examine and supervise all thrifts and will have all the regulatory powers previously vested in the Federal Home Loan Bank Board.

The Resolution Funding Corporation.--This corporation is to sell $50 billion of 30-year bonds to finance the initial bailout of the failed thrifts. Interest on the bonds will be paid by the RTC and the Department of the Treasury.

The Bank Insurance Fund (BIF).--The BIF, a separate fund under the jurisdiction of the FDIC, insures deposits up to $100,000 per depositor at commercial banks. The BIF collects premiums and makes any necessary insured deposit payouts.

NIPA treatment

In the NIPA's, the FDIC and the FSLIC prior to the enactment of FIRREA and now the FDIC, the SAIF, the RTC, the FSLIC Resolution Fund, and the BIF are treated as government enterprises.(2) Under the enterprise treatment, the income of the agency is considered a nonfactor charge against GNP and is included as part of the "current surplus of government enterprises." The current enterprise surplus of the FSLIC and the FDIC had been calculated as the deposit insurance premiums received from insured institutions less the agency's operating expenses. For the NIPA's, these expenses included net payouts to depositors in failed institutions--that is, the difference between the payment to depositors and the proceeds from the sale by the agency of any assets of such institutions. These expenses excluded various types of financial assistance provided by the FSLIC or the FDIC, such as payments to a "healthy" institution to facilitate their acquisition of, or merging with, a failing one. The financial assistance was treated as an asset transfer, which is excluded from GNP and charges against GNP because it does not arise from current production.

Deposit insurance premiums lowered the profits of the thrift and banking industries and increased the enterprise surplus by equal amounts. Charges against GNP were unaffected, and the Federal surplus was increased. Net payouts reduced the enterprise surplus and, because there was no offsetting entry in any other factor or nonfactor charge, reduced charges against GNP. The Federal surplus also was reduced. Because the net payouts reduced charges against GNP but did not affect GNP, they contributed to the NIPA statistical discrepancy, which is the difference between GNP and the charges against GNP--totals that are equal in principle but not in practice because they are estimated independently. (More recently, there also have been interest payments on money borrowed by the Resolution Funding Corporation to finance the bailout. Interest payments by government enterprises are treated as interest paid by general government, not expenses of the government enterprise. They do not affect charges against GNP, but they reduce the Federal surplus.)

BEA identified two problems with its current treatment of the FSLIC and the FDIC. The first is the statistical discrepancy to which the treatment gives rise. The second relates to the treatment of FSLIC and FDIC losses, which is inconsistent in that the enterprise surplus is reduced by losses generated by deposit payouts but not by the losses generated by financial assistance associated with the sale or merger of failing institutions.

To deal with the inconsistent treatment of losses, either (a) financial assistance provided by the FSLIC or the FDIC must be allowed to reduce the enterprise surplus or (b) net payouts to depositors must not be allowed to reduce the enterprise surplus. Under option (b), the statistical discrepancy problem disappears; under option (a), it is necessary to deal with the problem by adding an offset in charges against GNP for not only the financial assistance but also for the net payouts.

Under option (a), all losses could be treated as charges for bad debts. The enterprise surplus would be reduced by these losses and an offsetting amount, known as a defaulter's gain, would be added to the profits of the thrift or banking industry on the premise that the industry, by not paying off debts and "transferring" them to the government, gains the value of the debts. This alternative is analogous to the current treatment of bad debts of private businesses. This alternative was rejected because of the anomalous effect it would have on NIPA profits and the Federal fiscal position: Savings and loan failures would increase profits when the failed institutions were closed, and the losses would increase the NIPA Federal Government deficit, indicating increased fiscal stimulus.

BEA has decided that option (b) is most appropriate--that all losses are best regarded as asset transfers. Such transfers are excluded from GNP and charges against GNP because they do not arise from current production. This decision means that the net payouts should have been excluded in measuring the enterprise surplus, as were the various types of financial assistance provided by the FSLIC or the FDIC.

Typically, when BEA uncovers a problem, such as the inconsistent treatment of the FSLIC and FDIC losses, the correction is made at the next annual revision, which in this case will be in July 1990. If the correction affects the estimates of more than the 3-year period covered by an annual revision, the corrections to other years would be made at the time of the next comprehensive revision. However, because net payments to depositors may become very large before next July, BEA has decided to introduce the correct treatment effective with the release of the final third-quarter NIPA estimates, which appear in this issue of the SURVEY.

The corrections affect total Federal Government expenditures and the current surplus of government enterprises. In the third quarter of 1989, the correction reduced expenditures and raised the current surplus of government enterprises $2.0 billion at a annual rate (table 2). For 1986 through the second quarter of 1989, the corrections ranged from $0.5 billion to $4.0 billion, and they will be incorporated in July 1990. Corrections for earlier periods, which are very small, will be introduced in July 1991. [Table 1 and 2 Omitted]

(1)Quarterly estimates in the national income and product accounts are expressed at seasonally adjusted annual rates, and quarterly changes are differences between these rates. (2)Government enterprises are agencies that cover a substantial proportion of their operating costs by selling goods and services to the public and that maintain separate accounts. For a complete discussion of the NIPA treatment of government enterprises, see Government Transactions, BEA Methodology Paper No. 5 (Washington, DC: U.S. Government Printing Office, 1988), 6-7.
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Title Annotation:third quarter of 1989
Publication:Survey of Current Business
Date:Dec 1, 1989
Words:2708
Previous Article:Motor vehicles, model year 1989.
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