The Credit Crunch of 1970

In a Crunch, the country runs very dry of money. It is hard to understand that a country can run out of money because, after all, countries by definition can print money. But they can also be overtaken by events, after which the printing power does not alleviate the pain.

Everybody could tell, that June weekend in 1970, that a Crunch was on: it was difficult for small borrowers to breathe, and their ribs hurt. If you wanted to buy a $40,000 house, five years previous you might have put up $6,000 in cash and paid 5 1⁄2 percent for twenty-five years. Now, in the late spring of 1970, the savings and loan wanted $15,000 down and 8 1⁄2 percent, if it would make the loan at all, and some did not. Some smaller businesses were even worse off. They had been, let us say, used to taking out a bank loan for taxes, and then repaying that loan over a year.

Now they were told the loan would be cut down or out, and if they went to other banks, the other banks said they weren’t taking any new clients. That meant the small borrower was out on the street, hustling for money wherever he could find it.

Interest rates were at their highest levels in a hundred years. The prime lending rate at banks had been as high as 8 1⁄2 percent, and some said there was no reason it could not go to 10 or 12 or 15 percent. If the prime rate is at 15 percent, that is such a new ball game that the Dow Jones averages could fairly surely be predicted to sell at 002.

There are bankers around who say there was no crisis in 1970; you could always get money if you wanted it—you might have to pay 20 percent interest for it, that’s all. Or maybe take it in blocked dinars. Even the use of the word “crisis” is controversial—it always is—but the Federal Reserve Bank of New York used it in a retrospective. As that June weekend begins to fade, the crisis seems less acute. By the time of the annual report of the Fed’s Board of Governors, the language applied to the events was “serious uncertainties.”

The liquidity crisis of that time didn’t have much to do with the inability of buyers and sellers of stock to find each other and touch fingertips. Liquidity in this case meant usable funds, borrowable funds for American business. A decade ago nobody could imagine that money in the United States was finite. It was like all the rest of our natural resources: there was plenty for everybody, you could get what you needed, and you certainly didn’t have to worry about running out. The discovery that the supply of money was limited seems to have had a profound social effect as well, for, as with middle age, it does mean that you may be able to think of what you would like to do, but that does not mean you get to do it. There were two popular off-the-top-of-the-head rationales for the Crunch, and both of them were true. One was that nobody had bothered to finance the Vietnam war. There were no major increased taxes to pay for Vietnam, for reasons well spelled out by political commentators. It was not supposed to last that long, and increased taxes would endanger the Great Society program. The second reason was “inflation psychology,” which meant that you had better buy it today, because tomorrow it, whatever it might be, would cost more.

Right after the summer the money almost ran out, I had a long talk with the treasurer of the telephone company in one of our major industrial states. The telephone company has excellent credit, and even in a Crunch it can borrow. This particular treasurer—and his appropriate committee—committed his company to pay more than 9 percent for twenty years. If he had waited through the crisis, it might have cost his company only 8 percent or even less.

One percent on many millions of dollars can buy a lot of telephones.

I wanted to know if he felt dumb, though I didn’t put the question quite so baldly. He said he didn’t, and he had worked out a nice rationale. He had had a leeway of only six or eight months, he said, in which to borrow the money. “The rates were eight percent, so I decided to wait a bit,” he said. “Then they went to eight and a half. That is historically very high, so I wanted to wait until the rate came back to eight. Then the rates were nine—more than nine—and there was talk that they might go to ten or twelve. We needed the money, and I had run out of time. So I had to do it.”

I pressed him a bit.

“Listen,” he said, “we borrow money all the time, and if the rates stay down I’ll borrow some more and then the average won’t look so bad. Anyway, I’m retiring in four years.”

It still sounded dumb to me, but then I have never had to borrow money for the telephone company, and quarterbacking is easier from the grandstand, especially after the game is over. Even Presidents know that.

Good investing,

Adam Smith

Extract taken from Supermoney Copyright © 1972, by Adam Smith. Reprinted by arrangement with John Wiley & Sons, Inc.