The development of the captive finance company' — the finance

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					            COMPETITION, CREDIT POLICIES, AND
             THE CAPTIVE FINANCE COMPANY

                            By PAUL H. BANNER

     Introduction, 241. — The growth of captive finance companies, 242. —
Effects on competition, 243. — Other examples of the competitive use of credit,
246. — Noncompetitive uses of credit, 248. — Effects on credit policy, 248. —
Individual industry experience, 251. — Summary, 257.




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     The development of the captive finance company' — the finance
company wholly owned and operated as a subsidiary of a nonfinancial
firm — presents new problems in the field of consumer credit. The
captive finance company has as its primary purpose the underwriting
of the sale of the parent company's products and it is therefore influ-
enced in its actions and policies by merchandising requirements, not
by objective monetary standards and credit conditions. It is the
purpose of this study to determine the effect of this sales device upon
competition and upon credit conditions. This study suggests that
the captive finance firm is most effectively used by, and is a com-
petitive advantage primarily available to, the large company. A
second conclusion is that consumer credit controls now available to
monetary authorities are largely ineffective in dealing with this rising
source of consumer credit. It is possible therefore that either direct
controls will be required to regulate consumer installment debt
expansion or divestiture will become necessary if the current growth
of captive finance companies continues.
     Installment credit is an absolute necessity in certain industries
The automobile industry, for example, could not have grown to its
present size without some form of time payment plan. Credit, how-
ever, is not uniformly available as a sales method. Inadequacy of
credit facilities has been a chronic complaint in industrial and agri-
cultural history. In part, this complaint stems from the fact that
credit institutions normally approach new uses of credit cautiously.
New industries present greater risks than old ones. The prefabricated
house and home trailer industries are current examples — the auto-
     1. This study is concerned only with the financing of sales by nonfinancial
firms, in most cases manufacturing concerns. Factoring is not included since it
does not present the same competitive and monetary problems. Ownership of
financing affiliates by other financial firms is also excluded from consideration
since this is a problem of concentration and no new monetary problems are at issue.
                                         241
242	                 QUARTERLY JOURNAL OF ECONOMICS

mobile industry an illustration of a few decades ago. Inadequacy of
credit facilities is a relative matter, however, and in many industries
today certain firms feel this inadequacy because of their inability to
meet the credit terms offered by their competitors operating captive
finance firms.
           THE GROWTH OF CAPTIVE FINANCE COMPANIES
     This study indicates that the number of captive finance com-
panies has been increasing continuously. Since 1948 their number
has doubled and in recent years there has been an acceleration in
their formation.




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                    ORGANIZATION OF CAPTIVE FINANCE COMPANIES'
                         Year of	                                         Number
                       Organization	                                     Organized
                 1948 and prior years	                                      19
                 1949	                                                       2
                 1950	                                                       3
                 1951	                                                       5
                 1952	                                                       1
                 1953	                                                       3
                 1954	                                                       5
                 1955	                                                       5
                 1956	                                                       7
                 10 months 1957	                                             8
                 Unknown	                                                   11
                 Total	                                                     69
                 Number of parent firms	                                    55
       1. Sources utilized in the preparation of this study include: "A List of 1000 Large Manu-
facturing Companies, Their Subsidiaries and Affiliates," Federal Trade Commission, 1951; Standard
and Poors Corp. Records; Moody's Industrial Manual; Wall Street Journal; Journal of Commerce.
Company reports and stock registration statements were also used. The above summary does
not represent a complete census of financing affiliates. There is no directory of finance companies
reporting data such as is required to determine ownership. Subsidiary corporations are not always
reported separately in financial manuals or they are referred to so obliquely as to make their opera-
tions difficult to determine. In certain cases in annual reports partially owned firms are treated
as investments rather than as subsidiaries and little or no information is offered as to their opera-
tions. If the parent firm is not registered on an exchange, difficulties are compounded.


     Most of the captive finance firms studied are affiliates of firms
listed as among the 500 largest industrial firms in the country by
Fortune magazine in its July 1956 Supplement. To some extent this
indicates a limitation on the quality of the sample It is known, for
example, that automobile dealers frequently operate finance com-
panies in conjunction with dealerships. If the number of firms with
finance companies is considered small, however, it should be noted
that many industry products are of such low unit cost that financing
of sales is unnecessary. Also, in those cases where industry products
are intermediary rather than consumer products, different forms of
financing are utilized. In the petroleum, chemical, food and textile
                    COMPETITION, CREDIT POLICIES	                            243
industries, for example, sales financing is unnecessary to move a sig-
nificant proportion of industry product. Among the top 25 firms
ranked according to sales are 8 oil firms, 3 food processors and
2 chemical firms, all of which would not be expected to utilize install-
ment sales techniques.
                       EFFECTS ON COMPETITION
      Frequently it has been found that ability to provide credit is a
more effective competitive weapon than an attractive product price.
Many instances, especially in automobiles and housing, can be found
where the absolute level of monthly payment, not the over-all cost




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of the product, is the determinant of sale. Flexibility in financing
arrangements can be more important than total interest cost in sell-
ing a product. A captive finance firm whose only purpose is to
further the sale of the parent firm's products can, therefore, provide
competitive advantage.
     Examples of the advantage to a producer in having a financing
affiliate are found in many industries. Bus producers have insisted
that financing is one of the chief advantages of General Motors.
ACF Brill's president, for example, stated that his buses were priced
competitively but because he could not offer financing for so long a
period, he lost many sales.' The President of the Southern Coach
Manufacturing Company offered similar evidence. His firm was
specifically told it could have sales if it could provide financing. His
firm now makes no attempt to get customers unless it knows such
customers can finance purchases locally.' A representative of another
firm, the Flxible Company, stated that his firm had utilized General
Motors Acceptance Corporation (GMAC) to finance its sales. He
reported an instance of GMAC refusing to handle his financing of
a bus sale and General Motors thereupon receiving the same order
which it financed on longer terms through Yellow Motors Acceptance
Corporation, another General Motors affiliate.' Flxible now relies
on customer financing by local banks.' The Ford Motor Company
      2. Hearings, U. S. Senate, Committee on the Judiciary, Subcommittee on
Antitrust and Monopoly, 84th Congress, 1st Session (1955), Vol. VI, p. 2655,
hereafter referred to as Hearings.
     3. Hearings, p. 2659.
     4. General Motors Acceptance Corporation (GMAC) and Yellow Motors
Acceptance Corporation (YMAC) are wholly-owned subsidiaries of General
Motors Corporation. GMAC finances sales of the passenger cars and appliance
divisions of GM while YMAC's principal business is the wholesale and retail
financing of trucks and coaches manufactured by the GMC Truck and Coach
Division of GM, Euclid Division products and trailers, bodies, and special equip-
ment sold in conjunction with trucks, coaches and Euclid road moving machines.
      5. Hearings, p. 2665.
244	               QUARTERLY JOURNAL OF ECONOMICS

reportedly left the bus business not only because the market was
 declining but also because financing of customers was necessary.
      On July 6, 1956, the Department of Justice filed an antitrust suit
against General Motors charging among other things monopolization
of the manufacture of buses and the financing of the sale of buses
through YMAC on terms which General Motors' competitors with
more limited resources could not meet. One element of relief requested
was that General Motors be required to offer to finance the sales of
buses manufactured by any other company upon the same terms and
conditions as it finances its own buses.'
     Probably in no industry has credit become so important a sales




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device as in the retailing of automobiles. Only one firm, General
Motors, owns a sales finance company. The problem posed will be
discussed hereafter as part of a general discussion of the automobile
industry, but at this time it can be pointed out that in 1954-55
there occurred a major challenge to General Motors' leadership in
the automobile industry. The Ford Motor Company, planning a
public offering of its stock, drove the industry into the most com-
petitive battle for sales leadership in the postwar period. One retalia-
tory device resorted to by General Motors was liberalization of credit.
This liberalization occurred only shortly after the firm in a policy
announcement declared:
"GMAC's current experience shows that where down-payments on new cars are
less than one-third, repossessions are disproportionately higher, as dealers are
well aware."   '




     Shortly after this statement GMAC's policies were changed and
the number of transactions involving down payments lower than one-
third about doubled percentagewise.' This flexibility had an imme-
diate effect upon dealers of other cars and upon competing finance
companies. A dealer testifying before the Subcommittee on Anti-
trust and Monopoly stated that the finance firm he had used had
always offered competitive rates in the past, but in early 1955 he
found he was losing sales to GM dealers because of financing. GMAC
was taking automobile paper that in the past it would not have taken.'
     There are insufficient data available to reveal whether GMAC
        6. United States v. General Motors Corporation, Civil Action #15816, July 6,
1956.
        7. Hearings, p. 3999.
        8. A Study of the. Antitrust Laws, Staff Report of the Subcommittee on
Antitrust and Monopoly, Committee on the Judiciary, U.S. Senate, 84th Congress,
1st Session, p. 70.
     9. Hearings, p. 3104.
                       COMPETITION, CREDIT POLICIES	                                      245

initiated the liberalization of automobile credit terms in 1954 and
1955 which resulted in the greatest increase in automobile credit in
any single year, but from 1954 to 1955 it can be shown that the major
finance firms, the most important of which is GMAC, were more
liberal than their smaller competitors in the granting of credit. In
1954 the median credit on new car purchases for the four major
companies in this field was $1,590 in comparison with $1,650 for all
other sales finance companies. In 1955 the median credit allowed
rose to $1,790 and $1,770, respectively, or the four major companies
increased the median size of loans $200 in one year, while their
smaller competitors increased the median size of their loans only




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$120. 1 General Motors' share of the passenger car market in this
booming credit market rose to its highest percentage in history. In
a market in which credit purchases rose by one-half while cash
purchases rose less than one-sixth, the firm with a financing affiliate
found its market position considerably enhanced.
      Credit liberalization is so effective as a competitive weapon in
this industry because of the high number of sales involving trade-ins.
More than four of every five new car sales involve trade-ins so that

                    SELECTED AVERAGES FOR CREDIT PURCHASES

                                 (Mean dollar amounts)
                     Item                                       1955            1954
        Contract car price                                    $2890            $2690
        Effective car price'                                   2480             2320
        Value of car traded-in or sold                          590              580
        Net outlay                                             1900             1740
        Amount of additional cash'                              210              240
        Amount of credit'                                      1690             1500
      Source: Board of Governors, Federal Reserve System, .Consumer Instalment Credit, Part IV,
"Financing New Car Purchases," 1957, p. 65.
      1. Contract car price less estimated overallowance on trade-in, if any.
      2. Cash paid less encumbrance on trade-in, if any.
      3. Excludes finance and insurance charges; excludes any supplementary borrowing for
down payment.

cash requirements for the purchase of a new car represent the differ-
ence between down-payment requirement and the trade-in value of
the used car. Liberalization of credit can reduce cash requirements
to a negligible amount. A reduction in down-payment requirements
from one-third to one-fourth on a $2,400 car is $200. A three-year-
old car which cost when new $2,400, is roughly worth $800, or the
one-third down payment on a new car without any further cash
    1. "Financing New Car Purchases," Consumer Instalment Credit, Part IV,
Board of Governors of the Federal Reserve System, 1957, p. 73.
246	              QUARTERLY JOURNAL OF ECONOMICS

payment. A four-year-old car would be worth about $650, or would
require an additional $150 cash for a new car purchase on credit.
A decline in down-payment requirements, however, to one-fourth or
$600, would mean that another age group of cars could be tapped as
a market for new car sales without cash down payment. According to
Federal Reserve Board data the median interval before repurchase of
a car declined from 37 months in 1954 to 32 months in 1955 for credit
buyers of automobiles.' Concomitant with this decline in the median
time interval on transactions, credit rose and cash paid declined.
     While these important changes in the character of automobile
installment paper occurred one item did not change, the average




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monthly payment on new car installment contracts. This remained
constant from 1954 to 1955 at $72. Thus the lower down payments
were accompanied by a lengthening of maturities, the median for
which rose from 24 months in 1954 to 30 months in 1955. 3
     The effect can be seen in the age distribution of cars traded-in
on purchases of new cars. In 1953, 50 per cent of all cars traded-in
on new cars were three years old or less. Cars four and five years old
comprised 20 per cent of cars traded-in. In 1954 and 1955, cars aged
three years old or less declined to 45 per cent and 42 per cent, respec-
tively, while cars four and five years old rose to 28 per cent in 1955.
Thus concomitant with a decline in down-payment requirements
the importance of four- and five-year-old cars as trade-ins rose
50 per cent.
        OTHER EXAMPLES OF THE COMPETITIVE USE OF CREDIT
      Another competitive use of the finance company is in the intro-
duction of a new product. The firm offering liberal financing makes
its sale easier. A recent example is the automatic pinsetter for bowling
alleys. The substitution of capital equipment for labor in bowling
alleys is a large investment for a business which has not previously
required high capital outlay. The Murray Corporation and Brunswick-
Balk-Collender Company, developers and marketers of this product,
formed an affiliate, the Brunswick Murray Automatic Pinsetter Cor-
poration, to finance installment sales of these machines. Competition
was undoubtedly a factor also. A rival product is offered on a rental
basis by its developer.
      An older example of the use of credit to introduce a product is
the diesel locomotive. When General Motors introduced its diesel
engines 40 per cent of the mileage of American railroads was in
       2. Consumer Instalment Credit, op. cit., p. 37.
       3. Consumer Instalment Credit, op. cit., p. 37.
                    COMPETITION, CREDIT POLICIES	                       247

 receivership. Obviously railroad credit was poor, and in the depres-
 sion period capital expenditures were avoided. In order to introduce
 its product General Motors offered to finance its sale with no down
 payment required. A revolving credit of $5 million was established
 and engines were leased to railroads with purchase options. In 1937
 and 1938, GMAC financed 12 per cent and 67 per cent, respectively,
 of GM sales to domestic railroads.'
      In the appliance industry when production declined in 1956 and
 various firms dropped lines or sold out completely, General Electric
 turned to easier consumer financing as a stimulus to sales. It
announced that a home owner, or long-term renter, who made struc-




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 tural changes in his kitchen or laundry could have the whole project
 financed through General Electric Credit Corporation, if at least two
 major appliances were bought. The President of the Philco Corpora-
 tion, a firm with only one-tenth of the sales of GE, commented "GE's
 new financing plan will have a lot to do with sales and will make it
 very rough for other manufacturers. Only a big outfit like GE could
do such a thing." 5 The terms offered by GE include 10 per cent
down- payment with five years to pay the balance Philco is a well-
known name in the appliance industry. The effect of GE's competi-
tion on smaller firms can be imagined.
      Financing terms are powerful competitive tools which can best
be utilized by the large firm which has better access to the money
market and can borrow at lower interest rates. The large firm invari-
ably has established sources of financing. Its name is known and it
has established credit status. This is of importance since capitaliza-
tion of a finance firm is less important than its borrowing ability both
in the long-term capital market and in that for short-term money.
With the parent firm's credit status, name, and reputation, the newly
formed financing company has little difficulty in securing entry into
the capital market. Sears, Roebuck, for example, upon the organiza-
tion of its financing affiliate, did not find it necessary to operate its
subsidiary using capital funds alone until it had built up a credit
rating. Immediately upon the organization of the subsidiary in
November 1956 with a capitalization of $35 million, a $50 million
debenture issue was floated, underwritten by leading security houses
and repeated soon thereafter. The firm which handled the greatest
share of the issue was the firm which in the ordinary course of Sears'
business handled its financing and the sale of its commercial paper.
    4. Hearings, op. cit. VIII, 4352.
     5. Raymond A. Rich, Philco Corporation, quoted in Wall Street Journal,
June 4, 1956.
248	              QUARTERLY JOURNAL OF ECONOMICS

      With reference to the cost of money, a major part of the finance
company's cost of doing business, one need only consult the difference
in interest rates according to size of borrower. Rates normally vary
with the size of loan. In addition, the firm which can place its short-
term paper directly secures advantageous rates in comparison with
paper placed through brokers. The average money market rate in
1956, for example, was 3.06 per cent for directly placed finance
company paper in comparison with a rate of 3.31 per cent for prime
commercial paper of comparable maturity.' Thus it is not only that
the large firm can more readily utilize financing terms as competitive
weapons, but the advantages of the parent firm's size can be trans-




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lated into advantages of size in the money market.
                  NONCOMPETITIVE USES OF CREDIT
     Interesting variations in sales financing arrangements are occur-
ring in the carpet and trailer truck industries, variations which
would appear to benefit the smaller rather than the bigger firms in
the industry.
     Sales financing arrangements in the carpet industry have devel-
oped in such a manner as to minimize competitive effects among
carpet producers. In September 1955 Mohawk Carpet Mills arranged
with Allied Building Credits, a subsidiary of the Transamerica Cor-
poration, to finance dealer sales of its products. In succeeding months
other firms made similar arrangements with the same finance com-
pany. In October 1956 Alexander Smith, Firth Carpet Company,
A and M Karghensian and C. H. Marland and Sons simultaneously
announced these arrangements and in December James Lees and
Sons. Other mills' in the country are reported to have done likewise.
Terms offered are similar to all users and provide no advantage to
any particular manufacturer. Such an arrangement is apparently
the only noncompetitive intra-industry credit arrangement in effect.
      Another noncompetitiv credit arrangement different in purpose
has been suggested for the truck trailer industry. In this industry
a credit pool has been proposed to help both small truckers and
producers.
                      EFFECTS ON CREDIT POLICY
     The existence of large captive finance companies owned and con-
trolled by leading manufacturers in their respective fields cannot but
affect the credit structure of the country. The captive finance com-
 pany is not an independent business entity. The fundamental objec-
tive of the company is not necessarily the same as that of an inde-
       6. Federal Reserve Bulletin, Jan. 1957, p. 53.
                  COMPETITION, CREDIT POLICIES	                       249
 pendent finance company. Is it to function principally as a finance
 company, or is it to function as a means of furthering the interest of
 the parent? It would appear that the paramount purpose is usually
 the latter. If so, then the existence of captive finance companies, as
 major suppliers of consumer credit, can create conflict with over-all
 national credit policy. It may be to the competitive advantage of
 the parent to adopt policies at variance with monetary objectives
 and to be in a position to do so. If the government, for example, is
 fostering credit restriction to limit business borrowings for inventory
 purposes, banks will more carefully review consumer credit applica-
 tions and generally slow down their lending activities. If captive




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 finance firms are the sources of credit for dealer inventories, pressures
 from the parent firm to continue lending may be too strong to resist
 even though further lending may be unprofitable. Independent
 market forces do not directly pass judgment on this demand for
 credit. One automobile dealer informed the author that his greatest
protection from factory pressure to buy more cars was the independ-
ent finance company he used, which exercised independent judgment
as to how many cars it would floor plan for him. He obviously did
not build up the large inventories many other dealers did in the
latter part of 1955.
      Structurally, there are other effects of the captive finance com-
pany. In the market for funds, the captive finance company probably
has better credit than most independent finance companies. Its
affiliation with an important manufacturing firm is advantageous. It
has the credit of the parent organization behind it. It is therefore a
preferred credit risk to the independent finance company. Credit
policies that reduce the availability of credit will bear more heavily
upon the independent than upon the captive firm of comparable size.
The captive firm, though smaller than many independent firms, as
an affiliate of a large manufacturing firm with nationwide sales, can
secure credit lines in many banks.
      Complementary to availability of credit as a limit upon the
 activity of finance companies in a tight market is the treatment of
 credit risks. With higher rates and restricted availability, inde-
pendent firms survey their borrowers more carefully, ration credit,
and react in the manner monetary authorities anticipate. Captive
finance companies cannot be relied upon to react in this manner. It
must always be remembered that the captive firm exists primarily to
promote the sale of the parent firm's products. Not only may it not
feel the usual profit incentives operating upon the independent firm,
but knowing that these conditions exist it may take advantage of
250	             QUARTERLY JOURNAL OF ECONOMICS

the situation to enhance the parent firm's market position. If the
captive firm is to be used to further the parent firm's market position,
it cannot allow itself to be limited by the same criteria as limit the
independent firm.
     The captive firm usually has much better knowledge of its cus-
tomers' positions than a banking relationship alone would supply.
It surveys its own industry and while perhaps more parochial in out-
look, it is more knowledgeable of its specialized field. Hesitation in
judgment of credit worthiness or a general lagging in the granting of
credit is unlikely.
     More important, however, is the positive use of credit. If credit




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costs are rising it may be advantageous to absorb this higher cost
and if necessary operate at a deficit to enhance a market position.
The very limitation on credit for competitors' products may be the
impetus to provide credit for the parent firm's products. At such
a time new markets can be invaded and a broader distribution of
products achieved. These are advantages to the firm which would
impel it to act counter to current credit trends.
     The above discussion has been applicable to a period of restricted
credit. What of a period of liberal credit? In such instances either
the captive firm can retire from the market and act passively or it
can utilize its preferred position with the parent firm's customers to
assure itself of a market for its services. This has been done. Pres-
sure to use the financing and other services offered by a parent firm
are not uncommon
     An example of credit policies entirely subservient to the interests
of the parent corporation was previously noted in the action GMAC
took in 1954-55. The same flexibility in interest rates was noted
in the case of General Electric which in 1956 announced a liberaliza-
tion of financing terms in a period of continuously rising interest rates
and attempts by monetary authorities to limit availability of funds
for credit expansion. The president of General Electric at a press
conference praised the Federal Reserve Board's policy of credit
restraint but at the same time announced that the GE credit com-
pany was helping those feeling the pinch.'
     The tight money market has not prevented the growth of the
captive finance company. It is possible that there is no casual rela-
tionship and the growth can be ascribed to demonstration effect. On
the other hand, the very tightness of the market may be contributory
and in addition the profitability of installment paper, in comparison
with shrinking profit margins, may be influential. Large firms, and
       7. Ralph J. Cordiner, quoted in Wall Street Journal, Dee. 14, 1956.
                   COMPETITION, CREDIT POLICIES 	                        251

those studied were primarily among the largest manufacturing firms
in the country, usually have established sources of credit and can be
expected to attempt to circumvent credit restrictions as a barrier to
sales. Furthermore, the large firm with a distributive organization
can readily expand its services to include sales financing. Ease of
entry is not a problem. The effect of such entry is a problem.
                  INDIVIDUAL INDUSTRY EXPERIENCE
     The captive finance firm is usually a specialized firm. It handles
paper arising from the operations of the parent corporation, and rarely
handles other financing.' There can be, therefore, significant differ-




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ences among firms, and no uniform pattern of operations can be
expected. Credit requirements, procedures and practices vary among
industries and the captive firm will be designed to fit industry require-
ments. Indeed the very existence of the firm may be in part due to
the inadequacy, or lack of flexibility of alternative financing institu-
tions. Channels of distribution, seasonality, and historic practices
vary among industries and will influence credit requirements.
     The motor vehicle industry is particularly dependent upon
installment credit. Approximately two-thirds of all passenger car
sales involve the use of credit and automobile paper accounts for
almost one-half of the total outstanding installment credit. In an
industry in which credit is of such importance, only General Motors
owns its own finance company, and until recently its two major com-
petitors were restricted by law from any affiliation with such a firm.
In 1938 both Chrysler and Ford were prohibited by court order as a
result of an antitrust action from any such affiliation, an order which
was modified by the Supreme Court in 1948. General Motors now
owns and operates two finance companies, General Motors Acceptance
Corporation, the largest sales finance company in the world, and
Yellow Motors Acceptance Corporation, a separate firm to finance
the sale of GMC trucks and other heavy equipment.
     Credit has always been a problem in the automobile industry,
and in the twenties considerable attention was devoted by automobile
firms to methods of supplementing credit facilities. While the auto-
mobile industry was profitable, there were many failures and the
industry credit was low. The need for supplemental financing in the
automobile industry arose from the unwillingness of banks to finance
the installment sale of automobiles. Specialized lending facilities in
      8. General Motors, for example, financed the sale of 752,506 new automo-
biles in 1954, of which only 4,027 were non-GM products, or only one-half of
1 per cent of its retail auto financing.
252	            QUARTERLY JOURNAL OF ECONOMICS

 the forms of sales finance firms grew rapidly after World War I, and
without the ethical practices of the banking profession. Exorbitant
 finance charges, excessive insurance charges, "packs" fees and so
 forth were loaded upon the auto purchaser, and the charges quoted
in a purposely ambiguous manner so as to confuse the buyer. These
practices, while still utilized today, were more blatant in the twenties
when alternative financing sources were unavailable. The excessive
charges for automobile financing detracted from the reputation of
the industry and in addition raised the price of the product to the
consumer. Automobile firms, therefore, defensively concerned them-
selves with sales financing and sources of credit.




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      General Motors organized its financing affiliate in 1919. Ford
organized the Universal Credit Corporation in 1928. Other firms made
agreements with "factory preferred" finance companies. Arrange-
ments in the latter case varied but generally in return for lending at
agreed upon rates, the automobile firm paid a subsidy to the finance
firm or assumed responsibility for repossessions.
      General Motors initially provided its financing services as supple-
mentary financing, but this practice was soon modified. GMAC
financed on a recourse basis, that is, the dealer was obligated to buy
back repossessed cars, a risk dealers preferred to avoid. Furthermore,
it was profitable for the dealer to enter an agreement with a local
finance company. In 1925 GMAC wooed dealers by offering a rebate
on finance charges in the form of a dealers' reserve equal to 20 per cent
of the finance charge on new car sales and 30 per cent on used car
sales. Simultaneously pressure was exerted upon dealers to use the
affiliate's services. By 1935, when it was estimated that 55 per cent
of all new cars were sold on installment sales plans,' GMAC's retail
financing equalled 46 per cent of General Motors car sales, which
would imply that GMAC secured about 80 per cent of its dealers'
finance business.
      In 1935 General Motors announced its 6 per cent plan which
provided the purchaser with a quick method of computing his total
finance charges. The plan while not the same as 6 per cent simple
interest offered lower interest rates than were currently being charged
by other finance companies and forced a competitive reduction in
finance charges. The competitive advantage of the plan can be seen
in that from 1935 to 1936 GMAC retail financing increased 50 per cent
while car sales of General Motors increased 21 per cent in value.
     9. National Association of Sales Finance Companies, quoted in W. C.
Plummer and R. A. Young, Sales Finance Companies and Their Audit Practices,
National Bureau of Economic Research (New York, 1940), p. 95.
                   COMPETITION, CREDIT POLICIES 	                       253

 General Motors' market share in the passenger car field also rose,
 from 38 per cent in 1935 to 43 per cent in 1936. In the following year
 as other firms met the GMAC rate, General Motors' market share
 dropped back.
      The importance General Motors attached to financing can also
 be illustrated by its action in Germany upon purchasing an 80 per
 cent interest in Adam Opel A.G. When it purchased this firm in 1929
 it immediately formed a Germany Acceptance subsidiary. Opel
 Finanzierungs G.m.b.H.'
      Chrysler Corporation had an agreement with Commercial Credit
 Corporation, an independent finance company, from the time of the




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former's reorganization. In 1935 this agreement was revised and
 Chrysler bought considerable stock in the finance company. The
agreement provided that Commercial Credit pay Chrysler a per-
 centage of its earnings and that Commercial Credit provide financing
terms for Chrysler dealers as favorable as those given to all but Ford
dealers. Where preferable terms were given Ford dealers, their names
were supplied the Chrysler Corporation. Chrysler could request
Commercial Credit to provide lower rates but would have to pay the
subsequent difference in interest rates. Chrysler dealer and distribu-
tor contracts were revised to include the provision that charges in
excess of those of Commercial Credit could not be charged. Pressure
was also applied upon dealers to use Commercial Credit financing.
In return Chrysler profited and in the three years this contract ran,
Commercial Credit paid Chrysler more than $3 million.'
      Ford organized the Universal Credit Corporation in 1928 to
finance the sale of its cars. In 1933 Ford sold Universal to CIT.
Ford also owned a finance company in Japan, the Fordson Finance
Company, but it is unknown whether this firm is still in existence.
      On May 27, 1938 the Department of Justice, as a result of com-
plaints of independent finance companies and automobile dealers,
instituted an antitrust suit against the big three automobile pro-
ducers charging a conspiracy in restraint of interstate commerce and
coercion of dealers to use factory affiliated finance companies. On
November 15, 1938, civil suits were substituted for criminal indict-
ments and consent judgments entered in the cases of Ford and
Chrysler. General Motors preferred to stand trial. The court's
verdict held General Motors guilty and fines were imposed. General
      1. Annual Report, General Motors Corporation, 1929.
     2. Federal Trade Commission Report on Motor Vehicle Industry, 76th Con-
gress, 1st Session, H.Doc. No. 468, p. 614.
254	              QUARTERLY JOURNAL OF ECONOMICS

 Motors appealed and the judgment was affirmed in 1941. 3 A civil
suit was thereupon filed seeking divestiture. The final decree against
General Motors was entered in 1952 and was similar to the judgments
entered against Chrysler and Ford. In each case coercion of dealers
to utilize certain finance firms was barred but General Motors was not
forced to divest itself of GMAC. In 1941 and 1942 Chrysler unsuc-
cessfully fought the bar against affiliation. On September 19, 1946,
Ford appealed to have certain provisions of the consent decree lifted
and in 1948 was successful. The Supreme Court reversed a decision
of the lower court and lifted the ban on the Ford Motor Company's
affiliation with a finance company. 4




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      Financing of sales is also important in the sale of other trans-
portation equipment. In the railway car and locomotive field, financ-
ing was particularly important during the depression when railroad
credit was poor. General Motors as noted previously was able to
enter the diesel locomotive field because it was willing to finance the
sale of its product. ACF Industries, Incorporated, a producer of
cars, has various financing affiliates. Fairbanks Morse has its captive
finance company, the Municipal Acceptance Corporation. Pullman,
Incorporated, also has a financing subsidiary to aid in the marketing
of its railroad products.
      The largest producer of truck trailers, Fruehauf Trailer Com-
pany, established a financing subsidiary in 1948, the Fruehauf Trailer
Finance Company. In 1956 it established the Trailer Acceptance
Company in Canada to finance the sale of its Canadian subsidiary's
output. Trailmobile, a subsidiary of Pullman, Incorporated, estab-
lished the Trailmobile Finance Company in 1955. Fruehauf and
Trailmobile are estimated to control about 60 per cent of trailer
production with the remainder of the market divided among many
small producers. Since so many truck operators are relatively small
and equipment comprises the major cost of entry into this industry,
credit is extremely important. Fruehauf has offered its customers a
seven year financing plan, roughly parallel in time to equipment life,
and longer than regular financing agencies have offered. Smaller
trailer companies have been unable to offer similar terms. On August
       3. 121 F. 2d 376.
       4. 335 U.S. 303. The court in lifting the ban argued that so long as the
interdiction had not been decreed against General Motors the government must
prove its case rather than rest on a consent decree. If the government wished to
outlaw the Ford arrangements with a finance company, it had to establish its
case in court. Thus, the reversal still left Ford with the possibility, that if it did
affiliate, the government could reopen its case and attempt to prove the illegality
of the arrangement. The financing of Ford agricultural machinery output is
described elsewhere.
                  COMPETITION, CREDIT POLICIES 	                      255

 17, 1956, the Federal Trade Commission charged the Fruehauf Trailer
Company, among other things, with using its financing subsidiary
to lessen competition and unfairly diverting trade to Fruehauf from
its competitors.' This case has not been settled as yet.
      Truckers themselves, through the American Trucking Associa-
tions, Incorporated, are investigating a plan to establish an industry-
sponsored credit pool to help truckers. Such a pool established by
truckers and suppliers would not only help purchasers but would
help the many small producers of truck trailers.
      In addition to making passenger cars the big three auto pro-
ducers are also major truck producers. General Motors' other financ-




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ing subsidiary, Yellow Motors Acceptance Corporation, exists pri-
marily to finance its truck sales. There are about eleven producers
in the automobile industry which produce trucks but not passenger
cars. Among these producers are included International Harvester
which operates a finance affiliate. In 1955 Mack Truck arranged a
revolving credit with forty-eight banks to finance the sale of its
products. White Motor Company handles installment paper as
ordinary receivables.
      The aircraft firms have less need to finance the sale of their
products since the government is the largest single purchaser, and air
lines have in the past arranged their own financing. The two major
producers of aircraft for private use have financing subsidiaries:
Cessna organized a financing affiliate in 1955, and Beech Aircraft
organized an affiliate in 1956. Lockheed has had an affiliate since
1943; Bell Aircraft's major stockholder is a finance company.
      Sales financing is of particular importance in consumer durable
goods and agricultural machinery. Manufacturers of consumer dur-
able goods have been particularly active in the establishment of
finance affiliates.
      General Electric Corporation has had a financing subsidiary for
many years. Its major expansion, however, has occurred since
World War II. American Motors' Kelvinator Division has had a
financing subsidiary to finance the sale of its appliances since 1934.
The Westinghouse Credit Corporation was organized in 1956 with
initial capital of $10 million to help the company's appliance dealers
obtain financing. Philco established a financing affiliate in 1954,
with an initial capitalization of $5 million and its line of credit is now
$25 million
     AVCO Manufacturing Company announced plans for a multi-
    5. In the matter of Fruehauf Trailer Co.: Federal Trade Commission
Docket No. 6608, Aug. 17, 1956.
 256	          QUARTERLY JOURNAL OF ECONOMICS

 million dollar financing plan for its dealers to meet the extended terms
 offered by competitive producers but no further information is avail-
 able at this time. Borg Warner, producer of Norge appliances, estab-
 lished BW Acceptance Corporation in 1953. Various other manu-
 facturers of heating equipment also have finance firms.
      In the agricultural machinery field credit has always been of
 major importance and again we find the leading firms operating
 financing subsidiaries. Agricultural machinery producers in the past
 extended credit to their dealers and helped dealers to carry customer
accounts. This is still the method used by Deere and Company, the
 Oliver Corporation, and the Minneapolis Moline Company. The




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largest firms in this industry, however, have organized sales finance
firms. International Harvester, the largest producer of agricultural
 machinery, established its financing affiliate in 1949. Caterpillar
Tractor established its affiliate in 1954; Cockshutt Farm Equipment,
Limited, established the Farmers Financial Agency in 1955 and Allis-
Chalmers established the Allis-Chalmers Credit Company in 1956.
The J. I. Case Company has indicated that it, too, will organize a
financing subsidiary.
      Ford's activities in the agricultural machinery industry and the
financing of such products is of interest in the light of Ford's experi-
ence in automobile financing. Various Ford Motor Company officials,
though not members of the Ford family, including Ernest R. Breech,
John S. Bugas, Lewis D. Crusoe, John R. Davis, William T Gosset
and Delmar S. Harder, own more than one-half of the stock of the
Dearborn Motors Corporation which distributed Ford tractors and
manufactured agricultural machinery. The company has, as a wholly-
owned subsidiary, the Dearborn Motors Credit Corporation which
finances tractors and other farm equipment at wholesale and retail.
On July 31, 1953, Ford purchased the assets of Dearborn Motors
Corporation, excluding Dearborn Motors Credit Corporation. The
latter firm has continued its finance business and has financed more
than half of the wholesale sales of Ford tractors and farm equipment
and a smaller portion of the retail sales of such equipment. Thus, the
Ford Motor Company does not own a finance company, but the
Chairman of the Board of the Ford Motor Company and five vice-
presidents own one which finances a goodly proportion of Ford agri-
cultural implement output.
     In the road machinery industry credit will undoubtedly be a
major determinant among firms selling equipment for the new road
building program. Contractors are generally small firms and in bid-
ding for jobs must indicate financial soundness. Rental, long term
                  COMPETITION, CREDIT POLICIES 	                         257

 lease and extended time sales for equipment will be sought by this
 industry. Those firms with finance affiliates will be in a strong posi-
 tion to bid for this market. It should be noted that the large truck
 and agricultural machinery producers also build road machinery
 equipment, and also own finance companies, unlike smaller producers
 of specialized equipment.
      In addition to manufacturers supplying credit, sufficiently large
 retailers have also entered the field of consumer credit. Various manu-
facturers who operate retail stores have been previously mentioned.
 In addition, the mail order houses have pushed time sales.
      Sears, Roebuck recently found it advantageous to establish a




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 sales finance company, Sears' second venture in this field. It first
 entered the installment field in 1911. When the Federal Housing
Administration was established Sears organized the Sears Finance
 Company to provide FHA improvement financing. When banks
entered this field, Sears retired, selling its accounts to banks and its
 financing affiliate became inactive at that time. It continued to
 finance installment sales, however, and the growth of such sales has
been impressive. In the nine month period ending October 31, 1956,
installment sales comprised 44 per cent of total sales.' In 1937 Sears
began selling some of its installment paper to banks. In 1952 as
installment sales continued to rise, Sears borrowed $200 million from
various banks to finance the time payment accounts held rather than
sold.' On January 31, 1952 installment balances outstanding were
$493 million and by October 31, 1956, these balances had grown to
$973 million and the number of accounts from 5.7 million to 8.1
million With the maturity of the bank loans Sears established the
Sears Roebuck Acceptance Corporation, wholly owned by Sears. Its
initial capital was $35 million plus $50 million in debentures. Sears
is particularly well situated to enter the field of consumer credit. It
has extensive local representation in the form of retail stores and
catalogue offices.
      Montgomery Ward finances its own credit accounts and at
present holds in excess of $200 million of such accounts.
                                SUMMARY
     It is probable that monetary authorities have little interest in
the competitive effects of captive finance companies and that anti-
trust authorities have little interest in their monetary effects. Each
problem is significant in its own right but together they add up to
the general problem of size in our economy.
    6. Prospectus, Sears Roebuck Acceptance Corporation, Jan. 10, 1952, p. 2.
    7. Moody's Industrial Manual, 1955, p. 280.
258	           QUARTERLY JOURNAL OF ECONOMICS

      If we are to experience a continuing expansion of captive finance
firms, general credit controls will become increasingly inadequate to
limit expansion of installment credit and the only control methods
that could be effective in dealing with the situation created by the
captive finance firms are direct credit controls. Furthermore, a criti-
cal study of the captive finance firm is needed to determine whether
this is a more powerful tool to limit competition than has heretofore
been utilized.
     The captive finance firm is a growing influence in the credit
structure of the country. The basis upon which these firms operate,
their very reasons for existence, indicate that they are more effective




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from the parent firm's point of view when countering national mone-
tary policy than when paralleling it. There are also reasons to believe
that these firms are less responsive to general credit controls than are
independent finance companies. Secondly, since the captive finance
firm can be effective only if it has large sources of credit, its successful
use is restricted to the large firm. As such it is another competitive
advantage of size.
                                                     PAUL H. BANNER.
ST. LOUIS, MISSOURI

				
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