^ ^/ia3AiNn3Wv* ^«!/0JllV3JO>' -^(tfOJIlVDJO-^ < S'-no^ i^ o '^/5J!3AIN0]W^^ ^>^.OFCAllF0/?/fc, .^,0FCAIIF0% ^&Aavagn-^'^ ,^WE■UNIVERS//, vvlOSANC Q - -n "-^ O li- '''^OJITVOJO^ ^\\E UNIVLR^/A vvlOSAN&[lfx> o ^^^ ■ o ^lilBRARYO^ ^t-LIBRA '^Aa]AiNn-3WV^ %ojiwo-jo^ %om. i/y ^OFCAIIFO%> A'rtEUNIVERJ/A vvlOSANCElfXy^ o ^OFCAIIFO/?^ .^OFCAll ^f' ""^^AHvaaiH^^ '%i30Nvsoi^ %a3AiNn3WV^ "^AHvaain^ %xm\ ^ILIBRARYO/^ ^tUBRARYQ^ ^MEUNIVER5//i ■^/^il3AINn3WV^ ^;lOSANCElfj> O 3 "VAjiqAiNnrAV ^•OF-CAIIFO% K^ ^OFCAIIFO/?^ ^/c. %0JIW3-3O^ i^ ^OFCAllFOff^ \W£UNIVER% o ■rjl3DNVS01^ \WEUNIVER% o ■f'il30NVSOV^ ^lOSANCELfj> %a3AINa-3U^" o %a3AINIl-3U' -^HiBRARYOc. ^ILIBR/i ^OFCALIFO/?^ ^OFCAil '^AHvaan-^' ^^/Aaviii -r 3 ,;lOSANCElfx ^■ ^NtllBRARYOc ^.vNlLIBRARYQ.. .\\\EUNIVER% v^lOSANI |v^7\| %\Z/\ ^oiimi^"^ '^.I/OJIIVDJO^ Aavaaii# AWfUNIVERV/V o clOSANCFlfx> o -< "^/yjiaAiNn-awv^ ^^lllBRARYQc. -^tllBRARYQ^ ^.yOJIlVDJO'^ ^WEUNIVER% ^.tfOJIlVDJO'^ ^i5l30NVS01^ \WE UNlVER^//i o o .^;OFCAllfO% .^OFCAllFOff^ ■^Aa^AiNH 3WV^ "^OAbvaani^ "^ o " ^ so -^- -I ^OF-CALIF0% ^^AHvannA^"^ .^WEUNIVERVa 3". t^c> vvlOSANGEl/j> -^^^t•LIBRARYG^ ^tUBRARYQc^ xancing. Finally, some part of a bank's securities represent the foreclosure of hypothecated securities, acquired by the institution for its o\vn ultimate protection. But these instances explain only a fractional part of the aggregate holdings and do not touch the essential con- sideration, which is — that a bank buys securities because 17 National Monetary Commission it can find no other profitable investment during recurring periods when business is quiescent for such of its surplus funds as it would otherwise employ in its regular channels. When reserves become congested and the local demand for money is exhausted, neither the call money market in New York nor the masked rediscount of country bank paper nor the availability through brokerage houses of the promissory paper of a limited number of widely known mercantile and industrial establishments will absorb the excess, and recourse is had to the bond market. From whatever point of view regarded this apparent necessity under which American banks now labor of tying up large parts of their loanable funds in stock-exchange securities is unfortunate. It offers an unhealthy stimulus to corporate financiering by supplying a temporary and fictitious market for investment securities. It invites speculative gains and losses by the fluctuation in market price in the interval between purchase and liquidation. It curtails mercantile accommodation by the bank's reluctance to liquidate such securities in a declining mar- ket, and it injects an additional element of risk into banking stability in the temptation to invest in less seasoned and more productive bonds. In making such investments under existing conditions the banks, however, obey a perfectly sound economic im- pulse. Idle funds are as unhealthy for the community as they are unprofitable to the banks. It is probably better in the long run that investment be made in securities, with all attendant uncertainties, than that unemployed funds accumulate as swollen reserves or be applied to questionable credits. But such a necessary alternative is i8 Bank Loans and Stock Exchange Speculation lamentable, and one with which the banking institutions of no other industrial country of the world are confronted. Everywhere else the banking surplus of one community relieves the credit strain of another, and in so doing finds safe and convenient investment for itself. Here again we have the prime defect of our banking system — the two-faced evil of localized commercial paper — driving the banks on the one hand to inconvenient and uncertain in- vestment of unemployed funds, and lessening, by wasteful isolation of reserve, the maximum banking accommoda- tion which the mercantile interest of the country might enjoy. Finally, it is questionable whether the practice of investing in securities ordinarily results in profit to the banks. A not uncommon experience is for bonds to be bought at the higher level incident to an easy money mar- ket and to be disposed of when there is competitive selling and prices have weakened. Even when a profit might have been realized, bonds so bought are likely to be held until a loss is shown, then to be carried over and written off, and finally to be sold at original cost when the next easy money period begins. IV. The modern stockbroker is engaged in two kinds of activity — the purchase and sale of investment securities, and the conduct of speculative operations for principals or in personal behalf. Ordinarily both classes of business are conducted by the same house, but there are many bond houses who do not invite speculative accounts and, on the other hand, many commission houses figure inap- preciably in the investment market. 19 National Monetary Commission In connection with each class of business large banking accommodations are involved. Such bank advances take the form either of time or of call loans, according to the prudence of the broker, the state of the money market, and the disposition of the lending banks. The purpose of a sagacious broker, as of a cautious merchant, is to make sure of having at all times that amoiuit, and no more, of borrowed capital that he requires, and to pay for it the lowest price for which it can be obtained at any time during the period of its use. This end can never be completely attained. If money be cheap and the prospect for any stringency unlikely, there is yet reluctance to rely entirely on demand loans because of the ever-present possibility of an abrupt change in the general financial situation, certain to send the call rate bounding, and to make fur- ther or even continued advances impossible. On the other hand, time money ordinarily commands higher rates than call money, and borrowers are unwilHng in periods of easy credit to tie themselves up, so as to be unable to profit in the even easier money market likely to prevail in the future, by call loans and by the sale of securities. When the situation is reversed and the money market restricted, there is nevertheless the same reluctance to use call money exclusively, for conditions may easily be- come prohibitive; while, on the contrary, the exclusive use of time money, even were it practicable, is checked by the hope of improving markets and lower rates. One striking feature of such loans, whether time or demand, is to be noted. The merchant or manufacturer is able to secure banking accommodations up to a certain point upon his own personal credit — that is, by the dis- Bank Loans and Stock Exchange Speculation counting of his own promissory note or single-name paper, unsecured by pledge of collateral. Such is never the case with the bond dealer or stockbroker. However ample his resources or unquestioned his credit, the broker can only obtain loans upon collateral securities. Any attempt to secure credit on other terms is a confession of financial weakness and is never resorted to save in straits. The explanation of this seeming anomaly appears to lie partly in the greater amounts, relative to resources, involved in brokers' transactions as compared with mercantile business, but even more in the fact that the wares of the merchant and the unfinished products of the manufacturer, which serve as the ultimate basis of mercantile loans, are either immobile or inchoate, whereas the securities which rep- resent the stock in trade of the broker are capable of easy and convenient removal and possess immediate marketable value, thus readily lending themselves to the cautious impulse of the banker to protect his advances. Even in those branches of mercantile activity where the stock in trade is capable of reduction to marketable and movable form by warehouse storage — cotton, grain, canned goods — bank advances are ordinarily limited to collateral-secured loans. In so far as the activities of the stockbroker relate to the purchase and outright sale of investment securities, he is a dealer in merchandise. He buys securities of such kinds as will appeal to the varying desires of his customers, at prices which will permit sale at usual business profits. Accordingly, his vaults, like the shelves of the merchant or the warehouse of the manufacturer, are at all times stocked with investment wares awaiting the demands of his investing clientele. National Monetary Commission It is true that a considerable part of the stockbroker's wares will consist of undistributed syndicate holdings or unabsorbed underwriting participation, upon which credit advances have been made in the manner already discussed in a preceding section. But over and above such holdings the ordinary bond house is the owner, by actual purchase and payment, of blocks of securities acquired for purposes of sale at profit, and the actual distribution of which is pressed with all the energy and skill of commercial vending. Advances of credit upon the unsold part of this stock in trade are sought from the banks in supplement of the broker's own working capital. The relation of the stockbroker to the banks is, in this particular, like that of any other business man. He conducts a certain kind of business and has a certain amount of capital of his own with which to conduct it. Restricted within these limits, not only will his operations be meager and un- profitable, but the facilities which he can offer the invest- ing public in variety and readiness of investment securities and the advantage which corporate seekers of capital can obtain from such middlemen, will be correspondingly curtailed. *To press the analogy, such restriction would find exact parallel in the case of a merchant denied credit upon unsold wares or a manufacturer upon undistributed produce. This service is rendered with reasonable adequacy by our present banking system. Bond houses suffer some- thing, in common with all mercantile enterprise from the inelasticity of bank credits in periods of economic expan- sion, but the treatment accorded is often preferential and the discomfort on the whole less acute. Bank Loans and Stock Exchange Speculation V. There has been much controversy as to the function of speculation in modern economic Hfe. Those directly en- gaged therein have insisted upon its respectability and dignity as a form of business enterprise. Radical attack has denounced speculation as a parasitic activity, the effect of which is legalized plunder and demoralization of wholesome business method. The consensus of qualified opinion is, however, that this latter sweeping condemna- tion can be applied, if at all, only to the extravagant excesses of speculative fever and that the intelligent dis- counting of economic developments — the essence of speculation — serves as a balance wheel of industrial life. Such a discussion, however, smacks of the academic. Whatever drastic measures may be taken to eliminate speculative abuses, it is reasonably certain that large play will still be left for those adventurous spirits who, by for- sight, daring, or blind hazard, seek to gauge the course of coming events and who reap profits or suffer losses ac- cording to the accuracy of their forecast or the accident of their guess. During the calendar year ending December 31, 1910, there were bought and sold on the New York Stock Exchange 164,051,061 shares of stock of an approximate value of $14,124,875,879. Dealings on the stock ex- changes of Boston, Philadelphia, Chicago, and Baltimore, aggregated 21,179,574 shares. Allowing for trading in other cities and in the outside markets of New York, it is probably a conserv^ative estimate to place the total number of shares dealt in the United States at 225,000,000 of an approximate value of $20,000,000,000. 23 National Monetary Commission A substantial proportion of this trading consists of outright purchases for investment purposes by corpora- tions, institutions, trustees, and individuals. But the overwhelming part of it, as well as an appreciable amount of trading in active bonds, represents speculative com- mitments for the rise or fall by stockbrokers acting as agents or trading for themselves. Such operations are financed in the main by bank advances. The ordinary procedure is for the operator to supply 20 per cent of the purchase price — or if acting through a broker 10 per cent and the broker another 10 — and the banks to advance the remaining 80 per cent on a demand loan upon a pledge of the securities purchased, or their equivalent, as collateral. The quota advanced by the broker will be drawn from existing bank deposits created largely by time loans negotiated to guard against possible market stringency, but likewise secured by collateral. The ready availability of banking funds for such speculative operations is, as has so often been pointed out, the direct consequence of unwholesome elements in the banking system of the United States. Under the provisions of the national-bank act interior banks are permitted to deposit three-fifths of their legal (15 per cent) reserves with correspondents in reserve and central reserve cities, and reserve city banks in turn, up to the extent of one-half of their legal (25 per cent) reserves, may count their deposits with central reserve banks as a part of such reserves. The original motive of such provision was probably the greater and more regular mercantile requirements 24 Bank Loans and Stock Exchange Speculation of the central reserve cities, notably New York, in con- trast with the seasonal fluctuations of banking needs in the interior cities. To insure such remittance, the New York banks are in the habit of allowing 2 per cent interest upon country bank deposits subject to call. The consequence is that the interior banks, failing any other avenue of profitable short-time employment, remit to New York not only the authorized quota of their reserves, but also the surplus funds which accumulate with recurring business inactivity. It is not possible for the New York banks to employ all of such deposits in mercantile loans and discounts, even were it sound banking to lend call money on time loans. The only method of profitable use is demand loans, and the only large market is offered by speculative operators on the stock and produce exchanges. We have here all the conditions favorable to artificial stimulation of stock exchange speculation. At periods of seasonal dullness, and, even more, at times of business reaction, the irresistible lure of payment for idle money attracts the surplus funds of the interior banks to New York, there to be pressed upon the call money market for what it will bring, and, finding regular employment only in stock exchange operations, to encourage speculative commitments at the very time when quiescence is in order. As there is unwholesome stimulation, so there is sudden and wasteful liquidation. When reviving busi- ness leads the interior banks to reduce their New York balances, the depositary banks meet the strain by calling loans, with the result that the speculative movement for the rise is reversed and a repressive influence cast upon general business. 25 National Monetary Commission The primary cause of this unwholesome sequence is obviously again the inability of the interior banks to find profitable employment for idle funds during recurring periods of business calm. A part of the capital so dis- engaged is put, by the stronger or bolder banks, as has been noted, into stock exchange securities; but that more considerable part, likely to be required upon earlier or more abrupt occasion, and all balances of many banks reluctant to tie up any part of their resources in semi- speculative investment, flow irresistibly to New York depositaries. It is certain that a measure of stock speculation would persist, even if the resources of the New York banks were alone available for financing it, but the extent of such accommodation, even when supplemented by the demand loans made available by individual capitalists, would be limited and the cost of securing it would be greater. Individual speculation would be less in amount and nar- rower in distribution. Most of all, the periods of specu- lation, in so far as determined by the cheapness of money, would vary logically with the movement of general busi- ness, instead of, as at present, running in vicious oppo- sition thereto. /p^Any reform in our banking system which will create a logical form of investment for temporarily idle banking resources may therefore be expected to discom^age instead of to promote speculative excesses. The banking ex- perience of every other industrial country of the world shows that guaranteed bills of short maturity constitute |/ such proper investment. Over and above all other advan- tages which would attend the acceptance of commercial 26 Bank Loans and Stock Exchange Speculation paper, whether by a new central banking agency or by powerful existing institutions, there would surely follow through the diversion of periodically accumulating bank- ing funds into this more healthful channel a marked arrest of the wild course of American speculation. 97 71598 /^&Aavaaii-^^^ :lOSANCElfj> ''ia3AiNa-3W'^ -<^l•UBRARYa^^ ^HIBRARY^k^ so •%0JI]V3-J0>' A\\EUNIVERS-/A ^lOSANCFlfXvi. o ^ ^^a3AINI]-3WV ^OFCAliFOi?,]^ ^OF-CAIIFO% A\^EHNIVERS//> ^lOSANCElfj-;> %avaaiH^ "^^AavaaiH"^ "^uonvsoi^^ ^/sii]AiN(i-3\\v' ^t-LIBRARYQ^, ';,.OFCALIF0ff^ AOSANCElfj-^ '* ^rt:i i Sa3AINn-3WV -< :lOSANCElfj> ^ILIBRARYQC;, ^^tUBRARYQr ^WEUNIVERi//, ^lOSANGElfx^ O ^^M!BRARYQ^ I— » I "^/^a^AiNOjwv^ %oi\m-^Q'^ ^A 1 5 aua L 005 490 171 5 I ^ v^lOSANCElfx> o 3> = %J13AIN(1-3WV ^^UIBRARYQ^ ^.i/ojnv3-jo>^ ^OFCALIF0% ^OFCALIF0% ^WEUNIVERy/A >&Aava8ii'^^ ^^Aavaani^ aWEUNIVERVa c 3 o "J0'^ "^ ^OFCMIFOi?^ ^OAwaan-^^"^ ,^WE•llNIVER% o %J13AINfl-3WV ^.OF-CAllFOff^ ^' Or -n o )NVS01^ >^lOSANCELfj>^ "^AajAINH^UV ^ILIBRARYQ^ ,^WE•UNIVER% ^ ^«i/0JllV3JO^ %OJI1V3JO^ • rz ^ILIBRARY(9/ ^ o ^OF-CAIIFO/,,^ ^\WEUNIVER% ^v:WSAfJCElf4. ;lUVA,SLtLfj> ^tllBRARYOc ^HIBRARYQr yi^ >i .\ME'