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Operation of the National and Federal Reserve
Banking Systems

HEARINGS
BEFORE A

SUBCOMMITTEE OF THE
COMMITTEE ON BANKING AND CURRENCY
UNITED STATES SENATE
SEVENTY-FIRST CONGRESS
THIRD SESSION
PURSUANT TO

S. Res. 71
A RESOLUTION TO MAKE A COMPLETE SltRVEY OF TH E
NATIONAL AND FEDERAL RESERVE
BANKING SYSTEMS

APPENDIX
PART VII

Printed for the use of the Committee on Banking and Currency

34718




U N I T E D STATES
GOVERNMENT P R I N T I N G O F F I C E
W A S H I N G T O N : 1931

COMMITTEE ON BANKING AND CURRENCY
PETER NORBECK, South Dakota, Chairman
LAWRENCE C. PHIPPS, Colorado.
DUNCAN U. FLETCHER, Florida.
SMITH W. BROOKHART, Iowa.
CARTER GLASS, Virginia.
PHILLIPS LEE GOLDSBOROUGH, Maryland. ROBERT F. WAGNER, New York.
JOHN G. TOWNSEND, JR., Delaware.
ALBEN W. BARKLEY, Kentucky.
TOEDERIC C. WALCOTT, Connecticut.
TOM CONNALLY, Texas.
JOHN J. BLAINE, Wisconsin.
WILLIAM E. BROCK, Tennessee.
ROBERT D. CAREY, Wyoming.
ROBERT J. BULKLEY, Ohio.
JAMES J. DAVIS, Pennsylvania.
CAMERON MORRISON, North Carolina.
JruAX W. BLOUNT, Clerk

SUBCOMMITTEE ON SENATE RESOLUTION 71

CARTER GLASS, Virginia, Chairman
PETER NORBECK, South Dakota.
ROBERT J. BULKLEY, Ohio.
JOHN G. TOWNSEND, JB., Delaware.
FREDERIC C. WALCOTT, Connecticut.

n




CONTENTS
Introduction:
1. Relations of banks a n d t h e security m a r k e t s
2. Effects of b a n k s ' participation in security m a r k e t s
3. Anticipation of capital accumulation
4. Text of Questionnaires
P a r t I. Bank security loans:
1. Expansion of b a n k credit, 1921-1930
2. Growth of security loans
3. Analysis of security loan increase
4. Purposes of security loans
5. Character of collateral
6. Soundness of security loans
7. Loans to security affiliates
8. Deflation of security loans
P a r t I I . Brokers' loans:
1. Expansion of brokers' loans
2. Relation of brokers' loans to bank security loans
3. Loans for t h e account of others
4. Control of brokers' loans
m
5. Deflation in brokers' loans
P a r t I I I . Bank investments:
1. Expansion of bank investments, 1921-1930
2. Analysis of expansion
3. Types of securities purchased
4. Convertible bonds
5. Diversification
6. Marketability
7. Accounting for security investments
8. Losses on b a n k investments
9. Repurchase agreements
10. I n v e s t m e n t s a n d time deposits
11. F u r t h e r restrictions on bank investments
P a r t IV. Security affiliates:
1. Origin of security affiliates
2. Definition of security affiliates
3. Organization of security affiliates
4. Functions of security affiliates
5. Analysis of typical security affiliates
6. Results of security affiliate operations
7. Syndicate participations
8. Relations of security affiliates to banks
9. Bank loans to security affiliates
P a r t V. Examination of security loans and i n v e s t m e n t s :
1. Bank examinations
2. Soundness of security loans
3. Securities without active m a r k e t s
4. Undermargined security loans
5. Examination of investments
6. Losses on investments
7. Loans on stocks a n d bonds of real estate holding companies
Appendix. Law governing examination of security affiliates, New York

State.




m

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OPEBATION OF THE NATIONAL AND FEDERAL BESERVE
BANKING SYSTEMS
RELATIONS OF THE BANKS WITH THE SECURITY MARKETS
INTRODUCTION

1. Relations of banks and the security markets.—The commercial
banking system of the United States has been associated with its security
markets to a steadily growing extent during recent years. In its
earlier development, the banking system of this country was largely
divorced from the market for securities, and disastrous experiences
of bank failures due to frozen or worthless security holdings, such as
the case of the second bank of the United States after it assumed a
Pennsylvania charter in 1836, tended to enforce such separation of
commercial from investment banking in law.
Loans on securities, which expand the capacity of the investment
market to absorb new securities by permitting their purchase with
the aid of bank credit, have always played some rdle in commercial
banking, however. During the twentieth century, the rate of increase
of security loans has been considerably accelerated, while the banks
have participated in the security business in other ways as well.
The chief points of contact between the commercial banks and the
security markets may be summarized as follows:
(1) Security loans: These include loans made to brokers and
dealers, as well as to other borrowers, and may be made for a variety
of purposes, as indicated in Part I below. Such loans amounted in
June, 1930, to approximately 19 per cent of the total of commercial
banking assets.
(2) Investments: Bonds have long constituted a component element of banking assets in this country, but only during and since the
World War have bond investments of banks expanded rapidly. The
opening of thrift and savings departments of commercial banks
tended to stimulate to a large extent the expansion of bond holdings
of the banks. On June 30, 1930, investments amounted to 22 per
cent of the total of commercial banking assets in this country. Included in this total are securities bought under repurchase agreements
from the sellers, which are more like loans than investments in nature.
(3) Security affiliates: In order to operate in the security markets
in various capacities without the restrictive influences of existing
statutes, a number of banks have established affiliates which enjoy
identity of ownership and management with the bank, but are incorporated separately under State law and can freely operate as security
companies. The activities of these affiliates in the major financial
centers have assumed a very large scope in the case of many individual
institutions, and they have hitherto attracted far less attention than
their importance would deserve.




999

1000

NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

2. Effects of banks' participation in security markets.—The significance of rapidly mounting bank loans on securities and bank security
investments is imperfectly understood, even by a large proportion of
economists and students of banking. Various aspects of this expansion have been emphasized in public discussion latterly, serving to
clarify the broader aspects of the subject.
I t has been pointed out that security credit granted by the banks
furnishes funds to industry for productive purposes, just as would
business loans. This is unquestionably true, and a clear grasp of this
fact would quickly dispel the widespread popular fallacy that if a
bank advances funds on securities the supply of bank credit available
to business is thereby reduced. The security markets can not absorb
credit, but merely furnish a channel through which it is directed to
specific users. If the credit finances the sale of new securities, the
corporations or governments originating these securities get the proceeds of the loan, and can use them for their purposes. If the loan
is utilized to finance the purchase of already issued securities, the
proceeds of the security advance will go to the seller of the securities,
who may use them in turn to buy new securities, to purchase goods
or perhaps to buy other already issued securities. In the latter case
the funds are transferred a third time, but sooner or later the proceeds of security loans find their way at one or more removes,
into the hands of some seller of securities who will utilize them for
business or consumption purposes.
Since security loans represent purchasing power which makes itself
felt as buying power in the hands of purchasers of goods and labor,
an expansion of such loans has approximately the same net effect as
an expansion of commercial loans. The rise in security loans during
the period w^hich culminated in the stock market panic of 1929 thus
constituted an inflationary movement which permitted the maintenance of commodity prices despite the tendency to overproduction
and unbalanced production in numerous industries, but made the
subsequent production readjustment all the more drastic.
Security loans differ from commercial loans to a large extent in
their effect on the liquidity of the banking institutions making them.
If commercial loans are carefully made, they tend to be self-liquidating
transactions, which will be paid off with the sale of the goods that are
produced or carried with the proceeds. In the case of security loans,
however, liquidity depends largely upon the ability to sell the collateral, and if such loans become excessive a downward movement in
security prices will bring wholesale forced liquidation, such as occurred
during the "stock market panic" of 1929 and on recurring occasions
thereafter, as the volume of security credit was being reduced.
The granting of credit to business indirectly through the security
loan, rather than directly through the commercial loan, also reduces
the degree of control possessed by the bank over the flow of credit
to business. The bank knows the purpose for which most commercial
loans are made and can proceed to cut down the amounts of such
advances when thought desirable. In the case of security loans on
the other hand, the bank is interested primarily in the quality of the
collateral, and in the nature of the case it can have no real control
over the utilization of the proceeds by the original seller of the
security, since the loan is not to the latter but rather to the pur-




NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

1001

chaser of the issue, or perhaps to another party that buys securities
from those who use the proceeds to absorb new offerings.
3. Anticipation of capital accumulation.—When
the commercial
bank makes a loan to finance a single turnover of goods, whether in
production or trade, it facilitates the current processes of industry
and commerce. When it uses its power of credit expansion to finance
the sale of securities, however, either through the making of a loan
or an investment, it anticipates the accumulation of capital through
creating purchasing power which is devoted to capital purposes.
This tends to make the ability of the capital market to absorb securities much more flexible than would otherwise be the case, and thus
tends greatly to increase the amplitude of fluctuations in the supply
of capital available at different times.
During a period of widespread confidence and active business, the
stimulation of the capital market resulting from rapidly increasing
bank loans on securities and bank purchases of bonds tends to stimulate capital investment far more than would otherwise be the case.
At the same time the overdevelopment that ordinarily occurs in
various fields during such a period is correspondingly exaggerated,
making the subsequent reaction and period of deflation and liquidation all the more severe. The experience of the past 10 years lends
spectacular confirmation to the view that the more intensive participation by commercial banks in the capital market exaggerates financial and business fluctuations and undermines the stability of the
economic organization of the country.
The further participation by the banks in the security markets
through security affiliates has the same general effect, since these
companies tend to rise to the forefront of activity in the capital
market during active periods, because of their strong connections with
the banks, while in deflation periods the possession of large portfolios
of securities and lack of a large outside demand for issues they sell
tend to make all of them relatively inactive.
4. Text of questionnaires.—The subcommittee on Senate Resolution 71, in investigating the relations between these banks and the
security markets, sent out six questionnaires to a selected group of
institutions. The text of the questionnaires is reproduced herewith, and the material presented in this report is largely based upon
the replies received to these questionnaires
No.

1. QUESTIONNAIRE ON SECURITY LOANS (TO BANKS)

Direct loans by banks on securities now constitute about 80 per cent of all
security loans. The purposes and soundness of such loans must be better known
in the future if effective credit control policies are to be developed in the banking
system.
1. What was the total of loans on stocks and bonds reported by you at the last
condition call?
The date of this call was
2. Give comparable figures for the five previous calls:




Date

_

Amount

1002

NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

3. What proportion of such stock and bond collateral loans, as reported in
the last condition statement, was made to brokers and dealers in securities?
4. What proportion of such loans was made by the borrowers, in your opinion,
for direct commercial, industrial, or agricultural use?
5. What proportion of such loans were made, in your opinion, for the sole
purpose of carrying securities?
6. What proportion of the collateral on such loans carried by you consisted of
stocks?
7. What proportion of your collateral on such loans consisted of listed securities?
8. What proportion of your collateral loans is secured by investment trust
issues?
9. What proportion of your collateral loans is secured by issues without active
markets?
; b y unlisted issues?
10. What proportion of your outstanding security collateral loans is secured
by stocks and/or bonds having a market value of less than 110 per cent of the
amount of the loan (excluding loans on Government bonds) ?
11. What is the amount of security collateral loans made to controlled or
affiliated institutions:
Name of institution

Amount of loans

12. Indicate maximum security collateral loans made to all affiliated or controlled institutions in each of the past five years:
Year

Maximum loans to affiliates

13. Indicate the maximum amount of security loans made by you in each of
the past four years against securities issued by real estate holding companies:
Year

Loans on stocks

Loans on bonds

No. 2. QUESTIONNAIRE ON SECURITY AFFILIATES (TO BANKS)

Little information is now available on the condition of security affiliates of
commercial banks. In view of the important r61e and large resources of such
organizations, a clear picture of their condition and relations with parent banks
is desirable.
1. List names and addresses of all affiliates of your bank which deal in or hold
securities, with capital and surplus of each:




NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS
Name of affiliate

Address

Capital

1003

Surplus

2. How was the capital and surplus of each security affiliate provided?.
3. What was the maximum indebtedness of each security affiliate to your bank
and affiliated institutions in 1929?
;
in 1930?
4. What was the average amount of such indebtedness in 1929?
; in 1930?
5. What proportion of such indebtedness was secured?
6. What proportion of such indebtedness was secured by stock collateral?
7. How is identity of ownership of your bank and security affiliates assured?
8. What was the total amount of securities bought by you from all your
security affiliates under repurchase agreements in each of the past four years?
9. What was the maximum amount of such repurchase agreements from all
your security affiliates outstanding at any one time in each year?
10. Append income accounts of security affiliates for 1928, 1929, and any
portion of 1930 available.
11. Append balance sheets of security affiliates at end of 1928, 1929, and latest
date in 1930 available.
12. Append full portfolio of security affiliates at close of 1928, 1929, and latest
date in 1930 available, with original cost and present market values indicated.
13. What was the aggregate amount of syndicate and other participations of
your security affiliates during each of the past four years?
14. Describe the nature of the five largest participations of this sort in 1929.
No.

3. QUESTIONNAIRE ON LOANS FOR " O T H E R S " (To

MONEY BROKERS)

A major obstacle to effective credit control during the inflation period of 19271929 was the rapid growth of loans to brokers from nonbanking sources. Such
loans were largely handled by the New York banks, but substantial sums flowed
into the money market from other sources as well. The aim of this survey is to
determine the chief channels through which this flow of funds occurred and the
sources from which it came.
1. What was the approximate daily average of brokers' loans funds you handled
in 1929?
2. What was the maximum handled in cine day for that year?
3. Approximately what proportion of these funds were advanced directly to
brokers and dealers in securities, rather than through commercial banks?
4. Is it practicable for you to advance funds directly to brokers and dealers
without banking intervention?
5. Please indicate briefly reason for answer to question 4.
6. Approximately what proportion of the brokers' loans handled by you in 1929
came from business corporations?
From investment trusts?
From foreign banks?
From other foreign sources?
7. What is your usual charge for handling such funds? __




1004

NATIONAL AND FEDERAL BESEBVE BANKING SYSTEMS
No. 4. QUESTIONNAIRE ON BANK INVESTMENTS (TO BANKS)

Bond investments of commercial banks have shown a marked increase in
recent years. This questionnaire seeks to throw light on several of the more
important causes and characteristics of this movement.
1. State the amounts of United States Government, domestic, and foreign
securities held by you in your investment account on December 31 in each of
the past seven years (please consolidate, if feasible, bond holdings of banks
acquired during this period):
Date

Total investments

U. S. Government

1

"

Foreign

Domestic

"I

2. What is your explanation of the increases in each of these classifications
during the period shown?
3. Are the amounts of holdings shown above based on original cost, cost with
allowance for amortization to maturity, or prevailing market price?
4. Do you ever make allowance for unrealized appreciation or depreciation in
your bond accounts?
5. State names and amounts of your 10 largest holdings of bonds other than
those of the United States Government:
Name of bond

Amount

Cost

Present market
price

6. What proportion of your holdings consists of convertible bonds or bonds
with common stock purchase warrants attached?
7. State names and amounts of your 10 largest holdings of convertible bonds,
and bonds with common stock purchase warrants attached:
Name of bond

Amount

;
I

Cost

Present market
price

__.|

__J

•

i

""

_..

""1

__i
i

8. Do you think the present restrictions on bank investments in securities
adequate? If not, state suggestions for changes
9. Indicate percentage of present bond holdings which are listed on the New
York Stock Exchange
other stock exchanges
10. What was the total of security holdings held by you under repurchase
agreements during each of the past four years, showing United States Government bonds and other securities separately?
11. What was the maximum amount of such repurchase agreements outstanding
at any one time in each of these four years?
12. What were the chief reasons for utilizing the repurchase agreement in
preference to advancing direct security loans in these cases?
^



NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS
No.

5. Q U E S T I O N N A I R E ON L O A N S F O B " O T H E R S "

1005

(TO B A N K S )

A major obstacle t o effective credit control during t h e inflation period of 1 9 2 7 1929 was t h e rapid growth of loans to brokers from nonbanking sources. Such
loans were largely handled b y t h e New York banks, b u t substantial sums flowed
into t h e money m a r k e t from other sources as well. T h e aim of this survey is t o
determine t h e chief channels t h r o u g h which this flow of funds occurred, a n d t h e
sources from which it came.
1. W h a t was t h e a p p r o x i m a t e average a m o u n t of brokers' loans "for t h e
account of o t h e r s " handled by you in September, 1929?
2. W h a t was t h e m a x i m u m a m o u n t of such loans handled bv vou a t a n y one
time in 1929?
13. Approximately w h a t proportion of such loans "for t h e account of o t h e r s "
came from business corporations?
from investment trusts?
from individuals?
from foreign
banks?
from other foreign sources?
4. If you h a d not handled these funds for t h e lenders, is there a n y other channel
t h r o u g h which thev might h a v e found their way into t h e call loan m a r k e t ?
_.
No.

6.

Q U E S T I O N N A I R E FOR B A N K E X A M I N E R S

The soundness of security collateral loans of commercial banks is of v i t a
significance, in view of t h e unprecedented]y large t o t a l of such loans o u t s t a n d i n g
a t t h e present time. Present practices in examining such loans should t h r o w
considerable light on their soundness. Methods of examination of t h e i n v e s t m e n t holdings of commercial b a n k s are also subject to considerable v a r i a t i o n ,
a n d it is desired to secure further light on current practices.
1. W h a t criteria do you use in analyzing t h e soundness of security loans?
2. How do you arrive a t a valuation of stocks a n d bonds having no regular
m a r k e t quotations?
„
3. Do you find evidence of m a n y security loans with collateral of a value less
t h a n t h e a m o u n t of t h e loan?
Are these mainly in
small or large banks?
4. How do you handle security loans, the value of t h e collateral of which is
less t h a n the a m o u n t of the loan?
5. Do you t a k e t h e cost or m a r k e t value of investments in examining t h e
condition of a bank?
Is there any other valuation basis
y o u use?
6. On which t y p e of investment do you find t h a t t h e b a n k s you examined h a v e
suffered t h e most severe losses?
7. H a v e you noted a n y security loans based u p o n stocks or bonds of real
e s t a t e holding companies in t h e portfolios of b a n k s within your jurisdiction?
8. W h a t proportion of all security loans are based upon real estate holding
c o m p a n y securities, in your opinion?
r „,
9. W h a t is your a t t i t u d e toward such loans, a n d how do you determine t h e i r
soundness in examination?




PART I

BANK SECURITY LOANS
1. Expansion of bank credit, 1921-1980.—The decade 1921-1930 was
marked by an almost uninterrupted steady increase in the deposits of
American commercial banks. This increase in the total of outstanding bank credit was accomplished during a period of relative stability
of commodity prices, but the expansion in bank deposits, and thus
purchasing power, which occurred, had a distinctly bolstering effect
upon the price level, and stimulated a rapid expansion in the volume
of production and distribution at the same time.
Total deposits in the National banks, State banks, and trust companies of the United States, as reported to the Comptroller of the
Currency, increased from $29,697,009,000 on June 30, 1921, to
$49,151,326,000 on June 30, 1930. This increase of approximately 65
per cent in total deposits during the decade was divided among the
three classes of institutions as follows:
TABLE 1.-—Total deposits
[Source: Annual Reports of the Comptroller of the Currency}
June 30,1921

Class of banks
National banks
State banks
Trust companies
Total

. _

-

-

__ ._

June 30,1930

$12,991,320,000
10,849,807,000
5,855,882,000

$23,268,884,000
12,385,792,000
13,496,650,000

29, 697, 009, 000

49,151,326,000

The total resources of these three classes of institutions increased at
the same time from $42,898,053,000 to $62,089,101,000, a gain of
almost 45 per cent. Among the major assets, the item of security
investments showed the greatest increase in dollars, with a rise of 63
per cent during the period. Real-estate loans showed the fastest rate
of growth, with a gain of 95 per cent, to some extent attributable,
however, to a change of classification. Security loans registered a
rise of 50 per cent, although the increase was probably considerably
greater than this because of the more inclusive definition of " secured
l o a n s " as used in 1921. "Other loans and discounts" registered a
gain of only 10 per cent.
T h e percentage of total banking resources invested in each of these
ways at the two dates mentioned compared as follows:
1006




NATIONAL AND FEDERAL RESEEVE BANKING SYSTEMS

1007

T A B L E 2.—Percentage of resources invested

[Source: Annual Reports of the Comptroller of the Currency]
Type of assets
Security loans
Investments..
Other loans..
Real estate loans

.

Total

-

June 30,1921 June 30, 1930
_

_

..._._.

_

_

_
_.

- .

_

18
20
37
5

19
22
28
7

80

76

I t is thus seen that funds placed in security loans and investments
together increased, according to this compilation, from 38 per cent to
41 per cent of the total banking resources of the United States. The
rise in security loans was actually considerably greater than thus
shown, owing to changes in classification. These two items in fact
played a dominant r61e in the great expansion of credit during this
decade, and careful analysis of them is necessary as a background for a
sound policy of credit control.
I t must be kept in mind that the effectiveness of bank credit is
determined by two factors, its volume and its velocity. The statistics
presented above show the nature of the increase in volume. D a t a on
velocity are not available in reliable form, but the statistics on bank
debits to individual accounts, usually used as a rough index to velocity,
indicate that for the most part the velocity of turnover of bank
accounts increased as rapidly as did the total of bank deposits. The
relative velocity of deposits arising out of security loans and investments varies, but there is good reason to believe that at least the
former category enjoys a specially high degree of rapidity of turnover.
In view of the fact that the proceeds of a security loan are for the most
part immediately turned over to a seller of securities, frequently a
speculative operator, in toto, an a priori case can be built up for the
theory that a specially high rate of velocity attaches to this type of
bank asset.
2. Growth of security loans.—Until the post-war period, banking
statistics on security loans were not satisfactory. However, from the
inadequate available data the conclusion is clearly indicated that such
advances have been a major element in American banking only since
the World War.
Before 1914 the Annual Report of the Comptroller of the Currency
classified loans chiefly into the two categories of " d e m a n d " and
" time." Beginning with June 30, 1914, statistics for State banks and
trust companies distinguish loans secured by stocks and bonds from
other secured loans, such as those secured by chattel mortgages and
commercial paper deposited as collateral. Such distinction was not
made for national banks. On June 30, 1914, loans secured by stocks
and bonds for State institutions, and secured loans other than real
estate for national banks, were reported as amounting to $1,526,319,186 in the report of the Comptroller of the Currency, or only about
13 per cent of the total of 1930.
During the war a great mass of loans secured by United States
Government bonds was created, as part of the program for financing
the conflict. These loans were rapidly deflated after 1920, but collateral loans secured by other stocks and bonds underwent a rapid




1008

NATIONAL AKD FEDERAL RESERVE BANKING

SYSTEMS

increase, beginning with 1922. Security loans in all banks, as reported
to the Comptroller of the Currency, compared as follows:
T A B L E 3 . — Total security

loans *

[Source: Annual Reports of the Comptroller of the Currency]

Class of b a n k s

Increase,
per c e n t

J u n e 30,1921

_
_ _

Total

$4,361,884,000
1, 525,894,000
1,704,065,000

$5,484, 713,000
1,435, 529,000
4, 534,946, 000

26
—6
166

7,591,843, 000

National banks
State banks
T r u s t companies

J u n e 30, 1930

11,455,18S, 000

50

i The classification "security loans" was more inclusive in 1921 than in 1930, so that, as already indicated,
the increase was actually greater than shown in the above table. The 1921 totals apply to "all collateral
loans other than real estate."

A continuous record showing the increase in the total of security
loans is available for the reporting member banks of the Federal reserve system since 1918. Such loans are divided as those secured by
United States Government bonds and those secured by other stocks
and bonds since August 15, 1919. The increase in security loans
since that date has been as follows:
T A B L E 4.-—Security loans,

reporting

member

banks

of the Federal

Reserve

system

[Sources: States ent of Condition, Reporting Member banks in Leading Cities, issued by the Federal
Reserve Board]
Number of
banks

Date

Aug.
Dec.
Dec.
Dec.
Dec.
Dec.
Dec.
Dec.
Dec.
Dec.
Dec.
Dec.
Dec.

15, 1919
26, 1919
31, 1920
28, 1921
27, 1 9 2 2 . . .
26, 1923
31, 1924
30, 1925
29, 1926
28, 1927
26, 1928.
31, 1929
31, 1930

_
.-

769
796
820
806
782
764
737
719
688
657
626

Secured by
United States
Government
bonds

Secured by
other stocks
and bonds

,319, 521,000 $2,945, 970,000
, 020,
359, 000 3, 300,331,000
908, 722,000
3,173, 823,000
512, 520,000
3,165, 481,000
290, 261,000
3, 774,775,000
228, 365,000
3,857, 662, 000
194, 974,000
4, 667,760, 000
170, 107, 000 5,759, 678, 000
144, 075,000
5, 708,092, 000
128, 253,000
6, 587,067, 000
106, 239,000
7,023, 487,000
d,304, 000,000
7,814, 000,000

Total of security loans

$4, 265,491,000
4, 320,690,000
4,082, 545,000
3, 678,001,000
4, 065,036,000
4,086, 027, 000
4,862, 734, 000
5,929, 785,000
5,852, 167,000
6,715, 320, 000
7,129, 726,000
8,304, 000.000
7,814, 000,000

It will be seen from the statistics of security loans of reporting
member banks presented above that such advances rose more than 100
per cent from 1921 to 1929. This is a truer picture of the extent of
the growth in security loans than that furnished by the reports of
all banks to the comptroller, because of the changes in classification
that have occurred in the latter data. However, as the larger banks
included among the weekly reporting member banks have expanded
their security collateral loans more rapidly than have the smaller,
nonreporting banks, as shown by the following tables, the actual
increase in total security loans for the period was less than the 100
per cent rise shown by the former.
The data on security loans of the reporting member banks of the
Federal reserve system also indicate that the increase in this item




NATIONAL AND FEDEEAL RESERVE BANKING SYSTEMS

1009

became marked in 1924, in June of which year began the upturn in
security prices, accompanied by a rising tide of popular participation in speculation in stocks, which continued with only minor
interruptions to the stock market panic of 1929. It is also noteworthy that, apart from liquidation of loans on United States Government bonds, the volume of security loans did not change much
during the immediate post war inflation and deflation periods, covering the years 1919 to 1922, inclusive.
The reporting member banks, including the larger financial institutions of the country, advance more than 70 per cent of all security
loans, although possessing little over half the banking resources of
the country. Thus, on June 30, 1930, reporting member, nonreporting member, and nonmember banks compared as follows:
TABLE 5.—Security loans, member and nonmber banks
[Source: Annual Reports of the Comptroller of the Currency and Statements of Condition, Reporting
Member Banks]
Security loans
Banks

Total loans and investments

Per cent
of total

Amount

Amount

Per cent
of total

$8,442,000,000
1,983,000,000
1,030,000,000

Reporting member
Nonreporting member
Nonmember
TotaL

.-

74
17
9

$23,099,000,000
12,556,000,000
11,643,000,000

50
26
24

11,455,000,000

100

47,298,000,000

100

The statistics thus far presented as indicating the extent of the
expansion of security loans do not present a complete picture of the
situation in so far as loans may in effect be granted through indirect
arrangements. The most common of these is the utilization of the
resale and repurchase agreement, whereby the bank makes a technical
purchase of securities, with a contract to resell them at the same
price, plus an agreed upon rate of interest, within a stated period of
time. Repurchase agreements will be considered more fully in connection with bank investments in Part III of this report.
3. Analysis of security loan increase.—The expansion of security
loans occurred chiefly among the large member banks of the Federal
Reserve system.
Dividing the increase from 1921 to 1930 among the three classes of
banks, National, State member, and State nonmember, the showing
is as follows:
TABLE 6.—Increase in security loans, by classes of banks
[Source: Annual Reports of the Comptroller of the Currency and Federal Reserve Bulletin]
Class of banks
NationalState member
State nonmember..
Total




1921

.

1930

Increase,
per cent

$4,361,884,000
2, 551,022,000
678,937,000

$5,484,713,000
4,940,640,000
1,029,835,000

26
94
52

7, 591,843,000

11,455,188,000

50

1010

NATIONAL AND FEDEKAL RESEKVE BANKING SYSTEMS

For the period since June 30, 1928, separate data for security loans
of Federal reserve member banks in New York, Chicago, reserve
cities, and finally so-called country banks, are available. The percentage of the total outstanding security loans made on June 29, 1929,
by each of these groups of banks was as follows:
TABLE 7.-—Security loans, by groups of member banks
[Source: Member Bank Call Report, Federal Reserve Board]

Bank groups

New York City banks,..
Chicago banks
Other reserve city banks
Country b a n k s . . .
_.

Number
of banks

Amount

8,142
8,707

Total

$3,236,150,000
773,972,000
3,293,710,000
2,455,053,000

Per cent
of resources

9, 758,885,000

28
33
21
15

The banks of the two central reserve cities, it will be seen from the
above, had well over 28 per cent of their resources in security loans,
nearly twice the proportion of the country banks, which had 15 per
cent.
The expansion of security loans during the decade 1921-1930 was a
nation-wide phenomenon. This is proved by the statements of
reporting member banks of the Federal reserve system, as divided by
districts.
TABLE 8.-—Increase in security loans of reporting member banks by Federal reserve
districts
[Sources: Statement of Condition, Reporting Member Banks in Leading Cities issued by the Federal,
Reserve Board]
Federal reserve district

Jan. 7, 1921

Jan. 8, 1930

Boston
_.
New York
Philadelphia..
Cleveland
Richmond
Atlanta
Chicago
St. Louis
Minneapolis..
Kansas City..
Dallas
San Francisco

$241, 000,000
1, 743,
000,000
274, 000,000
404, 000,000
142, 000,000
86, 000,000
542, 000,000
150, 000, 000
53, 000,000
104, 000,000
50, 000,000
187, 000,000

$533, 000,000
3,488, 000,000
505, 000,000
740, 000,000
189, 000,000
152, 000,000
1,247,000,000
251, 000,000
86, 000,000
127, 000,000
113, 000,000
435, 000,000

Total...

3,976,000,000

Increase,
per cent

7,886,000,000

121
100
84
83
.40
77
129
67
62
22
126
133

The San Francisco reporting member banks show the sharpest
increase during this period, with a rise of 133 per cent. The Kansas
City atid Richmond districts show the smallest, with 22 and 40
per cent, respectively. The decade witnessed a further concentration
of security loans in the Boston, New York, and Chicago districts, the
reporting member banks of which together accounted for 63 per cent
of the total in 1921, and 67 per cent in 1930.
4. Purposes of security loans,—While the regularly published
banking statistics now give a clear view of many of the quantitative
aspects of bank security loans, thej^ do not attempt to present to any




NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

1011

important extent an insight into their qualitative characteristics.
At this point, therefore, it will be necessary to turn to the results of
the questionnaire sent out by the Subcommittee of the Senate Committee on Banking and Currency, covering several qualitative aspects
of the subject of security loans. 1
Considerable differences of opinion have been voiced by practical
bankers and students of banking concerning the ultimate purposes
for which security loans are made by the borrowers. Some have
claimed that they are almost entirely arranged for the purpose of
carrying investment or speculative purchases of securities. Others
argue that they are largely designed to fulfill the needs of the borrower
for business or in some instances for consumption purposes, and that
the security collateral is merely incidental and designed to provide
added protection for the bank advancing the credit.
The questionnaire, sent to a selected list of banks, asked the
following two questions:
What proportion of loans on stocks and bonds reported by you a t t h e last
condition call was m a d e by t h e borrowers, in your opinion, for direct commercial^
industrial or agricultural use?
What proportion of such loans was made, in your opinion, for the solo purpose
of carrying securities?

As would be expected, a number of banks had no data for forming
an opinion on this subject. Of the institutions answering the questionnaire, however, 56 per cent (10 out of 18) in New York City and 84
per cent (41 out of 49) elsewhere were able to give replies. In a
majority of cases the reply was given in approximate form, indicating
that the division was based upon empirical approximation. In
other cases, the division was more exact, at time given in percentages
carried to two decimal places, indicating that notations on loan cards
or other devices were being habitually used by many banks to indicate
the purposes of security loans. Such action by some institutions,
therefore, points to the general possibility of all banks securing at
least approximate information from customers as to the purposes of
security collateral loans. Loans to brokers and dealers in securities
can, of course, be considered as advanced entirely for the purpose of
carrying securities for investment or speculative purposes, although
the advance in many cases is planned as a temporary one pending
distribution of a block.of stocks or bonds to customers.
The replies to the questionnaire in some cases covered the September 24, 1930, call date, and in others that of December 31, 1930,
There was no significant difference in conditions at each of these
two dates to affect the replies to these questions to any extent.
Taking the banks which gave, more or less specific replies to the
questions, the answers of the New York City banks were as follows:
(number at left of table is an arbitrary designation for each bank):
i Questionnaire No. 1 for full text of which see the introduction to this Part VII.

34718—31—PT 7




2

1012

NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS
T A B L E 9.—Purposes of security loans—New

Bank

No.
No.
No.
No.
No.

1
2
32
4
5

Proportion
for commercial,
industrial,
or agricult u r a l use

Loans on
stocks a n d
bonds

Per cent
120
15
140
57.1
U5.3

_. $823,000,000
525,000,000
311,000,000
231,000,000
217,000,000

Proportion
for t h e sole
purpose of
carrying
securities

Loans o n
stocks a n d
bonds

Bank

Per cent
180
No.
'95
No.
No.
'60
42.9 | N o .
84.7
No.

York City banks

1

Proportion Proportion
for com- for t h e sole
mercial,
u r p o s e of
industrial, pcarrying
or agricul- securities
t u r a l use
Per cent

6
7
8
9
10

$138,000,000
110,000,000
1 105,000,000
; 104,000,000
; 33,000,000

Per cent
150

2.03
17.5
12
10

175
198
90

i Designated as an estimate, approximation, or belief.
2
For head office and larger domestic branch, given as 43.5 and 56.5, based on undivided analysis of loans.
3 Including consumptive loans.

The summary of replies on the purposes of security loans from banks
outside New York City was as follows:
T A B L E 10.—Purposes of security loans, banks outside of New York

S t a t e i n w h i c h located

Bank

No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.

L
2 „
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19.
20

_.
_. .
.

_

_

Massachusetts
Rhode Island

Ohio.,
do
Illinois
do
Michigan
do
Minnesota
do-__
do
Missouri
Nebraska
California
do
._
do
do
do
Washington

Loans on
stocks a n d
bonds

$169,000,000
28,000,000
82,000, 000
113,000,000
36,000,000
548,000,000
54,000,000
47,000,000
7,000,000
..
28, 000,000
16, 000,000
11,000,000
__.
59,000,000
1,000,000
159,000,000
91, 000, 000
32,000,000
21,000, 000
_..
20.000,000
1,000,000

Proportion
for commercial, i n d u s trial, or agric u l t u r a l use
Per cent
120
i 10
9.7

(2)

123
15
10
140
19.2
25
190
10
17
30
9.846
33
10
20
26

City
Proportion
for t h e sole
p u r p o s e of
carrying
securities
Per cen
166^
185
90.3
36.49
1
100
177
195
1 100
l
60
1 84
65
1 10
90
83
70
80.206
50
90
80
20

1 Designated as an estimate, approximation or belief.
Very small percentage

2

The two conclusions indicated in a general way by the above
tables are that first, in the majority of cases which reported, much
the larger part of security loans were not made for commercial,
industrial, or agricultural uses, but rather for the purpose of carrying
securities; and secondly, that a few banks find it feasible to separate
such loans according to purpose with considerable nicety, while a
great many others are able to make a rough division without any
apparent difficulty.
The chief purposes for which security loans are made may be summarized as follows:
(1) Carrying of securities by dealers pending distribution to
investors.




NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

1013

(2) Carrying of securities with intention of the holder to resell
eventually at a rise in price, to permit reimbursement of the loan out
of the proceeds. The general run of brokers' loans ai^e in this cate(3) Carrying of securities intended for long-term investment, the
borrower expecting to liquidate the security loan gradually out of
income.
(4) Carrying of securities for indefinite periods, for purposes of
corporate control, etc.
(5) Business, agricultural, and commercial uses, with the securit}T
collateral deposited to protect the bank against loss.
(6) Consumption purposes, with the security deposited as protection to the bank.
In general, it might be said that in the first, third, and fifth types
of security loans the bank does not rely solely upon the collateral
for the liquidity of the loan, since the borrower is expected in the
normal course of business to be provided with funds out of which
the security loans are to be liquidated. The second type of loan,
which accounts at times of speculative activity for the bulk of the
total of such advances, is rather anomalous in the field of commercial
banking, for its liquidity depends primarily upon ability to find a
market for the collateral, rather than upon the self-liquidating character of the loan itself. Although a large part of such loans are
payable on demand, actually wholesale liquidation without disturbance is out of the question, because buyers for cash can not be
found for any large volume of securities previously carried on credit
without a drastic and painful deflation in the security markets.
5. Character oj collateral.—During and immediately after the war,
a large proportion of security loans were secured by United States
Government bonds, and these were reported separately until 1929 by
the reporting member banks. Loans secured by United States
obligations constituted about one-third of all security collateral loans
of reporting member banks in 1919, but declined thereafter, especially
during 1921 and 1922, to small proportions. At the end of 1928, the
reporting member banks showed only about l}{ per cent of all their
security loans collateraled by United States obligations, although
investments in such securities rose sharply, reflecting the shifting of
the bulk of Government debt from private to institutional ownership.
Through the questionnaire on security loans already referred to, it
was sought to determine the extent to which the security loans of the
banks are secured by stocks as against bonds. The opinion has been
advanced that a large proportion of the aggregate volume of such
credit outstanding has been backed by bonds in course of distribution.
The question asked on this score was:
What proportion of the collateral on such loans (i. e., loans on stocks and bonds)
carried by you consisted of stocks?

I t is understood, of course, that many loans are made on mixed
collateral consisting both of stocks and bonds, so that the figures given
present a division of the aggregate collateral held by the bank.




1014

NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

An effort was also made to throw light on the character of the
collateral from the point of view of marketability. The questions
asked on this point were:
What proportion of your collateral on such loans consisted of listed securities?
What proportion of your collateral loans is secured by issues without active
markets?

The answers to these three questions are tabulated below:
TABLE 11.—Character and marketability of collateral of security loans
NEW YORK CITY BANKS

Loans on stocks
and bonds

Bank

No. 1
No. 2
No. 3
No. 4
No. 5
No. 6
No. 7
No. 8
No. 9
No. 10
No. 1 1 No. 12
No. 13
No. 14
No. 15
No. 16
No. 17

Per cent of
collateral
consisting
of stocks

Per cent of
collateral
in listed
securities

Per cent of
collateral
without
active
markets

_

_

Total, 17 banks.

$823,000,000
525, 000,000
311, 000,000
310, 000, 000
231,000,000
217,000,000
138, 000,000
110,000, 000
105,000,000
104,000, 000
95,000, 000
89,000, 000
63, 000, 000
33,000, 000
31, 000, 000
16,000,000
15, 000, 000

59
80
63
87
87
86
80
86
80
90
90
75
75
95
90
80
60

63
68
69
89
80
76
70
96
70
95
90
71
86
90
90
95
83

16
3
3.3
3.6
3.7
2.4
15
2.5
4
6
3
4
3.3

3, 216, 000, 000

,

76

78

-

1
2

BANKS OUTSIDE OF NEW YORK CITY

Bank

No. 1
No. 2
No. 3
No. 4
No. 5
No. 6--.
No. 7
No. 8
No. 9
No. 10
No. 11
No. 12
No. 13
No. 14
No. 15
No. 16
No. 17
No. 18
No. 19
No. 20..
No. 21
No. 22
No. 23

State in which located

Massachusetts
do
_
do
Rhode Island
New York
Pennsylvania
do..
Ohio
Illinois..
do
Michigan
do
Minnesota
do....
do
Missouri
Nebraska
California
do
do
do
do
Washington..

T o t a l , 23
banks.
t Negligible.




.

Loans on stocks
and bonds

* 169. ooo. ooo
59,000, 000
12,000, 000
28,000,000
82,000,000
56,000, 000
30,000,000
113,000,000
548, 000,000
54, 000,000
47,000, 000
7,000,000
28,000,000
16,000,000
11, 000,000
59,000,000
1,000,000
91,000,000
39,000,000
32,000,000
21,0000000
20,000,000
1,000,000
1,524,000,000

Per cent of
collateral
consisting
of stocks
77
90
82
85
90
52
77
75
50
90
89
78
90
44
60
60
87
100
67
70
70
38
77

Per cent of
collateral
in listed
securities
73
85
75
85
85
95
70
64
90
60
98

ee

100
70
58
80
95
83:
90
85
75
99
$4
54

Per cent of
collateral
without
active
markets
7.6
5
2
5
10. S

(0

3.5
1
10
25
10
1
.03
15
o

15
1
10
0
5
1
36
10

NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

1015

It was sought through the questionnaire to determine two other
points regarding the character of the collateral behind bank security
loans. Thefirstpoint was the percentage of collateral loans backed
by investment trust issues, to determine whether any important proportion in any case was secured by issues of this character, which
on the whole were regarded as relatively unseasoned bacause of their
newness at the end of 1930. In no case, the replies indicated, was
any large proportion of security loans backed by investment trust
issues. In New York City one trust company having total security
collateral loans of $95,000,000 reported 7 per cent were collateraled
by investment trust issues. Another institution with $231,000,000
in such loans reported 3 per cent secured by investment trust securities. In the majority of cases such security loans amounted to less;
than 1 per cent of the total.
In the case of banks outside of New York City, one Buffalo institution with collateral loans of $82,000,000 reported 10.1 per cent of
them secured by investment trust issues; a bank in San Francisco
with $20,000,000 in such loans reported 10 per cent, and a Chicago
bank with $54,000,000, and a Detroit bank with $47,000,000, in such
loans reported 5 per cent. Most other banks showed 1 per cent or
less of their collateral loans backed by investment trust securities.
With regard to the second point—the proportion of security loans
backed by stocks and bonds of real estate holding companies—it was
sought to determine whether any important volume of real estate
loans were being disguised as security loans through incorporation
of realty properties and issuance of stocks and bonds by them.
Specific replies were available in many cases, but for the most part
the banks stated they had no such loans. Such loans were reported
as follows by the few banks reporting any substantial volume of them:
T A B L E 12.—Loans secured by real-estate holding company

Bank

No. 1
No. 2

Location

_ New York City
do

N o ! 4 ™ I " I " " " I I I " I I " " " I I " I I I " " " " I""do"~"""I~I~~II~I~I~"
No. 5
Philadelphia
Los Angeles
No. 6

securities

Loans secured
by real estate
holding company issues
i $9,809,146
400,000
2 1,592,000
1,195,000
2 142,000
3 3,487,368

Per cent
of total
security
loans
1.2
.4
1.5
1.3
.5
3. S

i Of which $3,576,800 in stocks and $6,232,346 in bonds.
All bonds.
J Of which $2,712,914 in stocks and $774,454 in bonds.

2

The general conclusion from the replies received was that no
significant volume of real-estate loans is included in the security loan
total through collateral advances on real estate holding company
stocks and bonds.
6. Soundness of security loans.—The determination of the general
soundness of security loans is a complex and difficult matter. The
usual test of soundness is the percentage that the market value of
collateral bears to the face value of the loan. This test may be
misleading from two main viewpoints. During a period of drastic
liquidation security collateral tends to lose marketability to a large
extent, even in the case of relatively active listed issues, and any



1016

NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

concerted effert to liquidate loans upon the part of the banks generally
is thus impracticable^ This is especially true of inactive and unlisted
issues. Secondly, borrowers in individual cases m a y have other
resources which make the loan better than appears on the surface
from a consideration merely of collateral value.
In order to get some approximate idea of the proportion of security
loans which had an inadequate margin of collateral protection, the
following question was asked:
What proportion of your outstanding security loans is secured by stocks and/or
bonds have a market value of less than 110 per cent of the amount of the loan
(excluding loans on Government bonds)?

In current banking practice, various measures are taken when the
margin on a collateral loan becomes impaired, through a decline in
the value of the pledged securities. In some cases, when additional
collateral is not forthcoming, drastic action through calling of the
loan, and insistence upon immediate partial repayment or sale of
some of the pledged collateral, is taken. I n other instances, especially
where the customer is well-known to the bank or where the securities
have been sold to him by the security affiliate of the bank, a laxer
policy is frequently followed. Cases have been related where, on
the decline in the value of the collateral, the customer is asked to
convert his loan partly into an unsecured advance, leaving the
balance as a security loan. I n such instances, the total amount of
the loan is unchanged, but the part falling within the technical classification of security loans is reduced, and thus the adequacy of the
margin is restored. No data is available to indicate how widely
these and similar practices prevail, b u t their existence must be kept
in kind in interpreting the conclusiveness of the replies to the questionnaire query.
The replies cover the end of 1930, when security prices were lower
than at any time in the preceding 15 months, but were also considerably higher than at the end of 1931. The percentage of impaired
security loans was doubtless considerably larger than reported below
by the end of 1931. The answers were as follows:
T A B L E 13.—Proportion of bank security

loans

undermargined

NEW YORK CITY BANKS

Bank

No.
No.
No.
No.
No.
No.
No.
No.
No.
No.

Percentage
Loans on stocks secured by
and bonds
less than 110
(other than U.ri. per cent in
Government) market value
of securities

1
2
3
4
5
G
7
8
9
10

$823,000,000
525,000,000
311,000,000
310, 000, 000
231, 000,000
217, 000,000
138, 000,000
110,000,000
105,000,000
104, 000,000

none.
none.

9.41
1.5

3.8
'3
1
.9
1
4

Percentage
Loans on stocks] secured by
and bonds
less than 110
(other than U. S. per cent in
Government) market value
of securities

Bank

No.
No.
No.
No.
No.
No.
No.
No.

11.
12
13
14
15
16
17
18

_„.

.

Total, 18 banks

$95,000,000
89,000,000
63,000,000
49, 000,000
33, 000,000
31, 000,000
16, 000,000
15, 000,000

10
6
1
15
0.3
1
3.5
1.3

3, 365, 000,000

i Nearly half of this, a loan for $3,000,000, ' 1 further secured by 2 guaranties considered good for several
million.




NATIONAL AND FEDERAL KESERVE BANKING SYSTEMS
'FABLE 13.—Proportion of bank security loans

1017

undermargined—Continued.

BANKS OUTSIDE OF NEW YORK CITY

Bank

No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
1

1
....
2__
3
4
5
6
7._
8
9
.._
10
11
....
12
_ .
__
13
_._
14
15._
16_
.
17.
18.
19
20
,
21_-_
22--.
23_-_
24
25
26.
__
Total, 26 banks

State in which located

-.
-

.

.

.
„

Massachusetts
__. .do..
do
_._
Rhode Island
New York
_
Pennsylvania . .
do
Ohio
do
Illinois.
.
_.
do
._
Michigan
. .,_ ._
do
do
Minnesota
do.
do
Missouri
__.
Nebraska
.
California
_. .
do
do.
do
do
. ....
do
Washington

Percentage
Loans on stock
secured by
and bonds
less than 110
(other than U. S. per cent in
Government) market value
of securities
$169,000,000
59,000,000
12,000,000
28,000,000
82,000,000
56,000,000
30,000,000
113,000,000
36,000,000
548,000,000
54,000,000
47,000,000
38,000,000
7,000,000
28,000,000
16,000,000
11,000,000
59,000,000
1,000,000
159,000,000
91,000,000
31,000,000
32,000,000
21,000,000
20,000,000
1,000,000
1,749,000,000

7.3
3.75
None.
7
19
(i)

6
.69
1
7.5
1
3
16
23
5.5
12
9
5
10

(*) 12

None.
2
7
.5
2
6

Practically none.

A further approximate index to the soundness of security loans is
furnished by determining the percentage placed through brokers and
dealers. As a rule there is good reason to believe that security loans
placed through brokers are sounder than those advanced directly
to customers. In the first place, the broker's liability is added to
that of the customer, and secondly, the broker is likely to be considerably more ruthless in insisting upon the maintenance of adequate
margins than are the banks themselves when making security loans
to individual customers. Loans to dealers on security issues in
process of distribution, or being held for long-term purposes, have in
practice proved less sound in several cases, since many banks, especially in New York and other financial centers, have at times become
so far involved in the affairs of investment houses as to refrain from
taking protective action in time in the event of a general decline in
security prices.
D a t a on the proportion of security loans advanced through brokers
and dealers is presented in Part I I of this report.
7. Loans to security affiliates.—The failure of the Bank of United
States in New York City in December, 1930, served to center attention upon the fact that banks may make large loans to affiliated
corporations which are not treated objectively, and which in that
particular case became so unwieldy as to have led to the collapse of
the institution. The development of affiliates, chiefly for purposes
of holding and distributing securities, has been especially marked in
New York City, but has spread to some extent in recent years to
other centers. A full discussion of the security affiliates is reserved
for Part IV of this report, b u t here an indication will be given of the
extent to which the banks have loaned money to them.



1018

NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

The questionnaire asked the banks addressed to state the amount
of security collateral loans to controlled or affiliated institutions as
of the end of 1930, as well as the maximum amount of such loans in
each of the precedingfiveyears. The answers are tabulated herewith:
T A B L E 14.—Loans to security affiliates, New York City banks
Loans to affiliates, Dec 31, 1930
Bank
Amount

l..
2..
3..
4..
5..
6..
7_.
8.,
9..
10.

$28,820,000
None.
None.
4,799,600
4,300,000
24,650,000
2,250,000
3,000,000
None.
207,000

3.5

9.7

1.5
3.1
22.3
2.2
3.4

2
5.1
20.3
8.9
4.1

1.3

5.2

Amount

Date

$28,820,000
18,100,000
31, 296,849
25,504,966
5,500,000
25,020,000
4,545,000
7,100,000
825,000
400,000

1930
1927
1927

Ili
ill

No.
No.
No.
No.
No.
No.
No.
No.
No.
No.

Per cent Per cent
of total of capital
security and surplus
loans

Maximum loans to
affiliates during year

1930

Out of 18 banks answering questionnaires in New York City,
only 7 had collateral loans outstanding to their affiliates at the end
of 1930. Several that had had large credits advanced to affiliated
security corporations previously had liquidated them by that time.
With one exception, the New York City banks showed moderate
commitments in this respect at the close of 1930 relative to their total
security loans.
T A B L E 15.—Loans to security affiliates, banks outside of New
Loans to affiliates, Dec. 31, 1930 i
Bank

State in which located
Amount

No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
1

1
2
3
4
5
6
7
8.
9
10
11
12

._
_
_

_.

_._
.

Massachusetts
do
New York
Ohio
...do .
Illinois
do
Michigan
Minnesota
do
Missouri...
California-

_._
_
„
__
_
._
_

None.
$1,000,000
None.
3,200,000
575,000
14,100,000
2,696,000
1,344,472
166,000
937,266
550,000
380,000

Per cent Per cent
of total of capital
security and surloans
plus
1.7

3.3

2.8
1.6
2.6
5.0
3.5
1.0
8.7
0.9
1.9

8.4
6.8
10.1
13.5
12.2
2.4
8.5
2.2
4.5

York

Maximum loans to
affiliates
Amount

Date

$7,985,000
2,600,000
4,700,000
4,120,000
1,021,000
21,000,000
4,920,000
6,788,264
394,650
937,266
1,500,000
600,000

1930
1927
1929
1930
1930
1930
1929
1930
1928
1930
1926
1930

In a few cases, the data are as of Sept. 24,1930.

Out of 25 representative out-of-town banks answering the question,
only 12 reported having made collateral loans to affiliates within the
past few years, and but 10 had such loans outstanding at the end of
1930. In general, it will be seen that several out-of-town banks
had a substantial part of their capital and surplus advanced as loans
to affiliates. The practice is not, therefore, as some suppose, restricted
entirely to the largest cities.
The question arises as to how some banks advance more than 10
per cent of their capital and surplus to affiliates, in view of the limita


NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

1019

tions on loans to one interest contained in Section 5200 of the Revised
Statutes for national banks, and cognate provisions in many State
banking laws, to 10 per cent of a bank's capital and surplus. This
limitation is circumvented in some cases through possessing several
affiliates, each with a separate corporate entity and thus entitled to a
separate line of credit up to the 10 per cent maximum. I n another
case, it was found that the advance above the 10 per cent limit was
secured by United States Government bonds as collateral, thus
constituting an exception from the restriction contained in the
statute. These bonds were not owned by the affiliate, however, but
borrowed from an unnamed source.
8. Deflation of security loans.—The total of security loans by banks
reached its peak after the break in the stock market in October, 1929,
because of the immediate enormously heavy withdrawal of loans
placed through the agency of the banks with brokers "for the account
of others." While the total volume of credit advanced on security
collateral declined rapidly after the panic, the banks for a time had
to take the place of these nonbanking or " o t h e r " lenders.
The deflation of total security loans of member banks, which
together are responsible for over 90 per cent of such loans of all
commercial banks, proceeded as follows:
T A B L E 16.-—Deflation

of security

loans of member

banks

[Source: Member bank call reports, Federal Reserve Board.]

Date

Oct. 4, 1929...
Dec. 31, 1929.
Mar. 27, 1930.
June 30, 1930.

All security
loans

Per cent of
Oct, 4,
1929, total
100.0
101.6
100.8
104.3

$9,993,767,000
10,147,866,000
10,073,809,000
10,425, 353,000

All security
loans

Date

Sept. 24, 1930.
Dec. 31, 1930.
Mar. 25, 1931.
June 30, 1931,

Per cent of
Oct. 4,
1929, total
103.3
94,5
90.6
83.4

$10,335,938,000
9,439,160,000
9,053,749,000
8,334,479,000

The deflation in the security loan total of 16.6 per cent from the
October, 1929, level does not present a complete picture of the situation, as it does not take account of the simultaneous virtual elimination of some $5,000,000,000 of such loans made "for the account of
others." A fuller presentation of the extent and character of the
deflation in security loans is presented below, in the section on brokers'
loans.
The deflation of bank security loans has been at a somewhat more
rapid pace in the interior banks than in New York, owing to the
greater extent to which the latter are tied up with the security markets, so that they usually supply funds to replace those withdrawn
by other lenders. This is indicated in the following table:
T A B L E 17.-—Deflation of bank security

loans

[Source: Member bank call reports, Federal Reserve Board]
New York City banks

Chicago and
reserve city banks

Date
Amount
Oct. 4,1929
June 30, 1931




^

I

$3,040, 000,000 |
2, 960,000, C O
O

30
36

Amount
$4, 282,000, 000
3,313,000,000

Country banks

Per cent
of total
43
40

Amount
$2,671,000,000
2,061,000,000

Per cent
of total
27
24

PART

II

BROKERS' LOANS
1. Expansion oj brokers' loans.—Statistics of loans on securities to
brokers and dealers are available in partial form for the past 15
years. They have been published regularly both by the Federal
Reserve Bank of New York and the New York Stock Exchange
since 1926, while earlier data represent a private compilation by the
Federal Reserve Bank of New York.
"Street loans" placed by New York City daily reporting banks
were first reported in October, 1917, to amount to $903,000,000, of
which $688,000,000 was for own account and $214,000,000 for correspondents. The highest point for such loans before 1922 was reached
in October, 1919, when they aggregated $1,422,000,000. They subsequently dropped to $719,000,000 in August, 1921, a decline of nearly
50 per cent, in connection with the postwar security market deflation,
and thereafter began a steady rise which, with moderate interruptions, continued through the decade.
Beginning with January 6, 1926, these figures have been made
public weekly, and are segregated into loans "for own account,"
those "for account of out-of-town b a n k s , " including nonbanking
lenders placing funds through interior banking institutions, and
loans "for account of others," or nonbanking lenders dealing directly
with the New York banks.
The total of such loans increased as follows from the beginning of
1926 to the panic period of 1929:
T A B L E 18.—Brokers 1 loans by and through reporting member banks in New York

City

{Source: Statement of Weekly Keporting Member Banks in New York City, Federal Reserve Bank o
New York]
Date

For own account

For account of
out-of-town
banks

For account of
others

Total

i
Jan.
Jan.
Jan.
Jan.
Oct.

27, 1926
26, 1927
25, 1928
30, 1929
2, 1929

_
.-

$1,201,000,000
865,000,000
1,275,000,000
1,091,000,000
1,071,000,000

$1,287,000,000
1,126,000,000
1,472,000,000
1,853,000,000
1,826,000,000

$610,000,000
741,000,000
1,041,000,000
2,615,000,000
3,907,000,000

$3,098,000,000
2,732,000,000
3,789,000,000
5, 559,000,000
6,804,000,000

The division between brokers' loans from bank and nonbanking
sources can not be made exactly from the above data, since the
loans placed by the reporting New York member banks for t h e
account of out-of-town banks include advances made for nonbanking
customers of these institutions. Such advances actually are made
"for the account of others," b u t originate outside of New York
City. A partial indication of the extent to which these loans for the
1020




NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

1021

account of out-of-town banks are for nonbanking lenders is furnished
by comparing them with the statistics of loans by out-of-town member banks to brokers in New York, as given in the member bank call
report showing the condition of all member banks. The comparison,
which indicates that at times as much as half of these out-of-town
funds may be for "others/' follows:
T A B L E 19.— Brokers7 loans from out-of-town member banks
(Sources: Weekly brokers' loans report Federal Reserve Bank of New York and member bank call
report Federal Reserve Board]
Loans for account] Loans to biokeis
in New York
of out-of-town
City by outside
banks
member banks

Date

October, 1928 i.
January, 1929..
October, 1929.
1

$1,682,000,000
1,648,000,000
1,826,000,000

By out-of-town
nonmembers
and others

$805,000,000
917,000,000
789,000,000

$877,000,000
731,000,000
1,037,000,000

Corresponding classification not available previous to Oct. 3, 1928, call date.

Loans made in New York City to members of the New York Stock
Exchange through channels other than the New York City reporting
member banks are available in the monthly reports of the exchange,
which give borrowings of its members made through commercial
banks in the city and those made via other channels separately. In
addition, loans are made by banks, including New York City institutions but more especially those outside, to brokers outside of the city.
These are available in the member bank call report. The following
table summarizes data from all of these sources, showing total
brokers7 loans from banking and nonbanking sources in the period
leading up to the stock market panic in October, 1929;
T A B L E 20.—Total brokers'

loans

[ Sources: Weekly brokers' loan report Federal Reserve Bank of New York; member bank call report
Federal Reserve Board, and monthly report on members' borrowings New York Stock Exchange]
By and through New York From piivate To brokers outbanks
banks, brokers, side of New
etc., to New
Yoik by outYork Stock
of-town memExchange
ber banks
Bank account
Others »
members

Date

October, 1928
January, 1929
October, 1929

_ $1,807, 000,000
2,008,000,000
1,860,000,000

_.

$2,835,000,000
3,346,000,000
4,944,000,000

$866,000,000
1,071,000,000
1,472,000,000

$805,000,000
925,000,000
893,000,000

Total

$6,313,000,000
7,350,000,000
9,169,000,000

* As shown above, loans made for "out-of-town banks" are divided in such a manner as to include loans
made by nonmember banks with the "others."

The total of brokers' loans shown in the above table is not complete
In several respects. I t does not include:
1. Loans made by nonmember banks to brokers outside New York.
2. Loans made through agencies other than New York reporting
member banks to nonstock-exchange members within the city, and
all "loans for the account of others," whether made through the
mediation of a bank or otherwise, to brokers outside of New York
City.




1022

NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

3. Credit balances and special deposits kept with brokers and
investment bankers.
2. Relation of brokers' loans to bank security loans.—It will be seen
from the above discussion that the category of brokers' loans includes
security loans advanced by the banks to brokers and dealers in
securities, as well as loans of this kind originating from nonbanking
sources. We can thus distinguish three main classes of security
loans—first, bank loans to brokers and dealers; secondly, bank loans
to other customers, and thirdly, loans to brokers and dealers, advanced
mainly through the agency of the banks, by nonbanking lenders. In
October, 1929, at the time of the stock-market panic, when the
total of security loans from banking and nonbanking sources was at
its height, the computed aggregate of security credit outstanding,
with comparisons with the year before, was as follows:
T A B L E 21.—All security

loans

October, 1929

Increase
(per
(cent)

$2, 749,000, 000 $2,824,000, 000
6, 375,000,000
7, 875,000,000
3, 701, 000,000
6,416, 000,000

24
73

12,825,000,000 i 17.115.000.000

34

October, 1928

Source

B a n k loans to b r o k e r s a n d d e a l e r s - - *
B a n k s e c u r i t y loans t o o t h e r c u s t o m e r s . .
L o a n s t o b r o k e r s a n d dealers b y others
Total.

.-.
—

I t will be seen from the above that restrictive credit policies of the
Federal Reserve authorities during this period was really effective
only in curtailing loans by banks to brokers and dealers.
The proportion of bank security loans advanced to brokers and
dealers varies widely as between individual institutions. D a t a on this
point as of the end of 1930 were secured in Questionnaire No. 1 on
security loans. The replies are tabulated herewith:
T A B L E 22.—Proportion of bank security loans made to brokers
NEW YORK CITY BANKS
PercentL o a n s on stocks age m a d e
and bonds
t o brokers
a n d dealers

Banks

No.
No.
No.
No.
No.
No.
No.
No.
No.
No.

1
2
3
4
5. - .
6
7
8
9
10

.____,
__
.-




$823,000,000
525,000,000
311,000,000
310,000,000
231,000,000
217,000,000
138,000,000
110,000,000
105,000, 000
104,000,000

Banks

_..
37 N o . 11
48 N o . 12
35 N o . 13
56 ! N o . 14
43 N o . 15
49 N o . 16
40 N o . 17
49 N o . 18
36
28
T o t a l (18 b a n k s ) . .

PercentL o a n s on stocks age m a d e
t o brokers
and bonds
and
dealers
95,000,000
89,000,000
63,000,000
49, 000,000
33,000,000
31,000,000
16,000,000
15,000,000

42
35
31
30
62
4S
28
14

3, 265,000,000

42

NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

1023

TABLE 22.—Proportion of bank security loans made to brokers—Continued
BANKS OUTSIDE NEW YORK CITY

Bank

No.
No.
No.
No.

1.
2
3—.
4

_

No. 6
No. 7„__
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.

9__
10—
11.._
12-.
13--14.
15
16
1718
19
20.
21
22
23
24
25
26

State in which located

_

-

_
-.
-_

Massachusetts.
do
do
Rhode Island
New York
Pennsylvania
_._.
_ d o ..
Ohio
—
--.
_._
do
Illinois
-.
do.
Michigan .
do .
-_._
-.do
.__
Minnesota .
.-.
. . do
do
-Missouri
..
Nebraska
California . . __
do
—
do
do
..-. . . do
_.
. do
.
Washington - -

Total (26franks).

Percentage made
Loans on stocks to brokers
and bonds
and
dealers

_ _

$169,000,000
59,000,000
12.000,000
28,000,000
82,000,000
56,000,000
30,000,000
113,000,000
36,000,000
548,000,000
54,000,000
47,000,000
38,000,000
7,000,000
28,000,000
16,000,000
11,000,000
59,000,000
1,000,000
159,000,000
91,000,000
39,000,000
32,000,000
21,000,000
20,000,000
1,000,000

54
46
25
23
5
10
11
34
21
57
31
10
5
8
7
12
17
25
0
40
42
17
10
52
4
9

1, 757,000,000

38

The percentage of security loans taking the form of advances to
brokers and dealers for all the member banks of the Federal reserve
system, divided according to central reserve city, other reserve city
and country banks, as of the end of 1930, follows:.
TABLE 23.—Percentage of all security loans advanced to brokers, all member banks
[Source: Member bank call report, Federal Reserve Board]

Banks in—
New York City
Chicago
Other reserve cities
Country
Average, all

41
34
14
5
23

Brokers' loans of all kinds constituted 50 per cent of all security
loans, including both bank and other sources, in October, 1928. A
year later, at the peak of the stock-market inflation, they constituted
53 per cent of the total. In June, 1931, the proportion was reduced,
however, to 22 per cent.
It will be seen that, outside of New York, the tendency is for the
larger banks to advance a greater proportion of their security loans
to brokers than the smaller institutions, whose security loans are
not only a smaller percentage of total resources but are also made to
individual local customers in thei main.
3. Loans for the account of others.—It was noted at the beginning of
this discussion of brokers' loans that the New York reporting member
banks had fewer loans to brokers outstanding for their own account
in October, 1939, than they did at the beginning of 1926. Owing to
pressure on the part of the Federal Reserve authorities the banks




1024

NATIONAL AND FEDEPtAL RESERVE BANKING

SYSTEMS

refrained from increasing the volume of such advances by them
despite the rise in rates paid on such loans. Parenthetically, it should
be noted that security loans to nonbrokers did rise sharply. On the
other hand, loans to brokers for the account of others rose steadily
and at an accelerated pace, until they amounted, in October, 1929, to
a grand total of $6,416,000,000 as computed above, or nearly 37 per
cent of all security loans and fully 70 per cent of all brokers' loans.
No data have been available in the usual banking statistics on
the origin of these loans for the account of others. I t was known
that they are placed, in the main, by a few institutions in New York
for the regular commission of one-half of 1 per cent per annum on
the amount handled. Loans were not taken, under the regulation
adopted by the New York Clearing House, in amounts of less than
$100,000. On and after November 16, 1931, member banks of the
New York Clearing House Association have been forbidden by that
body to place loans for others than banks with brokers.
In order to secure definitive information on the sources of this
vast volume of funds advanced by nonbanking lenders to brokers a
special questionnaire was addressed to the large New York banks
asking for a classification of sources as of the date when the largest
volume of such funds was handled in 1929.1
T A B L E 24.—Sources of brokers' loans for the account of others

Bank

No. 1.
No. 2
No. 3
No. 4
No. 5
No. 6
No. 7.
Total (7 banks)

Per cent Per cent
Per'cent
from
Highest amount business from in- Per cent
from
from inhandled, 1929 corpora- vestment dividuals foreign
trusts
banks
tions

Per cent
from
other
foreign
sources

$757, 000,000
631,000,000
437, 000,000
3b0, 000, 000
z 241,000, 000
153, 000, 000
97, 000, 000

168
49
56
57
42
73
63

16
2
18
7
0.1
4

11
30
33
23
4
17
15

19
3
2
1
0.1
8
1

2
2
1
1
1
3
0

2,676, 000, 000

58

8

18

7.5

2

* Includes investment trusts.
2 Includes loans from out-of-town banks of unstated amount.

As all of the banks mentioned attained their peak totals of brokers'
loans handled for the account of others at about the same time, the
distribution shown above is doubtless typical of the situation prevailing at the culmination of the stock market boom, and throws
considerable light on the problems involved in any effort to control
the expansion of such loans under similar circumstances in the future.
The highest total of loans for the account of others reported by the
New York banks was $3,907,000,000, on October 2, 1929, so that the
seven banks shown above handled approximately two-thirds of the
total.
The conclusion indicated is that loans for the account of others
originated in the main from business corporations, which were responsible for 58 per cent of the total shown by the seven banks in the
table. If investment trusts be included, the total indicated for domestic corporations is 66 per cent, thus indicating that any effort to
control the expansion of such loans through laws affecting lending
i Questionnaire No. 5, the text of which will be found in the introduction to this Part VII.




NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

1025

corporations directly would reach the bulk of such advances as made
through the New York reporting member banks.
A further question asked was, "If you had not handled these funds
for the lenders, is there any other channel through which they might
have found their way into the call loan m a r k e t ? " In the majority
of cases, it was stated that the funds could have been advanced to
the broker direct or through a private banker. There is grave doubt
in the minds of many well-informed observers, however, as to the
willingness of large corporations to advance their funds through existing channels other than the large commercial banks, since the latter
have regularly shown a willingness to increase loans for their own
account to replace the loans of " o t h e r s " when the latter are withdrawn, thus giving a de facto guarantee of the safety and liquidity
of such advances. However, if the banks were prohibited from acting
as agents in placing such funds, it is likely that higher rates during
periods of widespread popular speculation would cause the banks or
large private banking houses to develop special agencies for placing
these loans for the account of others with adequate assurance of their
safety.
During the latter stages of the stock-market boom it was said that
substantial amounts of money were being placed in the call-money
market through nonbanking channels, chiefly through the agency of
the money brokers. A questionnaire was addressed to several firms *
of money brokers to determine the nature and extent of such advances.
The leading firm of money brokers in New York City reported handling a maximum of $65,300,000 in brokers' loans for the account of
others on any one day in 1929, but all of this was actually advanced
through the banks, the firm acting merely as intermediary between
lender and banks. No compensation was taken from the lenders for
this service.
Another concern affiliated with a large Boston banking organization handled $107,000,000 as a maximum amount for any day in
1929, but the details of the reply indicate that these funds were probably advanced for the account of out-of-town banks in New England,
rather than for other nonbanking lenders. In general, the conclusion
from these and other replies received is that in 1929, despite the fact
that brokers' loans for the account of others attained an enormous
aggregate in 1929, money brokers played an insignificant role. On
the other band, as shown in the monthly report of the New York
Stock Exchange, private banking houses, foreign bank agencies and
similar channels fed some $1,500,000,000 at the peak to stock exchange
members, both for their own account and for clients.
Brokers' loans for the account of others constitute a peculiar development in the credit structure, since, unlike bank loans, they do
not give rise to a corresponding increase in bank deposits. They
represent merely the transfer of already existing deposits to other
accounts. Nevertheless, in practice they constitute potential liabilities of the banking system, since on their concerted withdrawal they
are replaced by loans advanced for the account of the banks themselves, as shown by the October, 1929, experience.
From the broad point of view of credit analysis, loans for the account
of others tend to have the same effect as new bank loans, through
1

Questionnaire No. 3 the text of which will be found in the introduction to this Part VII.




1026

KATIOKAL AND FEDERAL BESERVE BANKING SYSTEMS

increasing the velocity, although not the amount, of the bank deposits
transferred. Funds placed on call for the account of nonbanking
lenders usually represent inactive deposits of the latter, which are
made active, or "energized," so to speak, through their transfer to
brokers, and through the latter to sellers of securities. The increase
in velocity does not necessarily affect business outside of the security
markets, however, since the same fund may be traced via corporations issuing new securities through several loans for the account of
others. Thus, Corporation A may place funds on the call market,
which funds are borrowed by X to permit him to buy stock in
Corporation B, an investment trust. The latter may in turn place
the same funds on call immediately on their receipt, and they are
then borrowed by Y to purchase shares of Corporation C, which may
conceivably in turn lend a portion of this same fund through the call
money market to Z. Thus this multiple increase in the aggregate of
loans for the account of others, while tending further to build up an
inflated and dangerous speculative structure in the security markets,
does not necessarily affect general purchasing power to the extent
indicated by the mere totals reported.
Furthermore, since loans for the account of others do not involve
a corresponding creation of new bank deposits, no increase in Federal
reserve credit is needed to support an expansion in such advances.
Hence, they can, and in 1928 and 1929 did, expand freely in response
to the attraction of high interest rates despite efforts by the Federal
reserve authorities to restrain brokers' loan expansion. There is
nothing in the existing credit control mechanism, except a general
" h a r d money" policy, which is effective in keeping these loans for
the account of others within bounds.
4. Control of brokers' loans.—The unprecedented expansion of
brokers' loans in 1928 and 1929, accompanied as it was by spectacular
advances in security prices, attracted widespread attention at the
time and occasioned some effort to control them.
The first official cognizance of possible abuse of brokers' loans was
taken as long ago as 1855, in a report of the Massachusetts Banking
Commissioners, which inveighed against " loans on stocks, instead of
discounts of promises representing something that has an intrinsic
value." In more recent years we find little official reference to brokers' loans until the period of major inflation in the security markets
beginning about 1926.
The Committee on Banking and Currency of the United States
Senate held hearings on the subject of brokers' loans early in 1928, in
the course of its consideration of Resolution 113, Seventieth Congress,
first session, directing the Federal Reserve Board to bring about a
contraction of loans for speculative purposes and to suggest legislation for controlling them in the future. This resolution, however,
was particularly directed at preventing the use of Federal reserve
credit as a basis for security loan expansion, rather than at curtailing
excessive security loans as such. I t stated:
Resolved, That it is the sense of the Senate that the Federal Reserve Board
should immediately take steps to restrict the further expansion of loans by member banks for speculative purposes and as rapidly as is compatible with the financial stability of the Nation require the contraction of such loans to the lowest
possible amount; and be it further




NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

1027

Resolved, That the Federal Reserve Board be directed to report to the Congress
what legislation, if any, is required to prevent the future use of the funds and credit
of the Federal Reserve system for speculative purposes.

Owing to the fact that Reserve bank credit supports approximately
a tenfold load of member bank credit, and that the proceeds of the
rediscount of one member bank, for whatever purpose made, tends to
be shifted immediately to the reserve accounts of other banks, the
effort to trace the use of Reserve credit in the expansion of security
loans naturally was without result.
Gov. Roy A. Young expressed the views of the Federal Reserve
Board on the situation as follows:
I am not prepared to say whether the brokers' loans are too high or too low.
I do not think anybody else can say so. I am satisfied they are safely and conservatively made.
Now, if there is a further expansion of this brokers' loan account and it gets
to the place where it is dangerous and borders on unwarranted speculation, I
have enough confidence in the American banking fraternity to believe they can
correct that situation themselves. My conclusion is that there is no constructive legislation that I can recommend to this committee at the present time.

The annual report of the Federal Reserve Board for 1928 again
associates the question of brokers' loan control with that of Federal
reserve credit as follows:
The Federal Advisory Council on November 22, 1928, recommended to the
Federal Reserve Board with respect to *' the proper function and use to be made
of banking investments in brokers' loans," that "in so far as this refers to noncustomer loans, the council is of the opinion that such investments are proper
for member banks to make with surplus funds only, except for the purpose of
meeting a temporarily disturbed situation. Member banks, however, should
not borrow to carry these loans solely for the purpose of making a profit."

In its annual report for 1929, appearing shortly after the panic,
the Board refers briefly to brokers' loans for the account of others,
as follows:
Loans to brokers by nonbanking lenders, although they do not directly involve
member banks, have none the less an effect on the banking situation, both
because the banks are aware of the necessity of taking over such loans in case
an emergency develops and because their existence and employment results in
a much more active use of bank deposits.

Despite the very significant and mischievous role played by brokers'
loans for the account of others during the stock-market inflation, no
special steps were reported by the Federal Reserve authorities to
investigate them for purposes of future control until the present
investigation was ordered by the Senate Committee on Banking and
Currency. At about that time, the Federal Reserve Bank of New
York set on foot a thorough-going analysis of the brokers' loan situation, which has been furnished to the committee.
5. Deflation in brokers7 loans.—The total of brokers' loans as
reported by various sources declined by 77 per cent from October,
1929, the peak of the inflation period, to June, 1931, a period of 20
months. During this same period, security loans to other customers
by all member banks dropped 8 per cent. It is thus evident that the
burden of deflation weighs especially heavily upon the brokers' loan
element in the security loan total, and that such loans can be cut
down in amount much more rapidly and effectively than the security
loans to nonbroker customers.
34718—31—PT 7




3

1028

NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

During the 20-month period from the stock-market panic to June,
1931, several stages of liquidation can be distinguished. The first,
reflected in the bank statements from early in October to the end of
1929, is marked chiefly by a drastic deflation in loans "for the account
of others/' which had to be replaced in large measure for a few weeks
and on very short notice by the New York City banks. This they
were readily able to do, at the same time maintaining the call money
rate at 6 per cent without change, by reason of liberal purchases of
Government securities by the Federal reserve banks. Bank loans
on securities directly to nonbroker customers also rose. The comparison in the security loan status of the beginning of October and
the end of December, 1929, is as follows:
T A B L E 25.—Deflation in security loans, October 4, 1929, to December 31, 1929

M e m b e r b a n k loans to brokers a n d dealers
B a n k security loans to other c u s t o m e r s - _
L o a n s t o brokers a n d dealers b y others
Total

Change
(per c e n t )

Oct. 4, 1929

___

-

$2,463,000, 000
8, 450,- 000,000
2, 419,000,000

—62

17, 044,000, 000

_ - . -

Dec. 31, 1929

$2, 824,000,000
7, 875, 000,000
6,416,000,000

Source of loans

13, 732, 000, 000

— 19

—13

+7

The second stage in the deflation was a moderate reduction in
bank security loans to customers, accomplished on a rising market
in the spring of 1930, along with further sharp reductions in loans by
others, which continued to decline rapidly through 1930 in view of
the low rates paid on such advances. The contraction in all security
loans during 1930 was distributed as follows:
T A B L E 26.—-.Deflation in security loans, 1930
Dec. 31, 1929

_.
. _ _ . . .

Total

Change,
per cent

$2,173, 000,000
8,000,000,000
587,000,000

—12
—5
—76

13, 732,000,000

M e m b e r b a n k loans to brokers a n d d e a l e r s . . B a n k security loans to other customers
-

Dec. 31, 1930

$2, 463,000,000
8, 450, 000,000
2,419,000,000

Source of loans

10, 760,000, 000

—22

The third stage of deflation, during the first half of 1931, witnessed
a more marked decline in bank loans on securities to nonbroker
customers, as well as in brokers' loans by the banks. I t will be noted
that real deflation in these two categories actually got under way in
drastic measure only after loans by other lenders had been reduced
from well over $6,000,000,000 to negligible amounts.
T A B L E 27.—Deflation in security loans, first half of 1931
Sources of loans

Dec. 31, 1930

M e m b e r b a n k loans to brokers a n d dealers
B a n k security loans to other customers _
L o a n s t o brokers a n d dealers b y others Total




.
-

$2,173,000,000
8,000,000,000
587,000,000

$1, 732, 000,000
7,250,000,000
366, 000,000

10, 760,000,000

Change,
per cent

J u n e 30, 1931

9, 348,000,000

—20
—9
-38
—13

(

NATIONAL AND FEDERAL KESEBVE BANKING SYSTEMS

1029

While the decline in the total outstanding volume of security credit
was most rapid in the first stage of deflation during and immediately
after the panic of 1929, the effects of the credit contraction on general
business, aside from psychological factors, may well have been greater
in the later stages of the deflation.
The basis of this assumption is that in the earlier stages the deflation was primarily in loans for the account of others, which include,
as has been seen, considerable duplication of funds, so that there was
not necessarily any corresponding decline in the velocity of the bank
deposits as applied to general business use. On the other hand, as the
deflation affected increasingly brokers' and other security loans made
by the banks, in its later stages repayment meant a cancellation of
bank deposits, which had a direct effect upon general purchasing
power. While contraction in such loans was offset largely by increases
in bank investments, chiefly United States Government bonds, there
is good reason to believe that the velocity of the deposits created by
these latter operations in securities is substantially less than the rate
of turnover of deposits canceled through repayment of security loans
by the banks.




PAET

III

BANK INVESTMENTS
1. Expansion of bank investments, 1921-1930.—Expansion
of bank
credit through the security markets may take either one of two forms.
It may occur through loans on securities, considered in the first two
p a r t s of this report, or in direct investments in these securities by the
banks. I n the former case the risk of fluctuation in the values of
the securities is borne, in the first instance, by the borrowers, and
t h e bank by timely action can usually protect the principal of its
loans. In the case of security investments, on the other hand, the
risk attending price fluctuations is borne entirely by the bank itself,
except where recourse is had to special protective devices, such as
repurchase agreements or contracts of guaranty against loss.
Neither the national bank act of 1863, nor the numerous banking
statutes in this country before that time, contemplated investments
in securities by commercial banks. However, under an opinion of
the Comptroller of the Currency, national banks did purchase bonds
for investment without additional legislative authorization under
section 5136 of the Revised Statutes, permitting them to discount
and negotiate promissory notes, drafts, bills of exchange, and other
evidences of debts. State banks in many instances have engaged in
the purchase of securities on even a broader scale, in some cases
being able to buy stocks as well as bonds for investment under State
law.
Before the war, national banks held a substantial volume of United
States Government bonds to secure national bank notes in circulation.
At the end of 1914, all member banks held $2,079,000,000 in bonds, of
which $760,000,000 were United States Government issues, held
primarily for circulation purposes, and $1,319,000,000 other securities.
During the war, the banks largely expanded their holdings of Government bonds, purchasing them as investments, so that by the end of
1918 holdings of United States obligations largely exceeded other
security investments.
The increase in security investments of all commercial banks during
the decade 1921-1930 was as follows:
TABLE 28.—Security investments, all commercial banks
[Source: Annual Reports of the Comptroller of the Currency]
June 30, 1921
Class of banks
Amount

National banks
State banks
Trust companies
Total

1030



_

-_ -

J u n e 30, 1930

Per cent
of total
resources

Amount

P e r cent
of t o t a l
resources

$4, 025,081, 000
2, 438,057,000
1, 942,676,000

20
J-7
24

$6,888,171,000
2,947, 712,000
3, 835, 746,000

24
19
22

8,405,814,000

20

13,671,629, 000

22

NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

1031

The increase in the security investments of all commercial banks
shown in the above table amounted to 63 per cent, which compares
with an expansion of 50 per cent in their security loans, as reported
by the Comptroller of the Currency, during this same period. The
expansion of investments continued steadily from year to year until
1928, when a period of high interest rates and declining bond prices
intervened to discourage the banks from adding to their bond portfolios. With the deflation in interest rates in 1930 the expansion in
the bond portfolios of the banks was resumed at an accelerated pace.
Bond investments for national banks were given specific recognition
in the McFadden Act of 1927, which provided that " t h e business of
buying and selling investment securities shall hereafter be limited to
buying and selling without recourse marketable obligations evidencing
indebtedness * * * in the form of bonds, notes, or debentures
commonly known as investment securities, under such further definition of the term 'investment securities' as may by regulation be
prescribed by the Comptroller of the Currency."
Thus, the only real limitation on the types of bonds which can be
purchased by national banks is the factor of marketability. The
Comptroller of the Currency is given the final responsibility for determining what is marketable, and he has ruled that the term be understood in its very broadest significance. His regulation on the subject
is as follows:
Under ordinary circumstances, the term "marketable" means that the security
in question has such a market as to render sales at intrinsic values readily possible.

He further states that three factors would be given consideration in
all cases in classifying a given security as marketable:
1. Sufficient size of entire issue to make marketability possible.
2. Such public distribution provided for as to insure marketability.
3. An independent trustee for the issue, either a bank or trust
company.
These regulations appear to have been interpreted very liberally,
so that virtually every public issue of bonds would qualify for national
bank investment under them.
2. Analysis of expansion.,-—The increase in security investments of
all banks from 1921 to 1930, divided as to member and nonmember
banks, was as follows.
TABLE 29.-—Security investments, member and nonmember banks
[Source: Annual Reports of the Comptroller of the Currency]
Year
1921
1922
1923
1924_
1925
1926
1927
1928
1929
1930

National banks

-_
-

_.

__
-




$4,025, 000,000
4, 563,000,000
5, 070,000,000
5,142,000,000
5, 730,000,000
5,842,000,000
6,393,000,000
7,147,000,000
6,657,000,000
6,888,000,000

State member
banks
$1,977,000,000
2,454,000,000
2, 687,000,000
2,821,000,000
3,133, 000,000
3,281,000,000
3,425,000,000
3,611,000,000
3,395,000,000
3, 554, 000,000

State nonmember banks
$2,404,000,000
2,162,000,000
2,324,000,000
2, 645,000,000
2, 720,000,000
2, 746,000,000
3,465,000,000
3,805,000,000
3,112,000,000
3,229,000,000

Total
$8,406,000,000
9,179, 000,000
10,081,000,000
10,608,000,000
11,583,000,000
11,869,000,000
13,283,000,000
14,563,000,000
13,164,000,000
13,671,000,000

1032

NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

The above table indicates that the expansion in investments was
most marked for the State member banks, which showed a rise of 80
per cent in this item for the decade. National banks reported an
expansion of 71 per cent in investment portfolios and State nonmember banks 34 per cent.
The continued resort to security investments as a commitment
for bank funds has been common to all groups of banks. This is
indicated in the following table on holdings of national banks in
central reserve city, other reserve city and country banks:
T A B L E 30.—Security investments

of national banks, by groups

[Source: Member bank call reports, Federal Reserve Board]
1921
Bank groups
Amount
Central reserve city banks.
Other reserve city banks
Country banks

„_

1930
Per cent
of total

Amount

Per cent
of total

___

Total

$629, 599, 000
685. 687,000
2, 509,615,000

16
17
67

$1,159,760,000
2,093,465,000
3,634,946,000

17
30
53

4, 025,081, 000

„_

100

6,888,171,000

100

The extent to which member banks, in each of these bank groups,
had invested their resources in securities at the end of 1930 is shown
in the following table:
T A B L E 31.-—Security investments

of member banks, by groups

[Source: Member bank call reports, Federal Reserve Board]
Bank groups
New York City banks„_
Chicago banks
Other reserve city banks.
Country banks
Total

Number of Security investbanks
ments

Per cent
of total
resources

48
14
402
7,588

$2, 435,356,000
517, 586, 000
3, 517,429,000
4,518,652,000

18
20
22
29

8,052

10, 989, 023, 000

23

Country banks, it will be noted, have a larger proportion of their
resources in bond investments than do city institutions, whereas the
latter are more heavily involved in security loans. This reflects the
relatively restricted demand for advances on security collateral in the
smaller communities, and the less direct access of country banks to
the financial centers, where the need for security loans is keenest.
I t also reflects the larger proportion of time deposits of the country
institutions, as it is generally felt the receipt of such deposits justifies
the making of less liquid commitments, including the purchase of
securities that may not be readily marketable.
The nation-wide character of the expansion of bank investments is
indicated in the following table, showing the increase from 1921 to
1931 for reporting member banks by districts:




NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

1033

T A B L E 32.—Investments of reporting member banks, by districts
[Source: Statements of condition weekly reporting member banks in leading cities]
F e d e r a l reserve district

Boston.
N e w York _
Philadelphia
Cleveland
Richmond
Atlanta
Chicago
S t . L o u i s . - -__
Minneapolis
Kansas City
Dallas
S a n Francisco

._

J u l y 2, 1930

$180,000,000
1, 337, 000,000
239, 000, 000
420,000, 000
126, 000,000
72,000, 000
485, 000,000
98, 000,000
40, 000, 000
91,000,000
49, 000, 000
310, 000, 000

$369,000, 000
2,431, 000,000
326,000, 000
725,000,000
180,000,000
135, 000, 000
731, 000,000
152,000, 000
125,000,000
220, 000,000
113,000,000
615,000, 000

105
82
36
73
43
88
51
55
213
142
131
98

3,447, 000, 000

6,120, 000, 000

78

_

..-

.- .- .
..
_ _
_

-

_-

_._ _ _.

-

_.
_ -

Increase,
per cent

J u n e 29, 1921

_
_,-

-.

Total

_._

3. Types of securities purchased.—Bank holdings of all classes of
bond investments showed increases during the decade 1921-1930.
The following table summarizes the growth in security holdings of all
commercial banks in the United States during the period by the
major types of securities held:
T A B L E 33.—Increase in investments

of all commercial banks, by types of
1921-1930

securities,

[Source: Annual Reports of the Comptroller of the Currency]
1921

1930

T y p e of s e c u r i t y
Amount

U n i t e d States G o v e r n m e n t b o n d s
State, county, and municipal bonds
Railroad and public utility bonds
O t h e r b o n d s , stocks
_Total

__

Per cent
of t o t a l

Amount

P e r cent
of t o t a l

$2,924, 000, 000
722,000,000
1, 396, 000, 000
3, 364, 000, 000

35
9
17
39

$3,614, 000, 000
1, 221, 000,000
1, 968, 000, 000
6, 869, 000, 000

26
10
15
49

8,406, 000, 000

100

13,672,000, 000

100

I t will be seen from the above table that practically half of the
security investments of the banks were outside the Government, railroad, and public utility groups in 1930, whereas less than 40 per cent
was so invested 10 years before. The increase in holdings outside of
these groups was especially marked in the case of smaller institutions,
as is seen from the following table showing the investments of national
banks by groups as to each of these types of securities:




1034

NATIONAL AND FEDERAL RESERVE BANKING

SYSTEMS

T A B L E 34.— Change in percentage distribution of investments,
banks,
1921-1930

by groups of member

[Source: Member bank call reports, Federal Reserve Board]
Central reserve Other reserve Country banks,
per cent of
cities, per cent cities, per cent
total
of total
of total

Type of security.

1921

._

1930

1921

1930

__

__.
_

__

52
10
15
23

56
5
16
23

53
11
13
23

52
13
13
22

48
9
19
24

28
12
29
33

100

United States Government bonds
State, county, and municipal bonds
Railroad and public utility bonds. __
Other bonds, stocks
Total

1921

1930

100

100

100

100

100

Security investments of member banks are now reported in considerable detail. The distribution of these investments at the end of
the first quarter of 1931 was as follows:
T A B L E 35.—Investments of all member banks, March 25, 1931
[Source: Member bank call reports, Federal Reserve Board]
Per cent
of total

Amount, Mar.
25, 1931

Type of security
United States Government bonds...
State, county, and municipal bonds
Railroad bonds
Public utility bonds
All other bonds.
Stock of Federal reserve banks
Other stocks
Corporation notes
Municipal warrants
All other
Foreign government bonds...
Other foreign securities

42
13

002,000, 000
554,000,000
004,000,000
103,000,000
295,000,000
167,000,000
574,000,000
214,000, 000
214,000,000
57,000,000
369,000,000
336,000,000

Total

11
1
5
2
2
1
3
3

11, 889,000, 000

100

A detailed classification of member bank investments in securities
as of the same date, March 25, 1931, again indicates the tendency
for the smaller banks to buy groups of securities generally regarded
as less marketable and secure.
T A B L E 36.—Percentage distribution

of member bank investments,

by groups

of banks

[Source: Member bank call reports, Federal Reserve Board]

Type of security

United States Government bonds. „.
State, county, and municipal bonds.
Railroad bonds
Public utility bonds. _
All other bonds
Stock of Federal reserve banks
Other stocks
Corporation notes
Municipal warrants
All other..
Foreign government bonds.
Other foreign securities
Total




|

New
York

Chicago

49
14
6
6
10
1

4
2

56
7
2
4
6
1
1
1
15
2
3
2

27
13
11
16
16
1
4
1
2
1
4
4

100

100

100

100

55
13
8
3
5
2
6
2

1
!

Other re- Country
serve
banks
cities

°
0

6
2
1
1 1
2 1
2

NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

1035

4. Convertible bonds.—Owing to the fact that national banks and
many State institutions are not permitted to purchase stocks for
investment, there has been some tendency to invest in stocks indirectly through the purchase of convertible bonds, or bonds with stock
purchase warrants attached. In order to determine the extent to
which such issues have been purchased by banks, the following
question was asked: *
What proportion of your holdings consists of convertible bonds, or bonds with
common-stock purchase warrants attached?

A list of the 10 largest holdings of this character was also requested.
TABLE 37.—Proportion of bond investments in convertible or option issues
N E W YORK CITY BANKS
Percentage in
convertible and
option
issues

Bank

No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.

1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18

_.

_

Natuie of larger holdings of this type

3.91 Railroad.
.10
Do.
4.09
Do.
2.75 Hotel, lailroad.
.20 Coal, holding company.
1.25 Chain stoie.
3.00 Raihoad.
.54 Installment finance company.
2.98 Railroad.
4.45 Hardware manufacturing company.
1.60 Utility, office equipment manufacturing company.
1.00 Cement manufacturing company.
3.61 Amusement company.
5.00 Railroad.
14.89
Do.
1.30
Do.
.67 Investment trust.
15.00 Holding company.
BANKS OUTSIDE N E W YORK CITY

Bank

No. 1
No. 2
No. 3.
No. 4
No. 5
_
No. 6
No. 7
No. 8
_
No. 9
No. 10
No. 11
No. 12...
No. 13
No. 14

State in which
located

Massachusetts
do
do
New York
Ohio
do
Michigan
.. _
Illinois
do
Missouri
Minnesota
North Dakota
California,
do

Percentage in
convertible and
option
issues
3.00
4.70
5.70
7.96
13.00
11.00
.30
1.00
2.20
1.12
.80
6.50
.54
1.60

Nature of larger holdings of this type

Razor manufacturing company.
Utility.
Investment trust.
Railroad.
Railroad, investment trust.
Public utility, holding company.
Railroad.
Public utility.
Coal company, public utility.
Public utility.
Railroad.
Public utility, investment trust.
Railroad, investment trust.
Hotel, razor manufacturing company.

A number of out-of-town banks and one New York City institution
reported no holdings of this kind whatsoever.
Despite the lack of restriction on this type of investment, such
holdings at the end of 1930 constituted but a small proportion of the
i T h e full text of questionnaire No. 4, on "bank security investments, is in the introduction to this
Part VII.




1036

NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

total of bank bond investments. No case was found where convertible or option issues amounted to as much as 15 per cent of a bank's
security portfolio.
Convertible issues as a class suffered quite severely in the decline
in bond prices, outside the gilt-edge group, in 1930 and 1931. This
resulted from the fact that this type of bond represents generally
less well-secured issues, which possess conversion and warrant features
as offsetting factors to attract the interest of investors. Several
sample lists of 10 largest holdings of this character, with original cost
and market values as of the end of 1930 compared, are presented,
herewith. Needless to say, sharp further declines in market value in
virtually every case took place in 1931.
Bank 1

Original cost

Bond

Chicago, Rock Island & Pacific, 4^/1960. .
F. & W. Grand-Silver Stores (Inc.), 6/1940.
Atchison, Topeka & Santa Fe, 4M/1948___.
Chicago & North Western, 4%/1949__
General Theatre Equipment, 6/1940
Metropolitan Stores, 6/1940
Baltimore & Ohio, 4^/1960
American International, 5^/1949_-_
Texas Corporation, 5/1944
Southern Pacific, 4M/1969

Market value
December,
1930

481, 250
395,312
184, 380
015,277
422,006
958,125
847, 968
797, 820
622,989
479,131

Total.

168,750
395,312
845,000
743,280
830, 280
958,125
790,500
717, 500
618,542
486,250

14,202, 258

12, 553,539

The decline of nearly 12 per cent which had taken place by the end
of 1930 had increased to approximately 30 per cent by the late summer
of 1931, assuming no change had taken place in these holdings in the
interim. Two of the holdings, the F. & W. Grand-Silver Stores (Inc.),
and Metropolitan Stores issues, had no markets, but similar issues
sold at large discounts from par at that time.
Bank 2

Bond

Missouri Pacific, 5/1949
Texas Corporation, 5/1944
Southern Pacific, 4^/1949
Simmons Co., 5/1944
Alleghany Corporation, 5/1944
Baltimore & Ohio, 4)^/1960
Chicago, Rock Island & Pacific, 4^/1960
Chicago & North Western, 4^/1949
International Telephone & Telegraph, 4^/1939
Alleghany Corporation, 5/1950
Total

Original cost

Market value
December,

$3,000, 000
1,266, 980
1,021, 835
950,822
744,375
691, 570
634,141
612,150
554, 711
430,972
9, 907, 556

760,000
267,200
044,690
950,822
562, 500
657,800
563,300
550, 710
395,000
333, 740
9,085. 762

The above list, by August, 1930, showed a depreciation of about
28 per cent from original cost.




NATIONAL AND FEDEEAL RESERVE BANKING SYSTEMS

1037

Bank 8

Bond

Atchison, Topeka & Santa Fe, 4M/1948
Niagara Share Corporation, 5*^/1950
Alleghany Corporation, 5/1944
Van Swerengin, 6/1935
_
Baltimore & Ohio, 4^/1960
Warner Bros. Pictures, 6/1939
Chicago & North Western, 4^/1949
International Telephone & Telegraph, 4^/1939
Missouri Pacific, 5^/1949
__
American International, 5^/1949
Total

Original
cost
$433,680
404,652
313,520
312,908
308, 690
298, 502
294, 235
282,300
214,053
201, 857
3,064,397

Market values, December, 1930
$421, 200
384,000
252, 750
270, 580
288, 750
223, 500
273,000
225,000
199, 000
188, 000
2, 725, 780

Depreciation in this case had increased to approximately 26 per
cent by August, 1931.
Bank 4
Bond

Cities Service, 5/1950
Van Swerengin Corporation, 6/1935
Associated Gas & Electric, 5H/1938...
—.
Kreuger & Toll, 5/1959__
Alleghany Corporation 5/1944
Chesapeake Corporation 5/1947
Associated Gas & Electric, 4^/1949
Commercial Investment Trust, 5J4/1949
Chicago, Milwaukee & St. Paul, 5/2000
International Telephone & Telegraph, 43^/1938
Total.

._

Market valOriginal cost ues, December, 1930
$714,033
640,076
560, 215
494, 687
468, 779
455,182
377,125
354,933
343, 206
301, 636

4, 709,872

$557,467
595, 000
436,815
430,000
420,000
451, 287
279,000
325, 655
176, 680
274, 500
3,946,404

The decline in this case of 16 per cent at the end of 1930 had been
increased to some 37 per cent by the middle of 1931.
5. Diversification.—The published banking statistics include detailed data on the distribution of bank investments among different
types of securities. They do not show, however, the extent to which
diversification takes place in the individual institution as between
individual issues.
The following table shows the percentage of its investments, other
than United States Government bonds, placed in its largest single
holding and its 10 largest holdings for each of a group of banks, based
on replies to Questionaire No. 4:




1038

NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

T A B L E 38.—Percentage of investment funds in individual issues, outside United States
Government, New York City banks
Percentage
of t o t a l in
largest
individual
holding

Bank

No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.

1
2
3...
4
5__
6.
7
8
9
10
11
12
13
14
15
16
17
18

_._
10 M u n i c i p a l
6
4 ~~~"do""-~-""--"~™II~~
4 German industrial
11 Foreign g o v e r n m e n t
U 4 Municipal
4 Traction
16 M u n i c i p a l
2
do
__
12 Foreign g o v e r n m e n t
___
7 Municipal
'_-.
12
do
16 R e a l e s t a t e . .
17 M u n i c i p a l
_
_._
8
173
_. _
_.
8 Railroad
21 H o l d i n g c o m p a n y .

—
__
__

_..

_._
._.
_
.
_._
__
___

Percentage
of t o t a l in
10 largest
holdings

N a t u r e of largest holding

_

40
25
23
22
34
38
17
41
18
35
27
48
78
24
43
84
50
75

i All issues of one municipality lumped in reply.
Percentage of investment funds in individual issues, outside United States
banks outside New York City

State in w h i c h located

Bank

No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.

1
2
3
4
5 .
6
7
S ..
9
10
11
12
13
14
15
16
17 .
18
19
20
21
22
23
24
25.

_

Massachusetts
do
do.._.
Rhode Island ,
New York.Pennsylvania
.
do .
Ohio
do
Michigan
do
do
.._
Illinois
do
Missouri
Wisconsin __
Minnesota
do
do
North Dakota
Nebraska
California
do
do
do

_.

Percentage in
largest
holding
13
5
13
3
10
18
7
2
5
13
14
11
7
29
8
3
11
8
5
3
4
6
5
2
13

Government

N a t u r e of largest holding

Foreign g o v e r n m e n t _ _
Public utility
.
__
Railroad..
_ _
Foreign g o v e r n m e n t
Holding company
Traction _
Municipal
. ..
do
Railroad
.__ . . .
Hardware Manufacturing C o m p a n y . _
Municipal..
-Sugar C o m p a n y , .
.
Municipal
- do
Federal i n t e r m e d i a t e credit b a n k s
Industrial
_. _
M u n i c i p a l _ __
_
do
do
do
Railroad
Municipal
do
do
do

Percentage
of t o t a l i n
10 largest
holdings
46
19
90
18
23
84
28
14
26
48
48
40
30
76
29
20
42
21
30
20
16
26
22
12
32

6. Marketability.—-The factor of marketability of security investments is conditioned by a number of factors, of which listing is merely
one. It has been said that whereas listing tends to enhance marketability of stock issues, it may mean lessened marketability for bonds,
because of the fact that market sponsorship may be discouraged
thereby. At any rate, concerted liquidation of bond investments
caused many very drastic declines in 1930 and 1921, both in the listed
and unlisted groups. Listed issues for the most part have the advantage, however, of known quotations at which actual transactions
take place.



NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

1039

The following tables show the proportion of security investments
listed on the New York Stock Exchange and other exchanges for a
number of banks, as shown in replies to Questionnaire No. 4:
T A B L E 39.—Proportion of bond investinents

listed

N E W YORK CITY BANKS
Percentage Percentage
listed on
on
N e w Y o r k listed exother
Stock
changes
Exchange

Bank

No.
No.
No.
No.
No.
No.
No.
No.
No.

1
2
3
4_
5-__
6
7
8
9

2
5
2
4
6
0
2
1
7

61
73
77
90
42
80
83
45
83

. .

Percentage u n listed

Percentage Percentage
listed i n
N e w Y o r k listed o n
other exstock
changes
Exchange

Bank

37 N o . 10
122 N o . 11___
21 N o . 12
6 N o . 13
52 N o . 14
20 N o . 15
15 N o . 16
54 ! N o . 17
10 N o . 18

50
73
25
9
76
42
18
95
81

._
._..

12
6
1
2
6
7
1
5
15

Percentage u n listed

38
21
74
89
18
51
81
0
4

1
Reply states "balance of holdings are mostly short-term State, municipal, and corporate securities not
listed but having an active market."

BANKS OUTSIDE OF N E W YORK CITY

No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.

1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19._
20

Percentage
listed o n Percentage
N e w Y o r k listed o n
o t h e r exStock E x changes
change

S t a t e i n w h i c h located

Bank

_

_

_
_

do
___
do
Rhode Island
New York
_. P e n n s y l v a n i a
do
Ohio.
do.
Michigan
Illinois
do
Missouri..
Minnesota
do.
_„_ North Dakota
Nebraska
California
do
do

_. _
_-_.
_

-

_

..
_ ._

.

51
60
75
85
69
83
60
50
65
75
22
76
26
70
83
50
30
74
70
46

23
19
13
3
8
4
10
13
5
1
5
9
30
1
35.

Percentage u n listed

26
21
12
12
23
13
30
37
135
20
37
19
65
16
15
70
26

30
54

* Estimates 80 per cent of total "readily marketable." It is interesting to note that this is a national
bank and that the McFadden Act laid stress on "marketable obligations" as suitable for banks investment.

The lack of marketability appears most marked in the case of
smaller industrial and real estate mortgage bond issues, and several
foreign short-term securities. Issues of this kind, without a previously
established market, can be disposed of only with the greatest difficulty
during periods of deflation in the bond market, when this quality
may be of special importance.
7. Accounting for security investments.—In view of the large proportion of total banking assets placed in bonds, the method of carrying
such investments in the banks' condition statement becomes a
matter of first-rate importance. At times of stable or rising bond
prices, the bond accounts give no trouble in this respect, but in a




1040

NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

period of deflation, such as 1930-31, the market value of the bond
portfolio may decline far below original cost.
Several alternative methods have been followed by banks in stating their bond investments in their condition statements. These
include:
1. Original cost.
2. Original cost, with amortization of premiums and accumulation
of discounts to maturity.
3. Original cost, with a partial reserve against market depreciation.
4. Composite market value of the entire portfolio, permitting
appreciation in some issues to offset depreciation in others, in so far as
it exists.
5. Cost or market, whichever is lower.
Two questions on the subject of accounting for security investments were included in the committee's questionnaire. These were:
Are the amounts of bond holdings based on original cost, cost with allowance
for amortization to maturity, or prevailing market price? and
Do you ever make allowance for unrealized appreciation or depreciation in
your bond accounts?

Replies from 19 New York City banks were as follows:
TABLE 40.—Accounting for bond investments, New York City banks
Bank

Bond investments, end
of 1930

1
2
3
4

$392,000,000
308,000,000
263,000,000
248, 000,000

No. 5

146,000,000

No. 6
No. 7
No. 8
No. 9
No. 10
No. 11
No. 12
No. 13
No. 14
No. 15
No. 16
No. 17
No. 18
No, 19

124, 000,000
97,000,000
87,000,000
85,000,000
68,000,000
41,000,000
31, 000, 000
30, 000,000
24,000,000
14,000, 000
13, 000,000
11,000,000
5,000,000
5,000,000

No.
No.
No.
No.

Accounting method used

Original cost, with a reserve account for depreciation.
Cost, with "allowance for depreciation if and when necessary."
Cost. Only "exceptional cases of depreciation written off."
Up to Dec. 31,1930, United States Governments at par, others at cost or market,
whichever lower. At Dec. 31, 1930, total investment account at market.
Cost with allowance for amortization. "Occasional" allowance for depreciation.
Prevailing market price.
Cost.
Net cost. In published statement, security items shown " at or below market."
With amortization allowance.
Cost, less a reserve of $696,100 for depreciation.
Actual cost. "Depreciation sometimes charged to profit and loss account."
Cost with allowance for amortization.
Prevailing market price.
Original cost.
Cost or market, whichever was lower, used in 1929 and 1930.
Prevailing market price.
Original cost.
Do.
Do.

Of the 19 institutions whose replies are summarized above, 6 only
appear to give full weight to market values in reporting the bondinvestment account in their statements.




NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS
Accounting for bond investments,
State in which
located

Bond investments, end
of 1930

No. 1 -

Massachusetts..

$45,000,000

No.
No.
No.
No.
No.
No.
No.

2..
3.
4
5
6
7
8

do.__
do
Rhode Island_._
New York
Pennsylvania. _do
Ohio

37,000,000
3,000,000
43,000,000
48,000,000
72,000,000
6,000,000
59, 000,000

No. 9
No. 10
No. 11

_ -do
Michigan,._ „_
do

14,000,000
34,000,000
8,000,000

No. 12.
No. 13

Illinois
do

No. 14
No. 15
No. 16
No. 17_
No. 18
No. 19
No. 20
No. 21
No. 22
No. 23.
No. 24.
No. 25-

Missouri
Wisconsin
Minnesota
do,_
do
North Dakota. Nebraska.California
do
do
do.__.
do,
..

Bank

out-of-town

1041

banks

Accounting method used

Original cost. "Depreciation or bonds occasionally taken
when requested by national bank examiners. Reserve
set up in December, 1929, for depreciation of general bond
list."
Cost, less reserve for depreciation.
Cost. Makes allowance for depreciation in recent years.
Cost. Unrealized depreciation provided for by reserves.
Cost. " At times we set aside reserves for depreciation."
Allowance for depreciation, but not for appreciation.
Original cost.
Original cost, "except in few individual cases where securities were charged down."

Cost with amortization to maturity.
Cost or market, whichever is lower, except United States
Government.
270,000,000 Cost with amortization to maturity.
23,000,000 Cost. " Make reserves from time to time against depreciation."
32,000,000 Cost with allowance for amortization.
2,000,000 Cost. Premiums charged off.
32, 000,000 Cost.
31,000,000 Cost. Allowance for depreciation.
21,000,000 Cost.
2,000,000 Cost. Reserve for depreciation.
10,000,000 Cost, with allowance for amortization.
247,000,000 Cost, with amortization at premiums.
136, 000,000 Cost. "Make allowance for depreciation."
70,000,000 Cost.
24,000,000
Do.
21,000, 000 Cost. "Specific securities may be written down."

Of the 25 banks outside New York City whose replies are summarized above, 2 adopt the method of carrying bonds at cost or
market, whichever is lower. In addition, eight other banks make
some provision against unrealized appreciation by setting up reserves.
The determination of market values is frequently a difficult matter,
especially where a large proportion of the bond portfolio consists of
unlisted and not readily marketable securities. Even in the case of
those banks which follow the practice of writing down their portfolios to market values, large blocks of bonds which could be sold
only with difficulty, and then perhaps at large concessions, are carried at cost for want of another available basis of valuation. This
applies in particular to real estate and smaller industrial issues, as
well as some municipals.
Efforts of banking supervisory authorities to encourage or enforce
the practice of writing down bond investments showing substantial
depreciation to market value levels are understood to have been taken
in bad part by many institutions. The theory advanced in such
cases is that a bank investment once made may be held until maturity,
so that market value may be ignored in valuing the portfolio. During the years 1930 and 1931, however, when prices of others than
gilt-edge bonds were declining sharply for the most part, banks which
sought to liquidate bonds on a large scale to meet demands on them
frequently faced the necessity of taking heavy losses. In other
instances, where liquidation was not necessary, the published statement gave a misleading view of what could be realized on the security
portfolio, because of the general decline in values which was not
reflected in the condition statement.




1042

NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

In several States the policy of the supervisory authorities has been
to insist on a t least partial writing down of bond investments which
have depreciated if the institution is strong enough to stand it. Such
a policy often leads to unequal treatment of individual banks.
8. Losses on bank investments.—Until the major deflation period in
the bond market in the latter part of 1930 and 1931, losses on bank
security investments were reported as being of moderate proportions.
According to statistics on earnings of all member banks, issued by
the Federal Reserve Board, such losses were as follows down to t h e
end of 1930:
T A B L E 41.—Earnings and losses of all member

banks

[Source: Federal Reserve Bulletin]

Net earnings
and recoveries

Year

1926.
1927
1928
1929
1930

.'

$639,013, 000
655, 702, 000
721,062, 000
851, 987, 000
671,816,000

All losses

$207, 520, 000
208, 693,000
217,194,000
295,473,000
365,314,000

Percentage of
Losses on
losses on
stocks, bonds, stocks,
etc.
bonds,
etc., to all
losses
$35,909,000
37,284,000
45,293,000
95, 465, 000
109,028,000

17
1821
32

In the great majority of cases, such losses do not include unrealized
depreciation, as was seen in the previous section. A large number
of institutions, it is generally understood, dislike to sell securities
which have declined in price in large number, because of the adverse
effects of such a move upon earnings. Therefore, over a period of
time, and especially in times of deflation in bond prices, the unrealized
losses tend to assume substantial proportions.
A number of banks were asked to list their 10 largest bond holdings,,
with original cost and market valuations as of the end of 1930.
Several of these lists are presented herewith.
Bank 1 (New York
Bond

City of Detroit, 2.68/1931
Argentine Nation, 5/1931
Federal Intermediate Credit Bank, 3/1931
Stock Purchase Plan Corporation, 5/1934
St. Louis-Southwestern, 4/1932
Pennsylvania Co., 4/1931
North Carolina, 2.46/1931
Federal Intermediate Credit Bank, 3/1931
St. Louis, Iron Mountain & Southern, 5/1931
Alberta, 3^/1931
Total

City)
Original
cost

Market
value, December, 1930

$7,502,140
4, 510, 575
2,999,063
2,970,000
2, 796, 500
2, 599,695
2, 552,017
2,249,297
1,300,121
1,002,242

509,375
477, 500
000,000
970,000
800,000
596,701
550,000
252,813
298,668
002,500

30,481,650

30,457,557

In the list of bank 1, it is interesting to note that the holding
of St. Louis-Southwestern Railway Co., consisting of bonds of the
par value of $2,800,000 and costing $2,796,500, constituted 56 per
cent of the entire issue of $5,000,000 offered publicly. Despite its.
early maturity on June 1, 1932, this issue declined in the summer of




NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

1043

1931, to a little above, 60, at which price a loss of $1,116,500, or
nearly 40 per cent was indicated.
Bank 2 (New York City)

City of Paterson, 4H/1938-49
Southern Railway development and general 4/1956..
Missouri Pacific convertible 5 J^/1949
Northern Pacific refunded and improvement, 6/2047.
Deutsche Standard Works, 6/1930-39
New York Central equipment trust, 4^/1931-39
Florida East Coast, 5/1974
Great Northern general, 4 J^/1977
International Agricultural Corporation, 5/1942
Inter borough Rapid Transit, 7/1932___
Total.

Original cost

Market value
December,
1930

$5, 275, 731
4,099, 333
3,000,000
2,843,312
2,700,000
2, 557,293
2, 335,658
2,308, 541
1,959,946
1, 510, 681

$5,206,000
4,300,000
2, 760,000
3,300,000
2, 700,000
2,610,000
477,000
2,305,690
1,677,000
1, 669,860

28, 590,495

Bond

27,005,550

These 10 largest holdings, which showed a depreciation of something over 5 per cent at the end of 1930, sustained material further
price recessions in several cases during 1931.
Bank 3 (New York City)
Bond

I. G. Farbenindustrie (in marks)
Chicago, Milwaukee & St. Paul
National Hotel of Cuba
Erie Railroad
German Central Bank for Agriculture
International Telephone & Telegraph.
Wabash Railroad
Rhine-Westphalia Electric Power Co_
Chile Copper Co
Canadian Pacific

Original cost

173,809
999,009
808,365
646,037
437, 992
379,661
232,293
897,065
058,416
048,198
15,680,844

Total

Market values, December, 1930
173,809
117, 250
808, 365
381,580
261,370
088,055
167,090
868,940
992, 750
058,138
13, 917,347

Bank 4 (New York City)
Bond

A r g e n t i n e , 5/1931
_
_
. . _-.
_.
M i d d l e W e s t Utilities Co., various rates a n d m a t u r i t i e s t o 1932
F o x F i l m Corporation, 6/1931 (held u n d e r repurchase agreement)
_
B u n c o m b e C o u n t y , N . C , various rates a n d m a t u r i t i e s t o 1931 ($690,000
p a r a m o u n t u n d e r repurchase agreement)
_ ___
K i n g d o m of Spain peseta gold loan, 5/1940
-.
F e d e r a l I n t e r m e d i a t e C r e d i t B a n k , 3/1931
__
S t a t e of A l a b a m a , various rates a n d m a t u r i t i e s t o 1934. .
C i t y of A k r o n , Ohio, various r a t e s a n d m a t u r i t i e s t o 1933
S t a t e of Mississippi, 5J^, various m a t u r i t i e s t o 1933
_
T o w n of Bloomfield, N . J., various m a t u r i t i e s t o 1969 (held u n d e r r e p u r c h a s e
agreement)
Total

Original cost

Market
value, D e cember, 1930

$9,375,000
3,938,863
2,880,000

$9, 375,000
3,918,374
2,250,000

2, 633,314
2, 500,000
2,350,000
1,828, 759
1,805,488
1, 384,340

2,415,150
2,125,000
2,350,000
1,832,687
1,793,080
1,378,673

1,206,000

1,206,000

29, 901, 770

_

28,643, 964

This bank shows a distinct leaning toward short-term issues for its
portfolio. Leaving out an issue of municipals held under repurchase
agreement, and the Spanish gold-loan holding, the entire list would
34718--31—PT 7




4

1044

NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

mature within five years, and the bulk of it within two. The Argentine short-term note holding, the maturity of which on October 1,
1931, excited much comment and uneasiness, is one of the largestsingle holdings outside of United States Government bonds reported
by any one bank.
Bank 5 (New York

City)
Original
cost

Bond

$5,333,333
1,845,000
1,815, 557
1,448,370
1, 244, 313
1, 004,902
995,000
840,000
790,000
783,000

Republic of Cuba, 5M/1931
Simmons Co., 5/1944
New York City, various issues
Passaic, N. J., 4V2/1941-69
Commerz & Privat Bank, 5H/1937
City of Chicago tax notes, 5H/1931
General Gas & Electric Corporation, 4^/1931.
Associated Telephone & Telegraph, 5^/1955...
City and county of San Francisco, 43^/1947-76.
Province of Nova Scotia, 43^/1930
Total

_

16, 099, 475

Bank 6 (New York

City)
Original
cost

Bond

New York City corporate stock
Province of Santa Fe (Argentine), 6/1931
Phillips Petroleum, 5^/1939__,_
Chicago, Rock Island & Pacific A, 4^/1952
New York State Bonds
Fox Film, 6/1931
Federal farm loan, 4?,^/1942
Rheinische Bahn Gesellschaft (Germany), 83^/1931.Trustees of St. Patricks' Cathedral (Roman Catholic Diocese, New York)
534/1952
Province of Tucuman (Argentine),7/1931
Total

._.

Bank 7 (New York

500,000
500,000
7,124,017

City)

Bond

Concord Estates Corporation, guaranteed notes, 6/1933
Associated Gas & Electric Co., 5/1932
New York City, 4/1930
Stern Bros., 6/1947
Benenson City Terminal Corporation, 6^/1933
Gotham National Building (Inc.,) 6/1941
Warner Bros. Pictures, 6/1939
500 Fifth Avenue Corporation, 6K/1949
Elks Building, Brooklyn Lodge No. 22, serial 534
Brooklyn-Manhattan Transit, 6/1968
Total
1

, 842,672
995, 000
737,360
553, 985
505,000
490, 000
500,000
500,000

Original
cost
$4, 620, 000
4, 066, 655
3,121,943
2,432, 000
2, 431, 570
1, 850, 000
1, 215, 225
1, 034, 038
879,131
482, 644

$4, 620, 000
4, 066, 655
3,131,810
1, 567, 800
2, 415, 000
1, 850, 000
898, 843
1, 015, 200
863,170
494, 381

22,133, 206

Entire issue held. Note by bank says, "Consider them worth face value."

In the above list, the predominance of real-estate issues, constituting about half of the total of 10 largest holdings, is marked. The
lack of marketability of such issues is a significant factor in considering their suitability as bank investments.




NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS
Bank 8 (New York

City)
Original
cost

Bond

D o m i n i o n of C a n a d a
P r o v i n c e of C o r d o v a
C i t y of Chicago
_U n i t e d M e r c h a n t s M a n u f a c t u r e r s (Inc.)
Saco-Lowell S h o p s - .
Walter M . Lowney Co. (Ltd.)
P r o v i n c e of Silesia
Minnesota & Ontario Paper Co
W e s t P a l m Beach
P r o v i n c e of B u e n o s Aires_
Total.

-

Market value
December,
1930

$2, 799, 000
1,980,000
1,168, 000
1,047,000
792, 000
791,000
618,000
561,000
484,000
483,000

77.5, 000
980,000
155,000
039,000
792,000
791, 000
420, 000
561,000
484,000
375,000

10, 723,000

-

Bank 9

10,372,000

(Buffalo)
Original
cost

Bond

P e t e r Cooper C o r p o r a t i o n , 4J^/1935
_
N e w Y o r k , Chicago & St. L o u i s , 4 ^ / 1 9 2 8 - H e w i t t R u b b e r , 6/1935
_
_
N i a g a r a Falls Power, 6/1932
N e w Y o r k , 4^/1978
H a c k e n s a c k W a t e r Co., 5/1932
P u b l i c Service of N o r t h e r n Illinois, 4^/1980
N i a g a r a Share C o r p o r a t i o n , 5^/1950
G r e a t N o r t h e r n , 4^/1977
C a n a d a , 4/1960.

$2,865,000
608, 337
600,000
544,466
524, 375
498, 850
477,486
404, 652
393, 937
385,837

Total

7, 302, 940

Bank 10

Bond

I n t e r b o r o u g h R a p i d T r a n s i t , 5/1966-_
Alleghany C o u n t y , P a . , 4 ^ (purchase group)
Alleghany C o u n t y , P a . , 434 (account N o . 2)
U n i o n Gulf C o r p o r a t i o n , 5/1950
Chicago B o a r d of E d u c a t i o n , 6 per cent w a r r a n t s .
Montreal, 3H
Canadian National Railways equipment, 4H
C a n a d a P u b l i c Service, 5...
B a l t i m o r e & Ohio e q u i p m e n t t r u s t 6
U n i o n Coal & Coke, 5
Total

1045

Market value
December,
1930
$2,865, 000
571,875
540,000
533,000
516,250
498,85C
477. 500
384,000
394,000
383, 000
7, 253,475

(Pittsburgh)
Carr 4 ed on
books

Market value
December,
1930

$3, 583,273
3,268, 886
2,461,480
3,143, 990
1,000,000
999, 286
830, 996
656,984
557,121
6,184

$4, 810,000
3,268,895
2,461,480
4,145, 280
1,000,000
1, 002, 500
836, 550
655,688
586,460
1,342,480

16,508,200

20,109,333

This last-mentioned bank has an unusual bond portfolio among
those reported, carrying several large holdings at figures considerably
lower than any which had prevailed at any time in the market. J As
an extreme case, the $1,384,000 par value of Union Coal & Coke 5 s are
carried at only $6,183.75, despite the fact they consistently sold near
their par value. Another similar case were the $4,064,000 of par
value of Union Gulf Corporation 57s, which for the most part were
consistently quoted at a premium above par. Extensive participation by this bank in underwriting activities, and the apparent use of
profits therefrom to write down book cost of blocks of such issues
retained as investments, explain its peculiar ability to acquire blocks
of bonds at such low figures.



1046

NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

The 10 largest holdings at the end of 1930 had a stated market
value 22 per cent above the valuation at which they were carried on
the books of the bank.
Bank 11 {Cleveland)

Original cost

Bond

Akron, 4^/1940-52
Cities Service, 5/1950
Van Sweringen Corporation, 6/1935
Associated Gas & Electiic, 5^/1938
Kreuger & Toll, 5/1959
Alleghany Corporation, 5/1944
Chesapeake Corporation, 5/1947
_
Tokio Electric Light, 6/1953
Associated Gas & Electric, 4J4/1949
Associated Electric, 4^/1953
_
Chicago, Milwaukee, St. Paul & Pacific adjustment, 5/2000.
Total

_

$774, 203
714,034
640.077
560,215
494,688
468,779
455,183
443,325
377,125
352,266
343, 206
5, 623,301

Market value
December,
1930
$774, 203
557,468
595,000
436,815
430,000
420,000
451,288
435,000
279,000
337,500
176,680
4,892,954

The depreciation of these 11 holdings by August, 1931, had
increased to approximately 24 per cent of cost.
Bank 12 {Chicago)
Oiiginal cost

Bond

Market value
December,
1930

$7,810,870
5,022,880
3,443.675
2,517,000
2,335,000
3,568, 728
3,133,000
3,253,364
2,289,088
1.400,000

Total

$7,812,655
5,000,000
3,459,295
2,466,660
2,288,300
3,503,500

34,773,605

Detroit tax notes
Cuba certificates, due 1931
Chicago special-assessment warrants
Chicago corporate tax warrants
Chicago board of education wairante
Cook County tax warrants
Cook County judgments
New York City notes
Middle West utilities notes, due 1931-34
West Chicago park commissioners' tax warrants

34,502,670

0)

3,250,000
2,253,200
1,365,000

1
No market. Judgment note validated by circuit court, payable at par fiom next county appropriation
bill.

I t will be noted that this bank restricts itself almost entirely to very
short municipals for its 10 largest holdings. These, being payable
from current taxes, possess to a large extent the characteristic of
liquidity, although a ready outside market may not be available in
every case.
Bank 18 {Los

Bond

East Bay municipal utility districts..
Montreal treasury bill, 3^6
_
British Columbia, 3%.._
__.
Central Investment Corporation, 6...
Los Angeles electric plant, 4
_
Manitoba, 4 ^
Los Angeles County water works, 6_.
Los Angeles harbor improvement, 1%
Detroit tax, 2£i
_
California, 4
._
_-_
Total




Angeles)
Original cost

$3,747,313
2,008,331
2,000,000
1, 251,780
1, 701,719
1,498, 363
1,071,328
1,060, 550
1,001,217
878,955
16, 219,556

Market value
December,
1930
830, 200
007, 500
000,000
255, 625
735,763
496,250
078,170
061,690
001, 217
883,000
16,349,415

NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

1047

9. Repurchase agreements.—hi a number of instances a banksecurity investment is more properly classified as a security loan.
This occurs when, in connection with the investment, a contract is
made with the seller of the security or securities to repurchase it at a
stated price and within a stated period of time. Such repurchase
agreements have been extensively resorted to in recent years.
From the viewpoint of banking regulation, the repurchase agreement is of special interest in two ways. First, it might conceivably be utilized to circumvent section 5200 of the Revised
Statutes limiting loans made by national banks to one interest to
10 per cent of their capital and surplus, and cognate statutes in the
laws of many States governing State-chartered institutions. When
securities are purchased with contract to resell, the resulting transaction is not regarded in law as a loan, and so would not come under
the limitation provided in the statute for loans.
In the second place, such agreements when largely resorted to
obscure the actual status of a bank; and these agreements are used
at times for window-dressing purposes by individual banks. The
investment account is swollen and the collateral-loan account reduced by the amount of the resale agreements. In addition, substantial liabilities may exist in the form of repurchase contracts not
revealed in the regular statement of condition.
In order to secure data on the extent to which the repurchase
agreement is now resorted to the following questions were asked in
questionnaire No. 4.
W h a t was t h e total a m o u n t of security holdings held by you under repurchase
agreements during each of t h e p a s t four years, showing United States Governm e n t bonds and other securities separately?
W h a t was t h e m a x i m u m a m o u n t of such repurchase agreements outstanding
a t any one time in each of these four years?

The following table shows the aggregate amount of securities
reported as held by each of the banks addressed under repurchase
agreements during 1390 and the maximum amount so held at any
one time during that year:
T A B L E 42.—Securities held under repurchase agreements in 1930
NEW YORK CITY BANKS
M a x i m u m u n d e r repurchase
Total under repurchase
agreements
agreements
T o t a l investm e n t s , end of
1930
U n i t e d States O t h e r securi- U n i t e d States O t h e r securities
Government
ties
Government

Bank

No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.

1
2
3
4
5
62
7„„
8
9
10
11
12.
13
14
15
16 2
17

-.

$392,253,000
308,002,000
263,899,000
248,020,000
146,199,000
124,016,000
96, 635,000
86, 720,000
85,172,000
67, 812,000
41, 201,000
31,067,000
30,107,000
_..
24,439,000
13, 568,000
13,154,000
11,174,000

i Information not available.



$19,088,000
184,522,000
124, 692,000
107, 963,000
45,000
14,134,000
4, 390,000
3, 503,000

$183,965,000
24,822,000
130, 512, 000
156, 657,000
89,698,000
12, 593, 000
14, 591,000
7, 565,000
9,930,000
13,053,000
14,044,000
2,130,000

$1,244,000

$54,114,000

92,000,000
35,108,000
7,369,000

18,896,000
34, 759,000
14,934,000
9, 600,000
2, 243,000
6, 789,000

45,000
633,000
2,000,000
959,000

0)
8, 668,000

103,000
415,000
1, 272,000

5,178,000

2 Figures apply to 1929.

0)

3,689,000
3, 280,000
3,073,000
1,817, 000
3, 537,000
475,000
415,000
542,000

1048

NATIONAL AND FEDEKAXr RESERVE BANKING SYSTEMS

TABLE 42.-—Securities held under repurchase agreements in 1930—Continued
BANKS OUTSIDE N E W YORK CITY
T o t a l u n d e r repurchase
agreements

No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
No.
2

1
2
3
42-.
5
6
7_8—
92-__
10
11 2
12

T o t a l investments,
e n d of 1930

S t a t e in w h i c h
located

Bank

Massachusetts
do._
New York
Pennsylvania._ Ohio.
Michigan
Illinois _
„
_do
__ M i n n e s o t a
Nebraska
California
_.__ do

._

..

$45,102,000
36, 618, 000
47,803,000
72, 108, 000
58,836,000
34, 182,000
269, 576,000
22,771,000
30, 596, 000
10,030, 000
246, 538, 000
69, 701,000

United
States
Government

O t h e r securities

$2,512,666

$6, 288, 000
2,407,000

M a x i m u m , u n d e r repurchase agreements
United
States
Government

$2,512,000

105,666
Nominal.
2,000,000

2,969, 000
Nominal.
3, 087, 000
1, 786, 000
195, 000
200,000

O t h e r securities

$4, 721, 000
2,087, ooa
105, 0003, 045, 000

5,000

1,012,000
1, 785, 000
100, 000

200, ooa

Figures apply to 1929.

The replies received clearly indicate that repurchase agreements on
bank investments are most commonly used in New York City.
The questionnaire also asked:
What were the chief reasons for utilizing the repurchase agreement in preference to advancing direct security loans in these cases?

The answers to this question are summarized as follows:
1. Accommodation of customers: Such accommodation apparently
covers cases where security dealers and s}mdicates, wishing to obtain
credit beyond the legal limit of 10 per cent of the bank's capital and
surplus, utilize this device. Also, the repurchase agreement is preferred by customers because they can obtain the full value of their
securities thereby, rather than merely a stated percentage, as m
usual with security loans. Also, greater flexibility as to the period of
the loan is feasible than with time loans, while the repurchase agreement is preferable to a call loan from the borrower's standpoint.
One bank states, " I t is customary to carry for dealers in Government and municipal bonds (which form the bulk of this item) on
repurchase rather than on loan." Several other institutions indicate
that most such transactions are made with dealers in municipal
bonds, where protection in the form of a margin of collateral value
over and above the amount of the advance is not regarded as necessary.
2. A better rate of return to the bank. The bank usually retains
the full coupon rate of interest on the bond, and in addition where
the bond issue is tax free, no income tax need be paid on such return,
whereas interest received on loans is so taxable. Several banks
stressed this income-tax exemption in their replies as of first importance. The customer can afford to pay a higher rate than on loans
because his loan equals the full value of the collateral.
3. Simplify accounting for dealer customers in the case of nontaxable securities.
4. Various special reasons: A bank in New England says, "Chief
reason we believe is desire of taxpayers to adjust their portfolios to
conform to various State laws in order to decrease their taxable
holdings or increase their holdings of nontaxables."



NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

1049

Another institution explains a single transaction of this kind thus,
" T h e company wished the bonds available for its sinking fund at a
future date b u t did not wish to buy them in advance of the sinking
fund date."
A western bank says, " T h e borrowers wish to avoid showing
borrowed money on their statements."
In several cases of group banks the large banks report buying bonds
under repurchase agreement from other banks only for the purpose
of aiding them to meet special demands for accommodation.
A number of banks specifically indicate that the repurchase agreement is resorted to only on the request of customers, and that the
bank does not actively prefer them over loans.
10. Investments and time deposits.—The expansion of bank security
investments is usually ascribed primarily to the increase in savings
and other time deposits in the hands of commercial banking institutions. The Comptroller of the Currency ruled that there is nothing
in the national bank act to prevent a bank from opening a savings or
thrift department as long ago as 1903, and the Federal reserve act
specifically authorized the banks to accept savings deposits, which
were given preferred treatment as to reserve requirements with a
flat 3 per cent reserve provision.
Time deposits have shown a steady increase, especially since the
war. During the decade 1921-1930 the increase in time deposits of
all banks compared as follows with the increase in investments:
T A B L E 43.—Increase in time de-posit and investments

of all banks

[Source: Annual Reports of the Comptroller of the Currency]
Date
June 30, 1921
June 30, 1930.
Increase, per cent

Time deposits

_

_

._ .

i $9, 769,454, 000
20, 216, 314,000
107

Investments
$8,405,814,000
13, 671,629, 000
63

i This figure is probably too low by $1,000,000,000 or more, because of inadequate classification of State
bank deposits. This factor, when allowed for, cuts the gain in time deposits for the de.cade to approximately
88 per cent.

I t has already been seen that country banks have invested a substantially larger part of their total resources in securities than have
the city institutions, and they also have gone more heavily into real
estate loans. The country banks also have a much larger proportion
of time deposits, howxver, as shown in the following table at the end
of 1930:
T A B L E 44.— Time deposits and investments,

by groups of member banks

[Source: Member bank call report, Federal Reserve Board]
Investments and real
estate loans

Time deposits

Bank groups
Amount
New York City banks
Chicago b a n k s . .
Other reserve city banks.
Country banks
Total...




Per cent of
resources

Amount

Per cent of
all deposits

_..

$2,583,000,000
538,000, 000
5,128,000,000
. 5,974,000, 000

19
21
33
39

$1,296,000,000
510,000,000
5,202,000, 000
6,538,000,000

19
32
49
56

, . 14, 223,000,000

32

13,546,000,000

36

1050

NATIONAL AND FEDEEAL RESERVE BANKING SYSTEMS

The possession of a large proportion of time deposits is often
regarded as justifying a bank in investing a greater part of its assets
in securities and real-estate loans than would otherwise be considered
conservative. One reason advanced for this view is that the bank
retains the right to demand notice of 30 or 60 days in advance of
withdrawals, thus securing a respite during which slower assets can
be disposed of in case of concerted demands for funds on the part
of time depositors. In practice this provision may be valueless for
the commercial bank, however, as refusal to pay out time deposits
on demand tends to impair confidence in the institution, and thus
leads to a " r u n " which is joined by the demand as well as the time
depositors. The collapse of four substantial banks in Toledo, Ohio,
in August, 1931, was directly attributable to this condition.
On the other hand, the velocity of turnover of time deposits is
unquestionably much less than that of demand deposits. In normal
times this would justify a bank in making commitments in "slower"
assets with its time deposits, but experience on several successive
occasions has shown that in periods of deflation and impaired confidence depreciation in security investments, combined with withdrawals of time deposits, may become a major cause of bank failures.
Such experience indicates that liquidity of assets remains a necessity for commercial banks, regardless of the proportion of time
deposits obtained.
11. Further restrictions on bank investments.—A. further question
included in the questionnaire was as follows:
Do you think the present restrictions on bank investments in securities adequate? If not, state suggestions for change.

The almost universal response was that present restrictions were
sufficient. One large New York bank qualified such an answer by
saying that they were adequate for central reserve cities, implying
that banks outside New York and Chicago should be further restricted
in their security purchases.
A New England bank states, "Management will be always the
principal factor, but comptroller should have any reasonable increase
in his powers or appropriations that he desires." No indication is
given as to the direction in which such extension of the comptroller's
powers is thought desirable. A more radical suggestion from another
New England bank is that " Commercial banks with savings departments should be required to invest savings deposits in legal securities. " This suggestion, however, necessarily seems to involve the
segregation of savings deposits, a broader question than the regulation
of bank investments as such.
A bank in Philadelphia answers:
Law can not take the place of management. It has been too easy to get into
the banking business, and too many bankers have had little or no experience in
times of depression until the present time. Larger capital of banks should be
required, and the banks should not be permitted to organize in towns where
business and conditions in the territory do not warrant.

A reduction in the number of banks is thus preferred to specific
further limitations on investments.




NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

1051

The president of a large bank in the Northwest replies:
I think present restrictions on bank investments in securities are adequate.
No unusually strict or arbitrary rule would improve the situation. It is necessary
that a bank "have some leeway in order that it may properly conduct its business,
if the management is sound, and no legislation can protect a bank with unsound
management.

A large California institution states:
We believe restrictions at present are adequate and it would be difficult to
cure poor judgment by more drastic restrictions. Further, greater restrictions
would tend toward the employment of more funds in loans, which would deprive
banks of diversification obtainable in security purchases and desired liquidity.




PART

IV

SECURITY AFFILIATES
1. Origin of security affiliates.—American banking, from its early
days, has been subject to a degree of public regulation unknown in
other economically advanced countries. Recurrent epidemics of bank
failures through the nineteenth century, as well as the system of unit
banking, tended to confirm the popular opinion that such regulation
was needed, and caused an extension of its scope and character.
Above all, the tendency to separate commercial banking from the
merchandising of securities early became manifest. Such episodes
as the failure of the second Bank of the United States in 1841 after
it had become a Pennsylvania State-chartered institution, a result of
unwise and frozen security operations, merely served to increase the
desire of legislatures to prevent the banks from engaging in investment
banking activities. To legal restrictions on the power of the banks to
engage in investment banking may be ascribed the great development
of corporations affiliated with banks in recent years. In countries like
Germany and France, where such restrictions are not in force, no
need is felt for incorporation of separate entities by the banks to
engage in the security business. In Great Britain, on the other hand,
despite the lack of restriction, the force of precedent has been such
that the great commercial banks have voluntarily refrained from
entering directly into the business of buying and selling securities.
The earliest examples of the affiliate relationship was furnished by
the organization on the part of individual banks of other banking
corporations, to carry on types of business which the parent institution did not, or could not, perform. Thus, the First National Bank
of Chicago established the First Trust & Savings Bank, to specialize
in trust business and thrift accounts, which the national bank act at
that time did not specifically authorize or facilitate for institutions
chartered under it.
The first security affiliate on record was organized in 1908 by the
First National Bank of New York City. 1 The method adopted in
organizing this company was followed as a model by many other
banks subsequently. The First Security Co. was organized as a
corporation endowed with general powers, having a capitalization of
$10,000,000, equal to t h a t of the bank. The bank then declared a
cash dividend of 100 per cent, which, however, was not actually
disbursed to its stockholders. Instead, with the prior approval of
the shareholders, this sum was directly subscribed to the stock of the
security corporation, which was thus made fully paid and was deposited under a trust of which six senior officers of the bank were
made trustees. Shareholders of the bank then had indorsed on their
stock certificates a statement that they had a beneficial interest in an
i See Commercial and Financial Chronicle, Feb. 29, 1908, p. 522.

1052




NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

1053

equal number of shares of the security affiliate, which were to be
inseparable from those of the bank.
The letter sent by President George F . Baker, of the First National
Bank, to its shareholders was as follows:
DEAR SIK: It is deemed to be for the interests of the stockholders of this bank
that a security company, such as has proved advantageous in the case of several
other banks, should be organized for the purpose in part of transacting for its
patrons certain lines of profitable business, which, though often transacted by
bankers, are not expressly included within the corporate powers of national banks.
Among these are the acquiring and holding of real estate, securities, stocks, and
other property.
To this end it is desired to secure the assent in writing of our stockholders to a
plan of organizing a security company under the name of the First Security Co.,
with a paid-up capital of $10,000,000, the stock to be issued to and held by six
trustees, who shall be the president, vice presidents, and cashier of the bank.
These trustees shall exercise the powers of ownership of the stock, shall elect
the same board of directors as that of the bank, shall collect all dividends and
pay the same over to the bank for immediate distribution to its shareholders,
who have assented to this plan.
Upon receiving the assent of the stockholders the bank purposes to make a
special dividend of 100 per cent ($10,000,000) to be received by the trustees, and
be applied to the payment of the capital stock of the security company, which
stock shall be held by the trustees for the benefit of the shareholders of the bank
assenting to the plan.
Upon each certificate of every assenting stockholder of the bank there shall be
the indorsement that appears on the following page.
The formal agreement for incorporation, assent, etc., has been carefully prepared by our counsel, and has been approved by our directors, who have assented
and recommend your assent thereto.
Your proportionate share of the bank's assets will be in no wise changed.
Kindly sign and return promptly the inclosed power or call at the bank and sign
the statement.

The form of indorsement referred to in the above letter, to appear
on the certificate of bank stock, was as follows:
The registered holder of the within certificate is entitled, for and in respect of
each and every share of the stock of the First National Bank of the City of New
York represented thereby, to share equally and ratably with all other holders of
stock certificates of the bank similarly indorsed, according to their several interests, in the dividends or profits, or in the case of dissolution, in the distribution of
capital, of the First Security Co., a corporation of the State of New York, organized in pursuance of a certain written agreement date February 14, 1908, between
George F. Baker and others, trustees, J. P. Morgan and others, stockholders;
such interest of the owner of the within certificate, and of all like certificates,
similarly indorsed, being subject to all terms, conditions, and limitations of said
agreement; such ratable interest to be sold or transferred ratably only by the
transfer upon the books of the bank of one or more of the shares of the stock of the
bank represented by a bank-stock certificate bearing this indorsement; and all of
the interest in and to or in respect of said security company or its capital stock,
represented by bank stock certificate bearing this indorsement, shall pass ratably
with, and only with, the transfer of such shares of the bank represented by such
bank-stock certificate, and upon transfer thereof upon the books of the bank; and
an interest in the security company attached to any share of the bank shall be
alienable only in connection with such transfer of such bank stock.
No holder of the within certificate or any transferee of any share thereby
represented shall be entitled in lieu thereof to demand or receive from the bank
a new certificate except with the indorsement thereon; and a transfer of any share
of bank stock represented by the within bank stock certificate shall be made by
any other holder thereof only to a transferee accepting therefor a new certificate
bearing this indorsement.
No right to vote upo n or in respect of any stock of the security company passes
to or shall be exercise d by the holder of the within certificate, such voting right
being reserved to and by the trustees or their successors.




1054

NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

The National City Bank, also of New York City, followed the lead
of the First National in 1911, and during the following decade most of
the other large banks in the city and in other centers followed suit.
The significance of bank security affiliates and their operations was
known to the public in only a most general way, until the failure of
the Bank of United States in December, 1930, clearly indicated
the disastrous results that could follow upon a flagrant abuse of this
device, such as took place in that case.
2. Definition of security affiliates.—A great diversity of practice
exists among the banks possessing security affiliates as to methods of
organizing and operating them. Little standardization is noted in
this field, in fact, which makes generalizations concerning such
organizations difficult.
In defining a security affiliate for its questionnaire, 1 the Senate subcommittee of the Committee on Banking and Currency stated:
For t h e purpose of this questionnaire, a security affiliate shall be defined as a
corporation—
(1) A p a r t or all of the stock of which is deposited in t r u s t for t h e benefit of
stockholders of t h e b a n k ; or
(2) T h e shares of which are sold in units in combination with shares of t h e
b a n k ; or
(3) A controlling interest in which is held by t h e same interests which control
t h e b a n k ; or
(4) A controlling interest in which is held by t h e b a n k ; or
(5) A controlling interest in which is held by some other security affiliate of
t h e bank.

A more detailed definition is presented in the report of the commission appointed by Governor Roosevelt, of New York State, to
make a study of the banking law of the State, which resulted in making
security affiliates of State banks and trust companies subject to
examination by the superintendent of banks in order to determine
more fully the position of such institutions. The proposal of the
commission was:
For t h e purpose of determining whether a corporation is subject to e x a m i n a tion by t h e superintendent of banks in order to obtain full information as to t h e
financial condition of a b a n k or t r u s t company there shall be deemed to be
affiliated with a bank or t r u s t company.
(1) Any corporation of which such b a n k or t r u s t company directly or indirectly
owns or controls a majority of t h e voting shares of its capital stock or a lesser
n u m b e r of such shares if such lesser number shall a m o u n t to more t h a n 50 p e r
cent of t h e shares voted for t h e selection of directors a t t h e preceding a n n u a l
meeting of such corporation; or any corporation of which such b a n k or trust
c o m p a n y in any other m a n n e r directly or indirectly controls t h e election of a
majority of its board of directors.
(2) Any corporation which directly or indirectly owns or controls a majority
of t h e shares of capital stock of such bank or t r u s t company or a lesser n u m b e r
of shares if such less n u m b e r shall a m o u n t to more t h a n 50 per cent of the shares
voted for the election of directors at t h e preceding a n n u a l meeting of such bank
or trust c o m p a n y ; or a n y corporation which in any other m a n n e r directly or indirectly controls t h e election of a majority of t h e board of directors of such bank
or t r u s t c o m p a n y ;
Any corporation of which a majority of t h e voting shares of its capital stock r
or a lesser n u m b e r of shares if such lesser n u m b e r shall a m o u n t t o more t h a n 50
per cent of t h e shares voted for t h e election of directors a t t h e preceding annual
meeting of such corporation is directly or indirectly owned or controlled b y t h e
same or substantially the same stockholders as directly or indirectly own or
control a majority of t h e shares of capital stock of such corporation subject to
t h e provisions of this chapter or a lesser n u m b e r of shares if such lesser n u m b e r
shall a m o u n t to more t h a n 50 per cent of t h e shares voted for t h e election of
1

For full text of Questionnaire No. 2 on Security Affiliates, see the Introduction to this report.




NATIONAL AND FEDEBAL BESEBVE BANKING SYSTEMS

1055

directors a t t h e preceding a n n u a l meeting of such baiik or t r u s t c o m p a n y : Provided, however, T h a t either (a) there shall t h e n exist or within t h e preceding 2-year
period h a v e existed business transactions or relations (of a n y kind, character, or
description other t h a n stock ownership) between such corporation a n d such b a n k
or t r u s t company, or (6) such bank or t r u s t company shall t h e n own, h a v e outstanding loans secured in whole or in p a r t by or be in a n y m a n n e r interested in t h e
stock or securities of such corporation or in any property in which such corporation
is in any way or t o a n y extent interested or within t h e preceding 2-year period shall
have had such ownership, loans, or interest.
(3) Any corporation t h e election of a majority of t h e board of directors of
which is or m a y be directly or indirectly controlled by a n y instrumentality,
agency or a r r a n g e m e n t t h a t directly or indirectly controls t h e election of a
majority of t h e board of directors of such b a n k or t r u s t company.
Iks Any corporation a majority of t h e directors of which shall be directors of such
b a n k or t r u s t company or of which a majority of t h e executive committee of its
board of directors are directors of such b a n k or t r u s t company.
Any corporation t h e board of directors of which shall comprise a majority of
t h e board of directors of such b a n k or t r u s t company or t h e executive committee
of t h e board of directors of which shall comprise a majority of t h e executive
committee of such b a n k or t r u s t company.
Any corporation all or substantially all of whose executive officers are executive
officers of such b a n k or t r u s t company.
Any corporation whose executive officers comprise substantially all of t h e
executive officers of such bank or t r u s t company.
Any corporation the business or policy of which is dominated or controlled,
in whole or in part, by a bank or t r u s t company, whether by contract or otherwise.
Any corporation which dominates or controls, in whole or in part, t h e business
or policy of a b a n k or t r u s t company whether by contract or otherwise: Provided,
however, T h a t either (a) there shall then exist or within the preceding 2-year
period have existed business transactions or relations (of any kind, character or
description) between such corporation a n d such bank or t r u s t company, or
(b) such b a n k or t r u s t company shall then own, have outstanding loans secured
in whole or in p a r t by or be in any manner interested in tlie stock or securities
of such corporation or in any property in which such corporation is in any way
or to any extent interested or within t h e preceding 2 year period shall have
h a d such ownership, loans, or interest.
(4) Any corporation, association, or partnership having business transactions
or relations with a bank or t r u s t company the examination of which on application of t h e superintendent of banks and on notice to such company shall be
determined by a justice of t h e Supreme Court to be necessary or expedient in
order to ascertain whether the capital of a b a n k or t r u s t company is impaired
or whether t h e safety of depositors with such bank or t r u s t company has been
imperiled.
For all the purposes of the foregoing definition—
All corporations similarly owned or controlled shall be regarded as a single
corporation and if as a single corporation subject to examination each such corporation shall be deemed to be an affiliated corporation.
Stock held in t h e name of nominees of any bank, t r u s t company, or other
corporation or otherwise for t h e benefit of any bank, t r u s t company or other
corporation shall be deemed to be stock owned or controlled by such bank, t r u s t
company, or other corporation.

The above definition is considerably broader than that used by the
subcommittee in its questionnaire. However, if literally applied it
would take in all kinds of enterprises in the management of which
banks take an active interest, for it includes " a n y corporation'' where
the bank "directly or indirectly controls the election of a majority
of its board of directors/'
The definition used by the subcommittee would cover virtually
every usual case, with the exception of bank-holding companies, in
which case the security company controls the bank, instead of the
reverse.
3. Organization of security affiliates.—There are four common
methods whereby banks may provide capital for their security
affiliates. These are:




1056

NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

(1) Declaration of a cash dividend by the bank, which is specifically utilized to subscribe pro rata for shares in the security affiliate.
This, as has already been seen, was the method adopted by the
First National Bank in organizing its pioneer security affiliate, and
has been the most common procedure since. In that case each
stockholder specifically authorized the utilization of his dividend for
this purpose. In later cases such action has been authorized by a
general vote of shareholders, thus avoiding the necessity for
unanimous consent in advance.
An interesting question is raised by the possibility of individual
shareholders refusing to waive their cash dividend, and insisting upon
receiving it in lieu of the stock of the affiliate. No such instance of
refusal is on record, however.
(2) Organization of the affiliate as a wholly owned subsidiary of
the bank, through the bank subscribing for its shares. This method
is possible only where the bank has the right to purchase stocks. In
New York State, where trust companies have such a privilege,
several of the large security companies affiliated with banks are
directly owned subsidiaries of trust companies.
(3) Offering of new bank stock to existing shareholders at a large
premium over the par value, part or all of the premium being actually
subscribed to stock of the affiliate. Thus, a bank whose shares are
selling at $700 each may offer additional shares to its shareholders at
$500, of which $200 will be allocated to the capital and the surplus of
the bank and the balance of $300 utilized to subscribe to the stock
of the security a v i a t e .
(4) Direct offering of stock in the security affiliate to the bank's
shareholders. This method has been least favored, except for the
organization of investment trusts under the auspices of the banks,
because it does not facilitate the establishment and maintenance of
identity of shareholders for the bank and the security affiliate.
In practice one of the major problems in the organization of a
security affiliate is the permanent maintenance of identity of shareholding interests in the two institutions. The usual methods whereby
this is accomplished are the following:
(1) The stock of the affiliate is deposited in trust for the proportionate interest of the shareholders of the bank. I t is customary to
indicate this proportionate interest on the certificates of the bank's
shares. Since no shares of stock of the security affiliate go into public
circulation, it does not become possible to transfer them to other
names than those of the bank's stockholders.
(2) The stock of the affiliate is printed on the same certificate with
the stock of the bank, so that the two are transferred together. Suitable provisions appear on the certificate and elsewhere to prevent a
valid transfer of one equity without the other. Where this is done,
the security affiliate has a list of stockholders of record which is the
equivalent of the shareholders' list of the bank. Technical disadvantages, such as dual transfer taxes, etc., have been advanced by lawyers
as militating against this method in comparison with the first.
(3) The stock of the affiliate is fully owned, except for directors'
qualifying shares if needed, by the bank, where the power to own such
shares is given by law, as with trust companies and state banks in
certain jurisdictions.




NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

1057

The security affiliates may be organized in any State, and several
of them operated by New York banks are organized in Delaware,
because of more satisfactory charters available there. The directors
and officers of the security affiliate may or may not hold similar posts
in the bank. In some cases, a completely different set of individuals
hold such posts in the two affiliated institutions, but it goes without
saying that, through identity of stock ownership, there is identity
•of real control over the two.
4. Functions of security affiliates.-—An analysis of the operations of
a number of typical security affiliates reveals a wide variety of activities. The more important functions which they exercise are the following :
(1) Wholesalers of security isues, purchasing entire offerings or
participating in purchase and banking groups which acquire whole
issues of securities from governmental bodies or corporations.
(2) Retailers of securities, maintaining corps of salesmen and often
branches in other States than that in which the bank operates for the
distribution of stocks and bonds to institution and private investors.
(3) Holding and finance companies, carrying blocks of securities
for control or otherwise, which the bank could not or would not list
among its own investments.
(4) Investment trusts, buying and selling securities acquired purely
for investment or speculative purposes.
(5) An assets realization company, to take over from the parent
bank loans and investments which prove doubtful or nonliquid.
(6) A medium for supporting the market for the bank's own stock.
(7) A real-estate holding company.
In most cases the security affiliates have exercised a combination
of these functions, and in some instances they have exercised all of
them. A majority of the banks possessing security affiliates have but
one such organization, but in other cases more than one such corporation has been organized, at times with a specialization of function
among them. Where a group of affiliates is built up in this way,
their affairs frequently become interlocked through mutual loans and
stockholdings, so as to make any subsequent separation difficult,
even if thought desirable.
An analysis of the portfolios of a typical group of security affiliates
indicates that the business of retailing securities seldom involves a
large measure of risk. The security inventory carried in this connection, while it may include a relatively l$rge number of individual
issues, seldom ties up more than a moderate fraction of the resources
of the affiliate, and the rate of turnover, even in comparatively inactive
periods in the security business, constitutes an additional source of
protection for the security company against being tied up with any
large volume of securities that can not be marketed without serious
loss.
On the other hand, the wholesale underwriting of securities does
tend at times to leave the security affiliates with big unsold commitments that, in times of rapidly declining prices, may result in large
losses of at least a temporary nature. At the end of 1930, for example, several of the larger security affiliates still had commitments
amounting to several millions of dollars in each case in Bethlehem
Steel Corporation common stock, an issue of 800,000 shares of common stock of which company they had underwritten in the fall of




1058

KATIOKAL AISTD FEDERAL RESERVE BANKING SYSTEMS

1929. I t so happened that the stock offering of this company to its
shareholders, underwritten by these security companies, called for
payment at the end of October, 1929, coincident with the stockmarket panic of that year. Shareholders apparently took little of
this stock, so that it was left very largely in the hands of the underwriting bankers. The offering price to the stockholders of the company was $110 per share, from which a commission of several points
was allowed the underwriters. In at least two major cases the
underwriting commitments taken over were not disposed of to any
extent by the end of 1930, and meanwhile the market price of the
stock declined by more than 60 per cent from the quotation at which
the underwriters acquired the issue.
The portfolios of some of the security affiliates indicate that the
profits of years of operations can be more than wiped out through two
or three unprofitable commitments of this kind, at least on the basis
of quotations prevailing during a depression period.
Activities of a bank's security affiliate as a holding or finance
company or an investment trust are also fraught with the danger of
large losses during a deflation period. Bank affiliates of this kind
show a much greater tendency to operate with borrowed funds than
do organizations of this type which are independent of banks, the
reason being that the identity of control and management which
prevails between the bank and its affiliate tends to encourage reliance
upon the lending facilities of the former.
When the affiliate acts as a receptacle for slow or doubtful assets
of the bank, its existence is of apparent aid in maintaining the liquidity
of the parent institution, especially where the capital of the affiliate
is provided by stockholders and not by the bank itself. However,
when it becomes necessary to help finance the affiliate through loans
from the bank, there is no real benefit to the bank from its operations,
since the bank itself then advances the funds to hold these doubtful
assets. Furthermore, such transfer of doubtful assets to an affiliated
corporation, by giving the bank an appearance of liquidity which is
greater than the facts of the case warrant, may encourage assumption
of other commitments that might not be desirable in the light of
losses already indicated in the portfolio of the affiliate. I n fact the
mere existence of an affiliate which might be made the receptacle for
unwise loans and investments when needed tends to reduce the degree
of caution exercised by bank managements, there is reason to believe.
Activities of affiliates in supporting a bank's own stock or in holding
real estate have both been the source of substantial loss in individual
cases. Taken as a whole, however, it would appear that the security
affiliates of the banks studied in connection with the committee's
questionnaire ordinarily engaged in such activities to a moderate
extent only. I t is well to remember, however, that it was precisely
this type of activity, and especially that first mentioned, which brought
on the disastrous collapse of the Bank of United States in New
York in 1930, and contributed to several large bank failures elsewhere.
The bank-merger movement of the last few years has at times resulted
in specially large commitments in a bank's own stock, as efforts are
made to advance the price of the stock of a bank in order to make it
more attractive in an exchange for shares of another institution.
Also, certain mergers have involved commitments by the absorbing
institution, that shares of the bank being absorbed would be purchased
by the security affiliate of the former if desired, and such arrange


NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

1059

ments have at times resulted in the affiliate acquiring quite large
blocks of the bank's shares.
5. Analysis of typical security affiliates.—The period of securitymarket deflation which began in October, 1929, created an unfavorable situation for the security affiliates of the banks. The usual
sources of income from originating and distributing securities tended
to dry up, while sharp declines occurred in the market values of these
issues which were already held in their portfolios. Summaries of the
situations faced by several such organizations as indicated by replies
to questionnaire No. 2 on security affiliates are presented in the following cases:
Bank 1: The chief security affiliate of this bank had some 500
individual holdings. Nearly one-half of the total stated value of the
security holdings consisted of two issues, representing all of the
capital stock of two other affiliates. Each of these, on the basis of
market prices of their own holdings, had net asset values far below
the sums at which they were carried on the books of the chief affiliate.
This would not allow for the substantial good will of these two subsidiary affiliates, however, since they were more than mere investment
companies.
Aside from these two subsidiaries, there were several blocks of
shares with a cost of $1,000,000 or more in the portfolio of the chief
affiliate of this bank, and in the majority of such cases substantial
depreciation in market price had taken place by the end of 1930.
Bank 2: The security affiliate of this bank divides its holdings into
two groups—trading accounts and inactive accounts. The trading
accounts include about 350 bond issues, mostly small amounts
apparently purchased or held in connection with a retail security
distribution business. About 75 stock issues are also held in trading
accounts, of which two only are of substantial size. One of these latter
is the stock of an industrial which had been underwritten in connection with an offering to its shareholders, and the second is the stock of
the bank itself. These two holdings together showed a depreciation
of 25 per cent from cost on December 31,1930, and at the values then
prevailing constituted 15 per cent of the total stock and bond holdings
of the affiliate. In the inactive account, there was one very large
holding without a market, and nine others with an aggregate cost of
approximately $31,000,000 and a stated market value at the end of
1930 of about 35 per cent less.
The inactive accounts, which were apparently operated as an investment trust-holding company, constituted the larger portion of the
portfolio of this security affiliate.
Bank 3: The security affiliate of this bank appeared to operate in
large measure as an investment trust dedicated to the principle of
long-pull investment. At the end of 1928 its holdings showed an
appreciation in market value of more than 100 per cent over cost.
At the end of 1929 the appreciation shown was little above 50 per
cent. At the end of 1930 such appreciation had dwindled to about
15 per cent, and by the middle of 1931, assuming no substantial
changes in the portfolio during the first six months of the year, market
value and cost were nearly the same. However, the reported income
of this company was quite large in each year, averaging about 50
per cent on its capital, and indicating that its wholesale underwriting
and other operations were consistently profitable.
34T18—31—PT7



5

1060

NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

Bank 4: The security affiliate of this bank carries its security
holdings in two chief account groups—syndicate, joint, and carrying
accounts; and secondly, merchandise accounts. Municipal and.
general holdings are shown separately for each account group. At
the end of 1930, after deducting the reserve account set up from earnings, the aggregate market value of its security holdings was stated
to have been less than 5 per cent below the book value.
This security affiliate had only one really large commitment, a
block of shares in a large industrial whose offering to stockholders it
had underwritten. At the end of 1930 this one holding had depreciated by considerably more than 50 per cent in market price.
Bank 5: The security affiliate of this bank restricts its activities
very largely to the distribution of high-grade securities. Its commitments in individual issues are moderate in size for the most part.
The books are kept on a market-value basis, reflecting both appreciation and depreciation, and owing to apparent care with which the
inventory of securities is kept down, it was able to end the year 1930
with a profit of more than $1,000,000 after all adjustments to market..
Bank 6: This institution reported two affiliates, a security company
and an investment trust, the latter being controlled by the former.
The security company, which owned some $20,000,000 of stocks and,
bonds at the end of 1930, had a diversified bond list and a shorterlist of stocks, on several of the latter of which severe shrinkages in
market value had occurred. Thus, on five stock holdings which
together had a cost equal to about 70 per cent of the total original
cost of the security portfolio, a decline of more than 50 per cent in
market value had taken place by the end of 1930. The security
affiliate also reported a substantial indebtedness to the investment
trust affiliate, and on the basis of market prices prevailing at the
end of 1930 the market value of the holdings of the security affiliate^
had declined so far as apparently to eliminate its capital and paid-in
surplus on this basis of computation.
Bank 7: The security affiliate of this bank had done a large business
in wholesaling, as well as retailing, securities. I t held some 300
separate issues. As of the end of 1930 the stock accounts showed a
depreciation of almost 50 per cent from cost, the bond accounts more
than 20 per cent and substantial paper losses were also indicated on
unclosed syndicate accounts. In this instance also, if securities be
taken at market value, the elimination of the capital and surplus of
the affiliate would be indicated.
Among the banks outside of New York City which possessed
security affiliates of substantial size, the following references to
special cases may prove of interest:
Bank 8: This is a large Eastern bank which possesses an affiliate
doing both a security and an acceptance business. The security
holdings amount to more than $40,000,000 and fall into two main
classes—investments and inventory accounts, the latter being destined
for early sale. The investments account for about 30 per cent of the*
total, and to a substantial degree consist of holdings in affiliated
financial institutions. The inventory accounts consist of several
hundred different issues, for the most part of very high grade. Taking
the portfolio as a whole, the depreciation suffered by the end of 193G4
was much below the average for such companies.
Bank 9: About 20 per cent of the securities held by the affiliate of
this bank, located in Chicago, consisted of small blocks, o£ bonds,



NATIONAL AND FEDERAL RESERVE B A N K I N G

SYSTEMS

1061

apparently in process of distribution. The balance consisted of
stocks, and of the latter more than one-half was a block of 1,000,000
shares of the common stock of an investment trust affiliated with the
bank. The second largest holding, amounting to nearly 20 per cent
of the total investment list, was the common stock of the bank itself.
In other words, about two-thirds of the total security holdings of the
affiliate as carried on the books consisted of b u t two issues, on the
larger of which there was a depreciation of about 70 per cent by the
middle of 1931, while on the stock of the bank itself, the smaller of the
two, a depreciation of about 65 per cent had taken place.
Bank 10: The great bulk of the portfolio of the affiliate of this bank
which operates in the West, consists of stocks of affiliated financial
organizations and bonds of an affiliated mortgage company. A holding company-which controls the bank also has a diversified list of
security holdings which is made public.
Bank 11: About two-thirds of the portfolio of the security affiliate of
this bank consists of one item—capital stock of the bank itself. However, the affiliate has virtually no loans payable, its own capital funds
being almost exclusively used by it in its operations. The second
largest item in the portfolio is the stock of a real estate company.
The two items together constitute nearly 90 per cent of the total.
6. Results of security affiliate operations.—The financial results of the
operation of security affiliates during the period following the stock
market collapse of 1929 were on the whole unfavorable. Losses of any
substantial size were not reported in every case, the chief exceptions
being those organizations which restricted themselves to the distribution of high-grade bonds.
The determination of the earning power of security affiliates in any
one year as in the case of all companies whose assets consist chiefly of
securities held for investment, is complicated by variations in the
market values of stock and bond holdings. Several affiliates reported
large earnings in 1930, b u t at the same time suffered severe shrinkage
in the quoted market values of their portfolios. During 1931 such
shrinkage was largely extended further in most cases.
As a rough indication of the results of operations of security affiliates
during 1930, the following data is presented. Lack of quoted markets
on many items in the security protfolios of certain of the affiliates
makes the determination of the extent of portfolio shrinkage a
practical impossibility in certain cases. Reported earnings, as
shown below, have also been reduced in many cases by specified
adjustments of various kinds.
T A B L E 45.—Results of operation

Reported
earnings

Bank

No.
No.
No.
No.
No.
No.
No.

1
2
3
4
5
6
7

_._

-

$6, 989, 628
2,380, 691
5, 032, 968
1, 249, 517
1,067, 922
3,099,902
44,569

of security

affiliates,

Approximate
decline in
m a r k e t value
of portfolio
for y e a r
i $12, 500,000
i 12,500,000
29,562,330
4,608,835
2

()

13,235,000
851,000

Reported
earnings

No.
No.
No.
No.
No.
No.
No.

8.
9
10
11
12
13
14

i Several large holdings having no markets not included in computation.
Books kept on market-value basis.

5




1930

$133, 593
2,018, 956
2, 289, 011
369,127
224, 210
133,874
10,944

Approximate
decline i n
market value
of portfolio
for year
$4,000, 000
10,000, 000
2,500,000
1,500,000
1, 200,000
45, 239
950, 000

1062

NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

I t will be seen from the above computation that with two exceptions
none of the security affiliates included in the list avoided a net loss
for the year, if declines in the quoted values of holdings be allowed
for, and in some cases the losses as thus defined reached quite substantial proportions, especially if probable values of issues without
quoted markets be considered.
7. Syndicate participations.—In
view of the fact that syndicate
participations in connection with the origination and wholesaling of
securities are subject to a special degree of risk during periods of
declining security prices, because of the relatively large commitments
involved, the banks addressed by the subcommittee were asked to
state the aggregate amount of syndicate and other participations of
security affiliates during each of the past four years, as well as maximum participations of this kind. The replies for the year 1930 were
as follows:
Syndicate 'participations of security affiliatest 1930
Aggregate par- Maximum
participation
ticipation

Bank
No. 1
No. 2
No. 3
No. 4
No. 5
No. 6
No. 7
No. 8

$417, 052,855
583,193,357
38,424,627
452, 979, 000
150,602,750
260,867,029
102, 547,000
10,855,000

- -..

i Applies to 1929.

$33,987,105
20,000,000
34,353,911
18, 300, 000
i 15,000,000
15,000,000
12, 900, 000
l 3, 750, 000
2

Aggregate par- Maximum
ticipation
participation

Bank
No.
No.
No.
No.
No.
No.
No.

9
10.„11
12.
13_
14
15

$2,026,410
111, 495,933
17,189,520
19,000,000
a 201, 244,694
19,348,400
5,050, 000

_..

a

Retail sales only.

$800,000
8,000,000
4, 852,000
1,100, 000
3

()

3y 151,250
2, 541, 500

Not available.

The replies to this questionnaire indicate that security affiliates
follow the practice of assuming syndicate commitments which
amount in the aggregate to many times their capital and surplus, and
that individual commitments of this kind may amount to from 25
to more than 100 per cent of such capital and surplus in certain cases.
One security affiliate further indicates the nature of its 1930 participations in detail as follows:
1.
2.
3.
4.
&

Underwriting
Original terms
Purchase group
Banking group
Selling syndicate

S27, 175, 442
314,692,574
0
76, 464, 590
164,860,751

Total

583, 193, 357

I n this computation, duplications exist because of the fact that
selling and banking group participation in many cases cover the same
issues as those purchased on "original t e r m s " from the Government
or corporation which puts out the offering in the first instance.
Another large security affiliate reports its participations over the past
four years were as follows:
Purchase
group

Special and
banking
groups

Underwriting syndicates

Selling syndicates

Joint accounts

$222,170,964
178,856,915
133, 644,668
134,369,000

$145,877,500
108,163,450
142.672,804
122,909,000

$7,165,400
49,072,147
87,297,021
36,609,000

$34.510,000
27,618,000
11. 385,000
23,894,000

$48,444,146
36,704,490
38,089,000
34,365,000

Year

1927. . ...*.
1928
1929.
1930
..




Selling
groups
$163,866,900
106,899,100
99,851,321
100.842,000

NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

1063

The banks addressed were also asked to list the five largest syndicate or group operations in which their security affiliates participated
during 1929. Replies to this question indicate the varied nature of
these major commitments. Thus one bank reports the five largest
participations of its affiliate, together amounting to $75,903,695, as
follows:
1.
2.
3.
4.
5.

Market stabilizing account formed during the crisis of 1929,
Texas Corporation 5 per cent convertible bonds.
International Hydroelectric, 6/1944.
Canadian International Paper, 6/1949.
City of Chicago Board of Education 6 per cent tax anticipation notes.

The affiliate of another large Eastern institution reported that
its five largest participations in 1929 amounted to $94,194,165. They
were as follows:
1. Bethlehem Steel Corporation (28 per cent interest in original underwriting
group to underwrite sale of 795,000 shares to stockholders).
2. Bethlehem Steel Corporation (28 per cent interest in original underwriting
group to underwrite sale of 600,000 shares to stockholders).
3. American Cyanimid Co. (underwriting entire issue of 808,359^ shares of
common B stock).
4. Texas Corporation (20 per cent interest in purchase group on $100,000,000
5 per cent debenture issue.
5. P. Lorillard Co. (underwriting entire issue of 545,024 shares of common
stock).

The security affiliate of another large bank reported the following
five as its largest participations for 1929:
1.
2.
3.
4.
5.

New York Central short-term revenue bills
Offering of shares of an affiliated investment trust
Offering of shares of an oil holding company
Republic of Cuba serial 5]4 per cent certificates
Richfield Oil 6's
Total

$16, 750, 000
15, 000, 000
11, 695, 000
8, 001, 000
6, 250, 000
57,696,000

8. Relations of security affiliates to banks.—From the viewpoint of
banking regulation, the operations of the security affiliates can be of
interest only in so far as they affect the activities and soundness of
the banks with which they are affiliated. Basically, there can be no
objection to the stockholders of a bank engaging in any other business
they prefer with their own funds. However, if such activities tend
to affect directly the position and soundness of the bank itself, they
then become of prime importance in the regulation of banking.
Reasoning a priori, a number of ways in which the operations of a
security affiliate can affect the position of the parent bank may be
distinguished. These may be summarized as follows:
(1) The security affiliate may borrow money from the parent bank.
This relationship, which is very prevalent, is discussed more fully in
the following section.
(2) The affiliate may sell securities to the bank or another of its
affiliates under repurchase agreements, or vice versa.
(3) The bank is closely connected in the public mind with its
affiliates, and should the latter suffer large losses it is practically unthinkable that they would be allowed to fail. Instead, the bank
would normally support it by additional loans or other aid, thus
becoming more deeply involved itself. The knowledge that the
affiliate has suffered large losses may in itself be sufficient to cause
unfavorable rumors, however unjustified, to spread about the bank.




1064

NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

(4) The bank, to relieve the affiliate of excess holdings, may purchase securities from it. In one case of a large New York institution,
for example, two blocks of foreign bonds, aggregating approximately
$5,000,000, which were included in the portfolio of the affiliate as of
the end of 1929 were given in the list of five largest holdings of the
parent bank at the end of 1930.
(5) The bank may lend much more freely to customers on issues
sponsored by the security affiliate, in order to facilitate their distribution, than it would otherwise do. Also, it may prove more difficult
to insist upon the maintenance of adequate margins on these security
loans than on other such advances, in view of the fact that customers
are encouraged to make the loans by the bank's own affiliate.
(6) The good will of the bank with its depositors may be adversely
affected to a serious degree when the latter suffer substantial losses
on security issues purchased from the affiliate. Because of the tendency of the selling organization of the affiliate to consider the bank's
depositors as its preferred list of sales prospects, this condition may
become an important handicap to a bank during a major period of
security market deflation.
(7) Operations by the affiliate in the market for the bank's own
stock may cause undesirably wide fluctuations in the latter. Also,
efforts made in some cases to push the sale of the bank's stock
through the affiliate to depositors of the institution hurts the position
of the bank when its shares suffer a major market decline subsequently.
(8) Wide variations in the net asset value, earning power, and
dividend-paying ability of security affiliates tend to make bank stock
price fluctuations much greater than would otherwise be the case.
(9) The existence of the affiliates may induce the bank to make
unwise commitments, in the knowledge that in case of need they can
be shifted to the affiliates, and thus be removed from the bank's
condition statement.
(10) Knowing its access to the resources of the bank in case of
need, security affiliates in their turn may tend to assume various
commitments less cautiously than do private investment banking
houses.
(11) In the case of a trust company or a bank with a trust department, the possession of a security affiliate may adversely affect the
independence with which fiduciary activities are exercised.
In actual practice, the operations of a number of security affiliates
have affected the parent institutions to a greater or lesser degree in
several of the ways outlined above. The most direct manner in
which the affiliate may impair the liquidity of the bank is through
the first-mentioned method of borrowing.
9. Bank loans to security affiliates.—In the first part of this report
on security loans, some data was presented on the extent to which
banks make advances to their affiliates. In its questionnaire covering the operation of the affiliates the subcommittee asked a list of
banks addressed to state the maximum loans outstanding at any
one time to affiliates during the years 1929 and 1930, as well as the
average indebtedness of these organizations to the parent banks in
those years. The proportion of such indebtedness which was secured
by collateral was also asked. The answers to these questions are
tabulated herewith.




NATIONAL AND FEDEEAL RESERVE BANKING SYSTEMS
T A B L E 47.—Loans by parent

Maximum indebtedness of
affiliates to banks during
year

Bank

$16.294, 284
36, 757, 742
25, 020,000
16,500,000
19.172,276
10, 500,000
7,100, 000
20,570,000
2,134, 000
2,800,000
21,000, 000

_

____

_.__

__

1

affiliates,

1929 and

Average indebtedness of
affiliates to banks

1930

1929
No. 1
No. 2
No. 3
No. 4
No. 5
No. 6
No. 7_
No. 82
No. 9
No. 10
No. 11
No. 12

banks to security

1929

i $54,839,881
34,487,742
24,970,000
23, 700, 000
25,504,967
5. 500,000
6, 550. 000
18,970,000
13,878,000
4,120, 000
21, 000,000
600,000

1930

$1,802,335
4,636,573
10, 715, 000
691, 000
12,022, 500
174,151
2,662,400
14,574,300
30,000
1,483,333
12, 000,000

1065
1930

Percentage of indebtedness secured
1929

1930

100
32
100

57
47
100

155

$28, 813,049
14,545, 779
14.493,000
326,000
10,387,663
735,137
3,916, 500
14,946,600
4,417,000
3,174,583
17, 000,000
25,000

100
100
100
100
87

100
100
100

loo
100

100

i Of which $44,241,523 were loans to the chief security affiliate from the parent and affiliated banks.
2 Most of this indebtedness was from the security affiiliate to the investment trust affiliate.

Loan lines of banks to affiliates are at times not covered, in whole
or in part, by specific collateral, as seen from the last two columns of
the above table. Where loans exceed 10 per cent of the bank's
capital and surplus, legal restrictions are avoided by having such
excess secured by United States Government bonds, by having more
than one affiliate, and, thirdly, by the use of the repurchase agreement.
The banks addressed were asked also to state the total amount of
securities purchased by them from their security affiliates under
repurchase agreements over a period of years. The use of this
contractual device involves, of course, a further close tie between the
bank and its affiliate.
The replies of those banks which reported making such agreements
with affiliates, with numerical designations corresponding to the
preceding table, follow.
T A B L E 48.- -Repurchase

agreements of parent banks with security
and 1930

affiliates, 1929

Total repurchase agree- Maximum repurchase
ments with affiliates agreements with affiliates
Bank

Remarks
1929

N o . 1No.2_._
No. 6
No. 7
No. 8
No. 9

1929

1930

$2,441,251 $39,689,064
57,488,371 116,310,018
__

$701,833
23,542,809

$23,002,210
24,172,888

391,623
92,938,685

391,623
16,116,910

425,000




1930

363,048
9,656,000
2,974,000

425,000

363,048
2,870,000
2,974,000

Tax-exempt municipals.
From syndicates of which affiliate was
manager.
Mainly governments and municipals.

1066

NATIONAL AND FEDEKAL RESERVE BANKING SYSTEMS

The relative extent to which security affiliates operate with borrowed capital, including loans from sources other than the parent
bank, is indicated in the following table (repurchase agreements not
included):
TABLE 49.—Sources of funds of security affiliates, end of 1980
Capital and Capital and Borrowed
surplus:
funds:
borrowed funds Percentage Percentage
of affiliate
of total
of total

Bank

No. 1
No. 2
No. 3
No. 4
No. 5
No. 6
No. 7
No. 8
No. 9 --No. 10
No. 11

_

_

Total, 11 banks

$137,414,000
93,467,000
61,370,000
34,341,000
17,792, 000
23,291,000
35,015,000
23,140,000
60, 939, 000
41,440,000
6, 955,000

_
..-

-

.-.
_

_
--.
._.

79
76
36
83
39
76
66
38
43
53
96

21
24
64
ir
61
24
34
62
57"
4T
4

535,164,000

64

36

If all of the above security affiliates had written down their security
holdings to market values by charges against surplus, or capital if
necessary, the proportion of loan to own capital would have been
very much larger than shown above.
The loan relationship as it exists between the bank and its affiliate
differs from that 'prevailing with the general run of the bank's customers in an essential respect. When dealing with its affiliate, the
bank is really dealing with itself, in view of the identity of ownership
and management that is established. As a result, there tends to be
a breaking down of those limitations on the extension of credit which
the bank sets up in other cases to guard against the making of excessive or poorly-secured loans.
10. Dividends of affiliates.—Concrete evidence of the manner in
which a change in security market conditions affects the position of
security affiliates is furnished by the dividend policies of such organizations during the period 1929-1931. Where stock of the affiliate is
held in trust for shareholders of the bank, or where shares of the two
institutions are printed on the same certificate, each declares dividends
separately, payable to the same list of shareholders. In most, b u t
not all, of such cases, announcement is made of the dividend paid by
each institution. In other instances the aggregate amount of the
dividend is announced publicly, rather than the amount contributed
by each institution.
Where the affiliate is a direct subsidiary of the bank, with the latter
owning its shares outright, dividends declared by it are paid directly to
the bank. In such cases, it is not usual for publicity to be given the
amount of the dividend.
The following banks announced changes in rate of dividends paid
on shares of affiliates during 1931:




NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

1067

TABLE 50.—Dividends paid on New York bank stocks, 19S1
Annual dividend rate, begin- Annual
ning of 1931
dividend
rate,
middle
of 1931,
Paid by Paid by
all paid
Total
bank
affiliate
by bank

Bank

Chase National Bank
First National Bank__
Bank of America
.

_

__
.„

..^-..-.^

_.
._ ^..^

$3.00
20.00
4.00

$1.00
80.00
.50

$4.00
100.00
4.50

$4.00
100.00
2.00

In addition, several affiliates of trust companies made reductions
or commissions of dividends previously paid directly to parent banks,
both in 1930 and 1931.
11. Regulation of security affiliates.—The first extended reference to
security affiliates of banks by a regulatory authority is found in the
Keport of the Comptroller of the Currency for 1920. Mindful of the
effects on such organizations of the security market deflation of that
year, the comptroller made the following statement:
"SECUKITIES COMPANIES" AS ADJUNCTS TO NATIONAL BANKS OFTEN A MENACE

Some "securities companies" operating in close connection with, and often
officered by, the same men who manage the national banks with which they are
allied, have become instruments of speculation and headquarters for promotions
of all kinds of financial schemes. Many of the flotations promoted by the ' l securities corporations" which are operated as adjuncts to national banks have proven
disastrous to their subscribers, and have in some instances reflected seriously
not only upon the credit and the standing of the "securities companies" by which
they are sponsored, but also in some cases have damaged the credit and reputation of national banks with which the "securities companies" are allied.
It has been established clearly by decisions of the United States Supreme Court
that a national bank can not, except as authorized by the Federal reserve act,
hold the stock of other national banks or the stock of other corporations; but these
•adjunct or auxiliary companies whose* stockholders are identical with the stockholders of the national banks with which they are connected by various ties and
devices frequently deal actively in stocks, and they also sometimes acquire the
ownership or control of other banks, National and State, through their stock purchases.
In times of rising prices and active speculation some of these auxiliary corporations have made large profits through their ventures and syndicate operations,
but their losses in other periods have been heavy, and they have become an
element of increasing peril to the banks with which they are associated. The business
of legitimate banking is entirely separate and distinct from the kind of business
conducted by many of the "securities corporations," and it would be difficult, if
not impossible, for the same set of officers to conduct safely, soundly, and successfully the conservative business of the national bank and at the same time direct
and manage the speculative ventures and promotions of the ancillary institutions. These varying institutions demand a different kind of ability and experience on the part of those who manage them, and the two types of business when
combined with one management are likely to be operated to the advantage of
neither.
A national bank lends not only its own capital, but the money of its depositors,
and in doing this is not expected to tie up its funds in long-time and unliquid
loans in doubtful ventures. The "securities companies" theoretically invest
and speculate with their own funds—that is to say, the funds supplied by their
own stockholders—not with the funds of depositors; but as a matter of fact;
experience shows that "securities companies" often draw and absorb large sums
of money from the allied national banks, and sometimes also borrow heavily
from other national banks which operate other "securities companies," and so
on, in an endless chain of reciprocal borrowing and mutual lending for the
accommodation of speculative cliques.




1068

NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

These ancillary companies are being used with increasing frequency for promotion of speculation and for dealing in bonds and stocks, often those of new
and unseasoned issues, and which are attended with improper hazard risk, and
as a means of enabling banks to do, indirectly through their instrumentality,,
things which they can neither safely nor lawfully do directly.1

This forceful statement of the situation was without effect at the
time, although later the comptroller sought, and in many cases
secured, permission to examine security affiliates as part of the
examination of banks. However, he did not demand this as of right,
and in some instances such permission was refused as not coming
within his province.
In New York State, where most of the large security affiliates are
to be found, sentiment on the subject was aroused among bankers,
as well as the general public, by the effects of the stock market
deflation in 1929-30, and later by the collapse of the Bank of
United States, with its 59 different affiliates. The superintendent
of banks was given legal authority in 1930 to examine bank affiliates
by an act of the State legislature.
i Report of the Comptroller of the Currency, 1920, pp. 55-56.




PART

V

EXAMINATION OF SECURITY LOANS AND INVESTMENTS
1. Bank examinations.—There are three kinds of examinations to
which commercial banks may be subjected. The first, which applies
to all banks, is the examination prescribed by Federal or State statute.
In the case of national banks, this is carried out by the Comptroller
of the Currency, while for State institutions the respective State
departments of banking perform this function.
A second kind of examination is that made by the Federal reserve
banks of their member institutions. Such examination is less formal,
and usually much less complete, than in the case of the examinations
prescribed by statute for the legally-constituted authorities already
referred to. This is a natural consequence of the fact that the
Federal reserve examination is designed in the main to determine the
soundness of rediscounts or advances secured by United States Government bonds made by the reserve bank to its members, as well as
the soundness of the member institutions in relation to the activities
of the Federal reserve bank as collecting agent for out-of-town checks.
The Federal Reserve Bank of Chicago describes its practices in the
examination of member bahks, which appear to be typical for the
system, as follows:
Supervision of national banks rests with the Comptroller of the Currency, and
of State banks with the State banking departments. Copies of the reports of
examination of ail national banks are filed with us by the comptroller's representatives, and copies of reports of examinations of all member State banks by the
respective State banking departments, five States being represented. All reports
are carefully analyzed by agent's department, and a complete report made
thereon in each case, with its own classifications and conclusions.
Our field work in actual examinations is confined to a limited number of State
banks, principally the smaller institutions. A special examination is made for
our own account of all State banks applying for membership. In addition, we
are in contact with all member banks in the district through frequent calls by
men in our bank relations department, from whom we get much valuable information as to management of banks and general conditions.

A third kind of examination is that carried out by a limited number
of local clearing houses. Originally designed to protect the members
of a clearing house from losses they might incur from the failure
of a member, whose checks they might freely receive for deposit and
immediate credit, such examinations have in some cases become quite
comprehensive. In the case of the New York Clearing House, for
example, the examination of members has become so thorough, and
insistence upon compliance with recommendations made is so great,
that such examination is now regarded as considerably more significant
than that of the statutory authorities, while the examination by the
Federal reserve bank in that district has tended to become more
and more perfunctory, reliance being placed upon the other examining
agencies for the most part by the reserve bank. The fact that no
banks belonging to the New York Clearing House has ever been




1069

1070

NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

closed because of insolvency is attributed in part to the effectiveness
of its system of examination.
The increased importance of security loans, investments, and
security affiliates in the operations of commercial banks has made
these items loom larger in recent years in any comprehensive examination of the condition of individual banks. The subcommittee
addressed a questionnaire to bank examiners of the three classes
mentioned to determine their practices with regard to loans and
investments.
2. Soundness of security loans.—The first question asked was:
What criteria do you use in analyzing the soundness of security loans?

The Comptroller of the Currency described the criteria used by
his office as follows:
We rely largely upon market quotations for the valuations of all stocks and
bonds actively traded in on the exchange. Concentrations on specific issues are
noted and speculative issues. Loans secured by real-estate mortgage notes or
by other personal security should be supported by independent appraisals or by
an appraiser designated by the bank. In the event of any instance where such
appraisals are not to be found in the bank's files the examiner discusses the
situation fully with the managing officers and directors of the bank being examined.
In the substandard bank it frequently happens that the examiner experiences
considerable difficulty or is unable to obtain the desired information and must
rely largely upon his intuition in arriving at the value of such securities.

I t will be noted that difficulty is encountered in enforcing these
standards of the comptroller on the substandard bank. Similar
complaints have been voiced by State regulatory authorities, both in
this and other connections, creating a problem of enforcing standards
which these authorities have set up in their examinations. Suit for
forfeiture of charter, or frequent examinations of banks, are the devices
now available for enforcement, but neither proves effective if the
desire is to remedy a bad condition quickly without jeopardizing the
position of the bank.
The Federal reserve banks, in their reply to this question, indicate
that they seek to determine chiefly the adequacy of collateral. I n
some cases, diversification of collateral is also stressed, while the St.
Louis Reserve Bank is alone in that it seeks to determine whether a
program of liquidation of security loans has been arranged by the
bank with the borrower. A few banks also watch carefully loans to
officers and employees. The replies from the Federal reserve banks
are as follows:
Boston.—The bulk of such loans are secured by listed or readily marketable
securities so that the value of the collateral can be readily established. In the
case of loans having an adequate margin of collateral, usually no further investigation is made. If the value of the collateral is insufficient or difficult to determine, the character and standing of the borrower is investigated. If loans are
found of undue size, or if there is an undue concentration in the securities of a
single company or a single industry, it is called to the attention of the officers for
correction.
New York.—That the loans are sufficiently margined by marketable securities
with no undue concentration in any one issue or type of collateral. Margin
requirements would vary somewhat according to the type of collateral supporting
the loan, current prices and the degree of diversification. For example, a margin
of 20 per cent would be considered sufficient where a loan is secured by listed
stocks of high class railroads, public utility or industrial corporations, and when
prices are not above real values. At times when prices appear to be above
intrinsic values and out of proportion to past earnings, the margin requirement
would be increased proportionately. Also in cases where the loan is secured by




NATIONAL AND FEDEKAL RESEBVE BANKING SYSTEMS

1071

stocks of less desirable character or where the diversification is poor, margin
requirements would be materially increased.
Philadelphia.—The first step employed in analyzing the soundness of security
loans consists of the appraisal, as of the date of the examination, of the securities
which are held as collateral to each secured loan. Such appraisals are based on
current quotations of issues which are listed on the major security exchanges of
the country or world; bid prices, as reported by security houses which are from
time to time in the market for the issues, are accepted in the cases of inactive
issues and issues which are not listed. When large loans are involved, secured
wholly or to a major extent by inactive issues, we endeavor to secure bid quotations from sources independent of the security houses which sponsored the issues
and are understood to be interested in making a market for them. In such
cases, if the relative importance of the security value warrants the step, the
financial condition of the corporation whose stock or bonds are being appraised
is examined into by means of the analysis of its current balance sheet and operating statements. If adequate data are not available in support of important
inactive issues which are collateral to large loans, the loans are listed in a separate schedule of the report, the collateral is detailed and the suggestion or request
is made that definite information be obtained in support thereof. If the total of
guch loans, collateraled by inactive issues, is relatively large and the information
with respect thereto is inadequate or unsatisfactory, this matter becomes a
subject of criticism and is followed up in an endeavor to secure its correction.
In addition to the making of appraisals of the issues securing loans, an investigation is made in each examination to determine whether undue concentration
exists in the stocks or bonds, or both, of one company or affiliated group, in
one industry, or in the companies or industries of one restricted geographical
section. Investments in, or loans made on the security of stocks or bonds
issued by corporations with which officers, directors, or employees of the banks
are affiliated, are ascertained and set forth in separate schedules of the report.
Particular efforts are made to secure satisfactory appraisals of such of these
issues as possess no ready market if the amounts involved are more than nominal.
Cleveland.—Current market quotations as of the date of examination. The
financial responsibility of the maker is also considered.
Richmond.—Ample margin and diversification of securities. Also usual
restriction as to limitation of credit.
Atlanta.—The market quotations on the collateral pledged are used in analyzing
the soundness of security loans.
Chicago.—Marketability of collateral pledged, as well as probable intrinsic
value; general reputation of borrower, as well as collectibility of loan, based on
borrower's financial standing.
St. Louis.—Obtain current market value and determine adequacy of margin
considering character of the collateral. Consider borrower's business and
financial responsibility; also purpose of loan and period that the borrower has
been accommodated. Ascertain if a program of liquidation has been agreed
upon. Also if collateral pledged are securities in which any officer, director, or
employee is interested, ascertain who received benefit of proceeds.
Minneapolis.—The current market value of the securities behind the loan.
Kansas City.—Stability, marketability, yield, sufficiency, of original issue to
make general marketability possible at all times. Distribution of the issue,
and, on occasions, the provisions made by house of issue to support the issue.
San Francisco.—Market information. Statement of corporation when available. Poor's Manual. Standard Statistics.

Only a limited number of clearing houses maintain examination
departments. Replies from serai such organizations were as follows:
Boston Clearing House Association.—The distribution, marketability, and
value of the collateral; secondly, the responsibility of the borrower.
New York Clearing House Association.—Statements, earnings record, marketability, and character of collateral.
Philadelphia Clearing House Association.—The market quotations of securities
involved.
Clearing House Association of the Banks of Cleveland.—On active securities I
use market transactions and quotations of the various stock exchanges. Beyond
this is the personal equation of the borrowers.
Chicago Clearing House Association.—All factors are taken into consideration
when analyzing a collateral loan, i. e., intrinsic value and marketability of the
collateral held; the character of the borrower and his paying ability aside from
the collateral pledged.



1072

NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

Denver Glearing House Association.—Daily market quotations.
Los Angeles Clearing House Association.—The adequacy of the security, market^
ability and stability of the collateral, the amount or size of loan, and, in isolated
cases, history and financial strength of both the collateral and the borrower.

3. Securities without active markets.—The second question asked
was:
How do you arrive at a valuation of stocks and bonds having no regular
market quotations?

The Comptroller of the Currency replied as follows:
Such securities require an analysis of the financial and earnings statements of
the company issuing them and consideration of the character of the business in
which the company is engaged. Future prospects and relationship of the borrower
to the issuing company are considered. In this connection, there are instances
where we find that the securities are absolutely sound as to value but for one
thing or another have no marketability and are for that reason undesirable as
collateral to bank loans.

The Federal reserve banks similarly indicate that special analyses of
securities to determine their worth may be resorted to where issues
are without quoted markets, although there is no clear indication as
to how frequently such studies are made. The replies follow:
Boston.—If no current quotation can be found in the regular quotation services
resource is had to the credit files of the bank, consultation with the officers, and,
such other sources of information as are available including manuals, descriptive
circulars of issuing houses, etc. Statements are analysed, and in the absence of a
better figure, the book value or liquidating value is used.
New York.—A valuation would be fixed upon the basis of audited or certified
statements of the corporation if available. Consideration would also be given
the general credit standing and reputation of the company.
In the case of bonds, the security is generally one or more of the following
types:
1. A mortgage upon real property.
2. A collateral trust with securities pledged with a trustee.
3. Debenture bonds based upon the general credit of the issuing corporation.
In determining values, consideration is given the following:
1. In the case of mortgage and collateral bonds, the real value of the security
actually pledged.
2. In the case of debenture bonds, the equity back of the bonds and the terms
of the indenture protecting the equity.
3. In all cases consideration is also given to the earnings of the company,
sinking-fund provisions if any, and other provisions for repayment of the issue,
the character of the industry, and the progress trend.
If a bond meets all of these tests satisfactorily, it would generally be appraised
at its cost or face value, whichever is less. If any one or more of these factors
appeared unsatisfactory, the appraisal would be fixed accordingly. Consideration
would also be given to the proportion of bonds of this class in relation to the total
portfolio.
In the case of stocks, consideration would be given to the following factors:
1. Real equity back of the stock.
2. Whether or not there were senior securities and if so, the relation of their
equity to the total equity.
3. Ratio of quick assets to current liabilities.
4. Relation of operating profits to sales and to capital.
If all the factors were favorable, a valuation would be fixed mainly based upon
the equity and the earnings. Generally speaking very few unlisted stocks are
found in the investment account of banks. The unlisted stocks found among the
collateral for loans are generally those of local industries with respect to which
information is usually available. Margin requirements with respect to such
securities would be much higher than with respect to listed securities. If any
considerable portion of the assets of a bank were based upon such security or
collateral, the condition would be subject to criticism.
Philadelphia.—The extent of independent investigation into the intrinsic value
of inactive issues depends in every case upon the relative importance of such issues




NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

1073

to the condition of the bank, as well as upon any special considerations which may
develop. In any event, investments in and loans on issues which possess no
ready, dependable market, are set out in detail in the report so that the subject
may receive such action as may be deemed desirable in each instance.
Cleveland.—Bid and asked quotations for inactive issues are obtained if possible.
If procurable, the most recent financial statement of the issuing company is
analyzed, and the indicated book value of the securities together with the company's earning power over a given period is used as a basis for determining values.
Richmond.—Appraisal by officers and directors and analysis of financial and
operating statements when available.
Atlanta.—Quotations secured from a reputable local dealer in stocks and bonds
are used in arriving at the valuation of securities having no regular market
quotations. Where this information is not available, such credit information as
can be secured is used in this connection.
Chicago.—Character and reputation of concern issuing securities. Financial
and operating statement over a period of years. Consideration given to line of
industry represented, its current trend, and position maker of security occupies
in field. Inquiries made through brokers and other reputable concerns as to
values, if volume or conditions seem to justify such inquiry.
St. Louis.—Stocks: Make a complete analysis of the latest financial statement,
also earnings reports for the past several years. Inquire as to character of the
management of the corporation and endeavor to obtain last sale price or bid.
Bonds: Analyze all data available taking into consideration the appraised value
of the properties, sufficient insurance if real estate, location, income, maturities,
and sinking fund provisions. Ascertain if securities have been issued by proper
trustee or agent.
Minneapolis.—Financial statement of the corporation issuing the stocks or
bonds; character of its assets, record of its earnings and nature of business.
Kansas City.—On the basis of current financial statements, together with such
other credit information pertaining to the character of the management, stability
yield, anticipated future development, and its past record, as well as general
economic conditions affecting that particular industry.
San Francisco.—By analysis of issuing corporation's statement. Inquiry at
brokers dealing in unlisted securities or through other credit channels usually
available to examiners.

Replies on the methods of valuation of stocks and bonds having no
regular market quotations from the clearing houses follow:
Boston Clearing House.—By analyzing financial and operating statements of the
corporations and through information obtained from outside sources.
New York Clearing House Association.—Statements, earnings and dividend
record.
Philadelphia Clearing House Association.—Bond and stock brokers can in
many cases supply such information. In other cases information can be secured
from parties identified with the security in question.
Clearing House Association of the Banks of Cleveland.—On inactive securities
I use over-the-counter transactions and quotations, brokers' and bankers'
markets, the manuals and standard statistics services. On local, unlisted securities I utilize financial, operating, and dividend statements of the issuing companies. On local, unlisted collateral trust, mortgage, and leasehold bonds, I
analyze those trusts that are held within our clearing house bank and trust
companies.
On real estate mortgages, I make an individual examination of supporting
documents, utilizing appraisals made by appraisers satisfactory to me.
We are one community of banks that some years ago adopted a set of standardized forms of financial statements for borrowers. Few loans of any size or holdings of material blocks of stock are passed at a value, unless complete financial
and operating statements are available.
Chicago Clearing House Association.—Intrinsic valuation of securities not having a market is determined by three factors namely: (1) The strength and general
reputation of the concern issuing the securities; (2) the intrinsic values as reflected
in the financial statement of the company; (3) the earning power. (This last
condition generally reflects the character and efficiency of the management.)
Denver Clearing House Association.—Inquiry is made of sources believed to be
familiar with the issues.
Los Angeles Clearing House Association.—By financial statement of the corporation issuing the stock, past history and earning record and future prospects,




1074

NATIONAL, AND FEDEEAL BESERVE BANKING SYSTEMS

and the class of business in which the corporation issuing the stock pledged is*,
engaged. If this information is not at hand, then no value whatsoever can be
placed on the collateral.
4. Undermargined security loans.—Three questions were asked on.
the subject of undermargined loans. These were:
Do you find evidence of many security loans with collateral of a value less,
than the amount of the loan?
Are these mainly in small or large banks?
How do you handle security loans, the value of the collateral of which is less
than the amount of the loans?
The Comptroller of the Currency replied as follows:
There have been many such loans found in the past year due to a declining,
market. It is believed that a larger number of such loans have been found in the
smaller banks. While the larger banks will show a larger aggregate in dollars,
valuations are taken care of more promptly in the larger institutions. In thesmaller banks customers are apt to be slower to respond to calls for additional
collateral.
Collateral loans which are undersecured are shown in detail in reports of examination. The management is instructed to obtain partial payment or additional
collateral. Unless the officers can give reasonable assurance that the maker isfinancially responsible, regardless of the collateral, a loan is usually estimated,
for the deficiency, and unless the condition of the bank as a whole is reasonably
good the examiner undertakes to get correction during examination.
The Federal reserve banks reported t h a t undermargined loans*
were not found in excessive amounts at the end of 1930, the period
of the investigation although the stock market deflation had made
them larger than usual on t h a t date. The proportion of such loans
was said to be greater for the smaller banks in the Northeast, while
in the South and West the small banks had relatively fewer inadequately secured loans, because of the fact t h a t they abstained from
the security loan field in general.
Practice differs in handling such undermargined loans in the examination, according to the replies. Some reserve bank examiners
separate the loan into a secured and an unsecured part, and the latter
is analyzed on the basis of the borrower's general credit. Othersseek rather to get more collateral or have the amount of the loan
reduced. Where this can not be done, the portion of the loan regarded as inadequately margined is classified as a slow, doubtful,
or bad asset, according to circumstances.
The replies were as follows:
Boston,—There are some such loans, but the total is small in comparison with
the assets of the banks. Prior to the market break the large banks watched
their margins a little more carefully than the smaller banks, but at present such
loans are found in both classes of banks in about the same proportion.
The ability of the borrower to pay or reduce his loan is investigated. If it is
apparent that he can pay the unsecured portion within a reasonable time out of
his income, the loan is classed as slow and the bank allowed time to work it out.
If it appears that he can not reduce his loan within a reasonable time; the unsecured portion is classed as doubtful or a loss and the bank is asked to charge it off.
New York.—Undermargined loans are occasionally observed, but the number
of them and the amount involved have not been sufficient to present any problem.
Loans predicated mainly on real estate equities have given many banks serious
concern and in not a few cases have resulted in substantial losses. Real estate
values in some localities have declined to a point where the first mortgages, which
are usually held by savings banks, insurance companies, and building and loan
associations, leave little equity in the property.
Many of the real estate loans the security for which is now inadequate, judged
by present real estate values and conditions, appeared to be justified at the time
they were made, based on sales of property that were then taking place. This, .




^ A T T O ^ A L Am> FEDERAL RESERVE BANKING SYSTEMS

1075

of course, is due t o the present general depression in real estate which has resulted
in m a n y mortgage foreclosures.
I t is n o t possible t o classify completely t h e b a n k s h a v i n g such loans, b u t generally speaking i t is our observation t h a t t h e medium-size b a n k s are more a p t t o
h a v e loans of this t y p e t h a n are either t h e small c o u n t r y b a n k s or t h e large city
b a n k s . I n t h e ' s m a l l c o u n t r y b a n k s , due mainly t o their restricted loaning limit
t o one borrower, very few loans are observed with collateral of a value less t h a n
t h e a m o u n t of t h e loans.
Appraisal of unsecured portion of the loan is based on responsibility of borrower
as shown by s t a t e m e n t or other evidence of ability t o liquidate loan, consideration being given t o t h e general r e p u t a t i o n of t h e borrower, his ability t o lodge
additional collateral, as well as his present earning capacity.
Philadelphia.—The
n u m b e r a n d relative a m o u n t s of t h e so-called short
•collateral loans revealed in t h e reports of examinations of member b a n k s in t h e
t h i r d Federal reserve district are, generally speaking, surprisingly small considering t h e current level of security prices and t h e extremely sharp declines which
have occurred during t h e p a s t 16 m o n t h s . I know of very few cases among our
m e m b e r b a n k s where such loans have seriously embarrassed t h e banks.
We find some " s h o r t collateral l o a n s " in b o t h large a n d small member b a n k s
"without i m p o r t a n t distinction. As a rule, however, t h e larger banks have more
^efficient m a n a g e m e n t of the collateral-loan d e p a r t m e n t and w a t c h t h e collateral
values more closely, a t the same time looking t o t h e collateral for security a n d
liquidation of t h e loans r a t h e r t h a n to a n y other assets or t h e earning power of t h e
borrower. The smaller b a n k s do n o t usually provide as careful a supervision
over their collateral loans; they are inclined to a t t a c h considerable importance t o
t h e general financial standing and earning power of t h e borrowers and therefore
m o r e frequently p e r m i t collateral loans t o become short of collateral, relying on
the character and ability of t h e borrower to liquidate t h e loan from resources
a p a r t from the collateral pledged.
These loans are set o u t in a special schedule which details t h e n a m e of t h e
borrower, a m o u n t of loan, list of collateral and appraised value, and a m o u n t of
shortage. T h e aggregate of t h e shortage is also shown. T h e financial condition,
character, and earning power of each borrower are inquired into a n d s t a t e m e n t s are
/analyzed where available. T h e portion of each loan which is n o t covered b y
collateral is then given a special classification, if w a r r a n t e d by t h e information
secured or because of t h e lack of definite, reliable information, of slow, doubtful,
tor estimated as a loss, depending on t h e circumstances surrounding each case.
Cleveland.—Evidence
found of m a n y loans with collateral less t h a n t h e a m o u n t
of t h e loan. I n greater proportion since t h e m a r k e t break of October, 1929.
M o r e in large b a n k s t h a n in small.
Richmond.—No large volume of inadequately collateraled security loans, b u t a
noticeable increase in this class of paper since October, 1929. Chiefly in larger
tanks; not m a n y security loans in country banks.
Loans are criticized and where makers are not regarded as solvent or having
-some financial responsibility, t h e unsecured portion of loans is classified as doubti u l or loss.
Atlanta.—Very
few security loans with collateral less t h a n t h e a m o u n t of t h e
loan are found. These are mainly in large banks, as very few security loans are
found in small b a n k s in this district.
T h e b a n k is required t o secure additional collateral from t h e m a k e r if t h e
coverage is inadequate.
Chicago.—Under existing conditions quite a n u m b e r of loans have short m a r gins, b u t in view of the liquidation in security values t h e volume is small. I n
cities where industry predominates t h e volume is proportionately similar to t h e
larger cities. Agricultural a n d nonindustrial centers have lesser volume.
Where collateral value is less t h a n loan, character, reputation, and ability of
borrower to repay loan is considered. If unsecured p a r t is questionable, bank is
e x p e c t e d to m a k e adjustment. Under existing conditions, a tolerant a t t i t u d e is
generally taken.
St. Louis.—A small proportion of loans in some b a n k s is found t o be inadequately secured, mainly in small banks.
Review t h e loan in detail with the directors and officers. If t h e loan is large
review also with borrower. If t h e borrower's financial responsibility is limited
a n d demands for additional collateral have not been met, a charge off is required
i n an a m o u n t t h a t will leave t h e loan fully secured a n d provide a satisfactory
margin. If t h e borrower is represented to be responsible and d e m a n d for additional collateral has n o t been m a d e , the loan is criticized account of insufficient
34718—31—PT 7




6

1076

NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

collateral a n d lack of credit d a t a . T h e banker's estimate of t h e borrower's
net worth is accepted until next examination.
Minneapolis.—Not
m a n y undermargined loans. Mainly in the m e d i u m sized
a n d larger banks.
If t h e financial s t a t e m e n t of t h e note maker shows t h a t he is not entitled to
credit in t h e a m o u n t of t h e unsecured portion, the line is set up in the criticized
assets and t h e portion not properly secured is classified as slow, doubtful or loss,
as t h e circumstances indicate.
Kansas City.—Amount
very nominal; mainly in t h e large banks.
Unless supported b y a current financial s t a t e m e n t with a satisfactory showing
or a good indorser, t h a t portion of t h e loan a b o u t which there is a question is set
out as being of doubtful value, and if it is reasonably possible to determine a
definite loss, t h e a m o u n t so determined is classified'as a loss.
San Francisco.—Percentage
usually found to be small. Proportionally a b o u t
t h e same in small a n d large banks.
If borrower's financial s t a t e m e n t does not justify loan, the unsecured proportion is listed as a loss to be charged off, or otherwise secured.

The clearing-house examiners, who generally appear to follow the
same practices as those of the Federal Reserve banks, replied as
follows:
Boston Clearing House.—No evidence of m a n y undermargined loans. Larger
proportion in small banks.
Handling of such loans in examinations depends upon the earning power a n d
financial responsibility of t h e borrower.
New York Clearing House Association.—-Not very m a n y undermargined loans.
Both in large and small banks.
Inquire into the other resources of the borrower a n d estimate their value.
Philadelphia
Clearing House Association.—Relatively
small n u m b e r of such
loans just now.
We urge t h e banks to secure a reduction of t h e loan or additional collateral.
Clearing House Association of the Banks of Cleveland.—Not m a n y of this class
of loans are found, although a t this time, under present m a r k e t conditions, more
are found t h a n usual, and margins of collateral value are narrower. We have no
small banks among our association members.
W h e n encountered, I give t h e loan a collateral value, represented by t h e liquid a t i n g value of the collaterals pledged. The balance of the loan is t h e n regarded
by me as an unsecured obligation and is subjected to t h e same analysis as are all
unsecured loans, namely, a competent financial and operating s t a t e m e n t of t h e
borrower, together with such information bearing upon t h e "personal equation,"
as m a y be secured from the b a n k ' s officers or from outside sources. If on t h i s
basis t h e loan is classed as good, it is so passed. If a definite loss is determined,
it is t h e practice to provide reserves to cover or to charge off against profits;
If t h e value is slow, or problematical, or undetermined, it is so scheduled in t h e
examiner's report, and the aggregate of such values set up against t h e examiner's
showing of net worth, where it will command the a t t e n t i o n of t h e b a n k ' s m a n a g e m e n t and be carried forward for reviewal and reinvestigation a t the time of t h e
succeeding examination.
Chicago Clearing House Association.—While
a considerable n u m b e r of loans
a r e found with short margins, they are surprisingly few when considering t h e
d r a s t i c liquidation of security values which has taken place in recent m o n t h s .
Loans of this t y p e are no more prevalent in large t h a n in small banks.
A tolerant a t t i t u d e is t a k e n by this office on loans secured, by sound securities
even t h o u g h present m a r k e t quotations might reflect a short margin; to do otherwise would be to question t h e future of this country. T h e character of t h e
borrower a n d his own paying ability is likewise considered in loans of this kind.
Denver Clearing House Association.—I
have found some loans where t h e value
of t h e collateral was less t h a n t h e a m o u n t of the loan b u t t h e deficiency in m o s t
instances was not of sufficient a m o u n t to cause concern. I believe t h a t these are
mainly in t h e larger banks.
Request is m a d e t h a t t h e a m o u n t of the loan be reduced or additional collateral obtained.
Los Angeles Clearing House Association.—Under
present conditions, there a r e
more undermargined collateral loans t h a n usual, b u t relatively they are not very
serious. Their occurrence in large and small banks is a b o u t p r o p o r t i o n a t e .
This is more according to community t h a n t h e size of t h e bank.




NATIONAL AND FEDERAL BESERVE BANKING SYSTEMS

1077

The unsecured portion of the collateral loan is considered as other unsecured
advances and upon investigation of the borrower's financial condition, if same is
not warranted, the bank is requested to charge to its profit and loss account the
unsecured part of the loan.

5. Examination oj investments.—As seen in Part I I I of this report,
it is the custom among the great majority of banks to carry their
investments at cost in their statements of condition, with occasional
allowance for depreciation and write-offs for bonds that default. I n
making an examination of a bank, when the basic soundness of its
position must be determined regardless of what the statement of
condition shows, the market value of the investments has been the
prime criterion used by examiners in making their reports.
In order to obtain more detailed information on the method of
valuation followed by examiners, the following questions were addressed to them:
Do you take the cost or market value of investments in examining the condition of a bank? Is there any other valuation basis you use?

The Comptroller of the Currency replied as follows:
The present market value. No consideration is given to the cost of a bank's
investments except in determining the difference between the value at which the
bank is carrying them and the market value at the time of examination. No
other valuation basis is used.

In September, 1931, the Comptroller of the Currency issued instructions to his examiners providing for the classification of bonds
into 13 grades in their examination reports. The four highest,
characterized as "highest g r a d e / ' "high grade," " s o u n d , " and
"good," were specifically exempt from any charge-offs for depreciation, regardless of market price,unless a default had occurred on
them. The remaining nine grades, ranging from " f a i r " to hopeless
defaults, were to be marked down to market prices by charge-offs of
25 per cent of the depreciation semiannually, until the book value
was equal to the market price. Issues in default were to be marked
down to the market value at once. The depreciation was to be
deducted from the net worth of the banks examined, as previously.
These instructions were issued because of the drastic decline in
bond prices, and the fear that excessive rigor in applying the market
value basis in examination would force the closing of institutions on
account of temporary impairment of capital. Accordingly, with a
return to more stable conditions in the bond market, it is questionable
whether this ruling would continue in its existing form.
Examiners were instructed to determine the grade of each bond
through taking the lowest rating given by four statistical agencies.
The grades mentioned by the comptroller were converted into the
ratings of these agencies in his instrucitons. Obligations of the
United States, as well as general obligations of States, counties, and
municipalities, were made exempt from any charge-offs for depreciation as long as no default had occurred on them.
Under the comptroller's ruling, the banks were also given the option
of making their condition statements conform to these regulations.
Where they do so, they may write up bonds belonging to the four
highest grades to par, while writing down the others as indicated.
By following the ruling, some banks may thus raise the aggregate
valuation of their bond portfolios over the old basis of cost. The
comptroller's ruling was thus a pioneer effort to shift the criterion




1078

NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

of examination of a bank's bond investments from market value to
something akin to "intrinsic" values.
The Federal reserve banks replied to the query as follows:
Boston.—Market value. If no current quotation can be found, recourse is had
to the credit files of the bank, consultation with officers, etc., as with loans on
unlisted collateral.
New York.—For the purpose of appraising the assets of a bank and determining
the amount of its net capital funds, its investments in securities are appraised at
their market value regardless of cost, and in cases where no market value is
available, the value is arrived at on the basis described in answer to question No. 2
(with reference to examination of security loans backed by unlisted collateral).
In the case of appraising the banking house, which if owned by the bank may
be considered as an investment, it is allowed at its book value unless that value
appears to be excessive, in which case it is allowed at what is considered to be a
fair valuation. Such property is not ordinarily allowed at more than its book
value.
Philadelphia.—In our report the investment schedule shows the book value
and appraised market value of each issue owned which enjoys a ready, ascertainable market. The difference between the aggregate of these figures is shown as
appreciation or depreciation and included in the adjustments to the capital
account as a result of the examination.
Inactive investments are appraised in the same manner as are inactive issues
which are collateral to loans. In cases where satisfactory market values can not
be secured the issues are appraised as completely as is possible on the basis of
available information, the assigned values are designated as "nominal" as
distinguished from quoted or market values and a special schedule, a subdivision
of the investment section of the report, is prepared of these items so that their
total book and market values may be readily ascertained. Where warranted by
the circumstances, a portion of all of the book value of inactive issues may be
classed as slow, doubtful, or estimated to be a loss.
Cleveland.—Investment values are determined on the basis of market values
when obtainable. For unlisted securities, same method of appraisal is employed
as indicated for collateral loans backed by such issues.
Richmond.—Market value. Cost or appraisal used for inactive and unlisted
securities.
Atlanta.—Market value of investments used in examining the condition of a
bank, except that cost is used where cost is less than market value.
Chicago.—Market value is considered first. If depressed market, a liberal
attitude is taken, especially if securities are high grade and bank is strong. For
issues without active markets, same procedure as in loans with such securities
as collateral.
St. Louis.—Market value. In addition to market quotations, bond ratings
furnished by Standard Statistics Co. are used. Also outside inquiry is made of
investment bankers and others.
Minneapolis.—Market value. Marketability is one of the main considerations.
An investment security with no market or even a narrow market is criticized.
Kansas City.—Market value. Character and history considered in determining whether bank should be required to charge down to market value.
San Francisco.—Market value with due consideration to past range of price.
Do not use any other valuation basis.

The replies from the clearing-house examiners were as follows:
Boston Clearing House Association.—Market value. Financial condition of
corporation taken into consideration.
New York Clearing House Association.—Market, if well seasoned. If comparatively new, earning value and character of management.
Philadelphia Clearing House Association.—Market value.
Clearing House Association of the Banks of Cleveland.—On arriving at a
statement of a bank's liquidating value, I take the market value of investments.
The difference between cost and market value must not, however, necessarily
be classifiable as a loss. Accordingly, I take into consideration the grades of the
various securities. I classify them as to grade, present an analysis of them, and
upon the basis of my gradings and analyses, the difference is classed by me
either as ultimately solvent, as problematical, as questionable, as at present
undeterminable, or as a loss to be charged off.




NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

1079

I n m y s t a t e m e n t of t h e b a n k ' s physical condition these classifications are set
up against m y s t a t e m e n t of the b a n k ' s net worth, a n d if definite losses are determined, they are provided for.
Chicago Clearing House Association.—When
a depreciation is shown between
cost a n d m a r k e t values t h e banks are requested to set up reserves to cover as
rapidly as possible.
If no quoted m a r k e t is available, investments are classified on a basis of intrinsic
values based on earning power supporting same.
Denver Clearing House Association.—The
m a r k e t value a t t h e time of
examination.
Los Angeles Clearing House Association.—Market
value.

6. Losses on investments.—In order to throw light on the types of
investments from which the banks have latterly been suffering the
largest losses, the following question was addressed to the examiners:
On which t y p e of investment do you find t h a t the banks you examined have
suffered t h e most severe losses?

The answers refer to the situation prevailing early in 1931. Later
in that year bonds, except the very highest grade groups, suffered a
general and very sharp decline.
The Comptroller of the Currency replied:
On the low-grade bonds a n d issues paying a higher r a t e of interest, which some
banks purchased on account of inexperience or deemed it necessary to purchase
during recent years t o enable t h e m to cover t h e high r a t e of interest being paid
on savings deposits. Depreciation on high grade, highly rated issues has been
comparatively small.

The replies from the Federal reserve banks were:
Boston.—Over
a period of years the losses in traction securities have been
quite prominent. At t h e present time the heaviest depreciation is in secondgrade industrial a n d foreign bonds.
New York.—Generally
speaking, banks in this district have suffered their
greatest losses as a result of their investments in bonds. I n t h e case of member
b a n k s other t h a n national b a n k s where State laws permit investments in stocks,
we have noted a few instances where very substantial losses m a y result from such
investments. Generally speaking, however, even where State laws permit, banks
do not invest very largely in stocks.
Banks have suffered losses as a result of investments in practically every t y p e
of bond. This condition results from a n u m b e r of factors:
1. T h e desire for the high yield which is frequently m a d e necessary by t h e
p a y m e n t of too high a rate of interest on deposits.
2. Failure to investigate properly and check issues before purchase.
3. General inability and lack of experience with respect to t h e purchase of bonds.
Among t h e bonds showing t h e most severe depreciation in values are those
issued by small industries, public-utility holding companies, bonds originating in
certain foreign countries, and those based upon the security of real estate, such
as hotels, office buildings, and a p a r t m e n t houses.
Philadelphia.—Stocks
for State member banks. Considering member b a n k s
as a whole, State a n d National, in the light of the current position, the heaviest
losses or depreciation have been experienced on stocks a n d bonds owned, viz,
" i n v e s t m e n t s . " Capital loans, including loans based directly or indirectly on
real-estate equities, have also m a d e i m p o r t a n t contributions to losses sustained.
Cleveland.—Foreign
issues, southern municipals, a n d leasehold bonds.
Richmond.—Foreign
securities, secondary or speculative bonds, a n d voluntary
a n d involuntary investments in real estate.
Atlanta.—The
most severe losses or depreciation in t h e i n v e s t m e n t accounts of
b a n k s in this district h a v e been sustained in second-grade public-utility a n d
industrial corporation bonds. Severe losses have been sustained also in foreign
bonds.
Chicago.—Real-estate
loans, those m a d e originally on too liberal basis or t a k e n
as junior liens as only security available on existing debt. Repurchase of realestate loans sold to customers has proven a serious problem with m a n y banks.
Bonds now show material depreciation, particularly foreign bonds.




1080

NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

Si. Louis.—Drainage district and levee bonds and also low-grade foreign and
domestic industrial bonds.
Minneapolis.—Foreign bonds.
Kansas City.—Losses too nominal to warrant a comparison.
San Francisco.—Unlisted securities. Irrigation bonds have contributed quite
largely, and in the country banks, securities of local enterprises.
The replies received from clearing house examiners were as follows:
Boston Clearing House Association.—Convertible issues purchased at large
premiums.
New York Clearing House Association.—Loans.
Philadelphia Clearing House Association.—Commercial paper, bonds other
than high grade, and occasionally bank stpcks that have depreciated in value.
Clearing House Association of the Banks of Cleveland.—Commercial or unsecured
loans.
Chicago Clearing House Association.—Real estate loans conforming to the
restrictions of the Federal Reserve Act have not been the cause of losses to the
banks. However, more losses have been sustained in the past 10 years both
in city and country banks upon loans collateraled by junior real estate mortgages
or unsecured loans dependent upon real estate security held by the borrower
than among other class of losses. This condition applies to both city and farm
property and such loans have no proper place in a well managed commercial
bank.
Denver Clearing House Association.—The greatest depreciation in investment
accounts is noticed in the bonds of public utility corporations, bonds of other
corporations (mostly industrial) and bonds of railroad companies, in the order
named.
Los Angeles Clearing House Association.—Oil securities, irrigation and reclamation issues, and foreign bonds.
7. Loans on stocks and bonds oj real estate holding companies.—In
view of the growing practice of incorporating large real estate projects
as corporations, which raise their funds by selling stocks and bonds
just like other enterprises, the possibility arises that banks may get
tied into the real estate situation unduly through advancing loans on
the security of such issues. Accordingly, the following questions
were asked :
Have you noted any security loans based upon stocks or bonds of real estate
holding companies in the portfolios of banks within your jurisdiction?
What proportion of all security loans is based upon real estate holding comrany
securities, in your opinion?
What is your attitude toward such loans and how do you determine their
soundness in examination?
The Comptroller of the Currency replied:
Negligible, probably less than 1 per cent.
As a rule, such loans are found to be to men of the promoter or speculator type
and while these men usually show financial statements in large figures, it frequently happens that their assets prove to consist of equities carried at highly
inflated values. The bank's files usually contain an appraisal of the property
based upon the estimated sale value and this is almost invariably found to be
high.
T h e Federal reserve banks reported findings such loans in insignificant volume among security collateral advances, and to be critical
of them. Their replies follow:
Boston.—There are a few such loans, constituting a very small fraction of 1
per cent of all security loans.
If a current quotation can be found and there is an adequate margin of collateral, no criticism is made. If current quotations can not be obtained, the same
procedure is followed as with other loans on collateral without an active market.
New York.—Loans of this kind are occasionally noted, but in the case of most
banks they are comparatively few. It is seldom that the proportion of such loans
in a particular bank is sufficiently large to cause concern.




NATIONAL A ^ D FEDERAL RESERVE BANKING SYSTEMS

1081

Such loans are n o t looked upon with favor due to general lack of liquidity a n d
difficulty of determining real value. Their soundness is determined b y m a r k e t ability, valuation of properties, location, income a n d margin of safety. Criticism,
if any, would be based upon the a m o u n t of such loans as compared to the t o t a l
loans of the bank, as well as upon t h e character of each particular loan.
Philadelphia.—-The number and importance of such loans in our member banks
•are negligible.
If the securities of the real estate holding companies which we find serving as
collateral to loans are listed on one or more of t h e principal exchanges a n d their
m a r k e t is broad and substantial, we simply appraise t h e m a n d ascertain whether
the values are sufficient to adequately protect the loans. If the issues are inactive
o r do not enjoy a broad, free market, we examine into the condition and managem e n t of the issuing corporation, endeavoring in this way to form a reasonable
opinion as to t h e intrinsic merits of the securities. However, regardless of
intrinsic merit, we incorporate in our reports detailed information as to all
i m p o r t a n t loans secured by issues which do not have a satisfactory market, a n d
in cases where t h e concentration on loans of this character is sufficient to cause
•current or potential concern, corrective influences are brought t o bear on t h e
m a n a g e m e n t s responsible for the condition.
Cleieland.—While
a large n u m b e r of loans is predicated on real estate values,
t h e a m o u n t of loans to real estate holding companies a n d the a m o u n t based upon
the real estate holding companies' securities is negligible.
Where possible the appraised value of the real estate is used. Where no such
information is available it is necessary to depend upon the information given by
the committees or officers in charge of this class of loans. Unless we are reasonably sure t h a t this class of loans is basically sound a n d granted for legitimate
business purposes we feel t h a t they should be discouraged.
Richmond.—Not
more t h a n 5 per cent of all security loans are based upon real
estate holding company securities.
Attitude unfavorable as to loans secured by stocks of real estate holding companies as property is usually mortgaged. The loans secured by bonds or m o r t gages are usually slow. Soundness determined by estimate of equity on the basis
•of officers' and directors' appraisal.
Atlanta.—Some
have been noted in several of the larger banks of this district.
T h e proportion of all security loans based upon real estate holding company
•securities is very small.
Such loans are not regarded favorably. Unless t h e collateral is readily m a r k e t able, we endeavor to determine the value of t h e city real estate owned by t h e
holding company. If farm land is owned, t h e m a r k e t value of t h e average
quality of the t y p e of land he]d is determined, upon which t h e value of the holding company securities is based
Chicago.—Only nominal a m o u n t of loans based on bonds or stocks of real
•estate holding companies. Limited number of country b a n k s hold loans of
holding companies formed to b u y real estate which h a d been acquired. (A considerable number of banks hold too large a volume of loans based on real estate
equities.)
Attitude toward such loans unfavorable.
St. Louis.—Securities
of this t y p e appear to have been distributed mostly
a m o n g t h e small investors and used as collateral on small individual loans in t h e
m a j o r i t y of cases. T h e a m o u n t is relatively small.
If soundness appears questionable, a critical a t t i t u d e is assumed in connection
w i t h loans secured by stocks or bonds of real estate holding companies.
Stocks: M a k e a complete analysis of the latest financial statement, also the
earnings reports for t h e past several years. Inquire as to the character of the
m a n a g e m e n t of t h e corporation and endeavor to obtain last sale price or bid.
B o n d s : Analyze all d a t a available, taking into consideration the appraised
value of the properties, sufficient insurance, location, income, maturities and
sinking fund provisions. Ascertain if securities have been issued by proper
trustee or agent.
Minneapolis.—A
very small percentage, probably less t h a n 2 per cent. Such
loans are scrutinized carefully. If t h e security does not have a wide market,
consideration is given to t h e class of property back of t h e security, its cost, proba b l e sale value, record of its net earnings, etc.
Kansas City.—Very few loans of this type, probably averaging less t h a n 1 per
•cent. T h e financing of real-estate holding company securities in this district is
•confined almost entirely to so-called real-estate loans in which t h e first lien on a
•specific p r o p e r t y is included in a single note, a n d to so-called real-estate bonds




1082

NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

which are secured by a mortgage or deed of t r u s t covering a specific property.
T h e use of real-estate holding company securities, bonds in particular, is usual y
in connection with t h e financing of office buildings, a p a r t m e n t s , etc., a n d t h e
greater bulk of this class of financing is accomplished through investment houses
located outside t h e district.
Attitude t o w a r d such loans critical. Where there appears to be a question of
t h e soundness of loans dependent on such collateral an effort is made' to* g e t
reliable information as t o t h e value of t h e real estate a n d t h e relationship of
income to fixed charges, sinking-fund requirements, e t c .
San Francisco.—Real-estate
bonds are not unusual in California. F o u n d to a,
lesser extent in other States of this district. Proportion of t o t a l security loans
estimated very small.
Considered undesirable as b a n k loans, as being of a capital n a t u r e a n d usually
nonliquid. Soundness determined by character a n d appraisal of real e s t a t e
pledged a n d t h e marketability of securities.

The clearing house replies were:
Boston Clearing House Association.—Practically
nil, a b o u t one-fiftieth of 1 p e r
cent. N o t in favor of this t y p e of loan unless t h e collateral is readily m a r k e t a b l e .
Soundness determined by ascertaining t h e value of t h e real estate back of the*
securities.
New York Clearing House Association.—-Most
of t h e real estate loans are biased'
on equities, and usually are not secured by stock or bonds of a holding company.
I n the banks examined, a b o u t 8 per cent of all loans (and mortgages), secured
a n d unsecured, 1 find to be based on real estate (mostly e q u i t i e s 1 w i t h o u t collateral) . This would be equivalent to a b o u t 27 per cent of the capital, surplus,,
a n d profits of these banks a n d t r u s t companies. Of this 27 p e r cent, a b o u t 8
per cent is in investment mortgages and 19 per cent on second mortgages, real
estate stocks, and unsecured loans against equities, chiefly the latter. Of t h e
8 per cent of total loans, 2}{ per cent are investment mortgages and 5% per cent
are equity loans.
From s t a t e m e n t s of the makers and estimates of the value of their equities,,
t h e quality of these loans is determined. In these times equity loans are mostly
slow, and should be reduced, especially where the total (aside from conservative
first mortgages) is above the average figures as noted above.
Philadelphia Clearing House Association.—Not
any material a m o u n t . Where
properties are local, it is in m o s t cases possible to secure an appraised value o n
same. We do not criticize when only small a m o u n t s are held by t h e bank.
Chicago Clearing House Association.—Not
found to a n y noticeable extent.
Denver Clearing House Association.—Very
few loans based upon such securities:
have been found; at the m o m e n t I can recall only one such stock and t h a t was
a p a r t of miscellaneous collateral. I am of the opinion t h a t stocks and bonds
of such companies held by banks in this territory are not in sufficient a m o u n t s
to be of consequence.
Los Angeles Clearing House Association.—A nominal volume of loans is based
on real estate holding company securities, probably less t h a n 5 per cent. Loans,
collateralled by this class of security are naturally very low in r e p a y m e n t , b u t
in this district the banks do not t a k e this kind of collateral to any great e x t e n t .
1
Real estate equity loans are stated to include the following: (1) Real estate bonds junior to first mortgage; (2) bonds of real estate holding companies junior to first mortgage; (3) bonds of other corporationsbased on real estate subject to first mortgage; (4) real estate holding company stocks; (5) stocks of other
corporations whose assets are chiefly real estate; (6) unsecured loans to real estate companies, o p e r a t o r
owners, or any other individuals, firms, or corporations, whose eventual payment may depend on saleof real estate, i. e., where maker has not other available liquid resources sufficient to cover liabilities.




APPENDIX
The provisions in the banking law of New York State governing
the examination of security affiliates by the State department of
banking is as follows:
For the purpose of determining the financial condition of a corporation subject
to the provisions of this chapter and of obtaining full information for the purpose
of such determination, the right of examination shall extend to and include
corporations affiliated with any corporation subject to the provisions of this
chapter under examination, and for such purpose the following are deemed to be
corporations affiliated with a corporation subject to the provisions of this chapter.
(1) Any corporation of which such corporation subject to the provisions of
this chapter directly or indirectly owns or controls a majority of the voting shares
of its capital stock or a lesser number of such shares if such lesser number shall
amount to more than 50 per cent of the shares voted for the election of directors
at the preceding annual meeting of such corporation; or any corporation of which
such corporation subject to the provisions of this chapter in any other manner
directly or indirectly controls the election of a majority of its board of directors;
or
(2) Any corporation which directly or indirectly owns or controls a majority
of the shares of capital stock of such corporation subject to the provisions of this
chapter or a lesser number of shares if such lesser number shall amount to more
than 50 per cent of the shares voted for the election of directors at the preceding
annual meeting of such corporation subject to the provisions of this chapter; or
any corporation which in any other manner diiectly or indirectly controls the.
election of a majority of the board of directors of such corporation subject to the
provisions of this chapter; or
Any corporation of which a majority of the voting shares of its capital stock,
or a lesser number of shares if such lesser number shall amount to more than 50
per cent of the shares voted for the election of directors at the preceding annual
meeting of such corporation is directly or indirectly owned or controlled by the
• same or substantially the same stockholders as directly or indirectly own or control a majority of the shares of capital stock of such corporation subject to the
provisions of this chapter or a lesser number of shares if such lesser number shall
amount to more than 50 per cent of the shares voted for the election of directors
at the preceding annual meeting of such corporation subject to the provisions of
this chapter; or
Any corporation the election of a majority of the board of directors of which is
or may be directly or indirectly controlled by any instrumentality, agency or
arrangement that directly or indirectly controls the election of a majority of
the board of directors of such corporation subject to the provisions of this chapter; or
Any corporation a majority of the directors of which shall be directors of such
corporation subject to the provisions of this chapter or of which a majority of the
executive committee of its board of directors are directors of such corporation
.subject to the provisions of this chapter; or
Any corporation the board of directors of which shall comprise a majority of
the board of directors of such corporation subject to the provisions of this chapter
or the executive committee of the board of directors of which shall comprise a
majority of the executive committee of such corporation subject to the provisions
of this chapter; or
Any corporation all or substantially all of whose executive officers are executive
officers of such corporation subject to the provisions of this chapter; or
Any corporation whose executive officers comprise substantially all of the
^executive officers of sueh corporation subject to the provisions of this chapter; or
1083




1084

NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

Any corporation t h e business or policy of which is dominated or controlled, in
whole or in part, b y a corporation subject to the provisions of this chapter,
whether by contract or otherwise; or
Any corporation which dominates or controls, in whole or in p a r t , t h e business
or policy of a corporation subject to the provisions of this chapter whether by
contract or otherwise.
Provided, however, t h a t as t o any corporation specified in this subdivision
(2) either (a) there shall t h e n exist or within t h e preceding 2-year period h a v e
existed business transactions or relations (of any kind, character or description)
between such corporation and such corporation subject to the provisions of t h i s
chapter, or (b) such corporation subject to t h e provisions of this chapter shall
then have outstanding loans secured in whole or in p a r t by the stock or securities
of such corporation or by a n y property in wThich such corporation is in a n y way
or t o any extent interested or within t h e preceding two-year period shall h a v e
had such loans; or
(3) Any corporation, association or partnership having business transactions
or relations with a corporation subject to the provisions of this chapter t h e
examination of which on application of t h e superintendent of b a n k s a n d on
notice to such company shall be determined b y a justice of the supreme court
t o be necessary or expedient in order to ascertain whether t h e capital of a corporation subject to t h e provisions of this chapter is impaired or whether safety of
depositors with such corporation subject to the provisions of this chapter h a s
been imperiled.
For all the purposes of t h e foregoing definitions:
All corporations similarly owned or controlled shall be regarded as a single
corporation a n d if as a single corporation subject to examination each such
corporation shall be deemed to be an affiliated corporation.
Stock held in t h e n a m e of nominees of any corporation subject to t h e provisions
of this chapter or other corporation or otherwise for t h e benefit of any corporation
subject to the provisions of this chapter or other corporation shall be deemed to b e
stock owned or controlled b y such corporation subject to t h e provisions of t h i s
chapter or other corporation.
Examinations m a y be m a d e a n d inquiries instituted or continued in t h e discretion of the superintendent after he has t a k e n possession of t h e p r o p e r t y a n d
business of any such corporation, banker or broker, under the provisions of section
57 of this article until it shall resume business or its affairs shall be finally liquid a t e d in accordance with t h e provisions of this article.
If the examination shall be made by the superintendent, or by one or more
deputies or examiners who are compensated by salary only, no charge shall be
m a d e except for necessary traveling and other actual expenses.
The superintendent shall have power also, either personally or by his deputies or
examiners, to subpoena witnesses, to compel their attendance, or administer a n
oath, and to examine any person under oath before him or before a d e p u t y or
examiner duly designated for such purpose, and in connection therewith to require
t h e production of any books or papers relevant to t h e inquiry. If a person
subpoenaed to a t t e n d such inquiry fails to obey the command of a subpoena
w i t h o u t reasonable excuse or if a person in a t t e n d a n c e upon such inquiry shall,
without reasonable cause, refuse to be sworn or to be examined or to answer a
question or to produce a book or paper when ordered so to do by the officer duly
conducting such inquiry, or if a corporation, association, partnership, or individual
fails to perform any act required hereunder to be performed, he shall be guilty of a
misdemeanor and in addition thereto compliance with the above provisions m a y
be imposed p u r s u a n t t o section 406 of t h e civil practice act. Any officer particip a t i n g in. such inquiry and any person examined as a witness upon such inquiry
who shall disclose to any person other t h a n t h e superintendent of banks t h e n a m e
of any witness examined or a n y other information obtained upon such inquiry,
except as directed by t h e superintendent, shall be guilty of a misdemeanor.
If a n y person shall ask to be excused from testifying or producing any book or
p a p e r or other document before t h e superintendent or before any person duly
designated by him to conduct any such investigation upon t h e ground or for t h e
reason t h a t t h e testimony or evidence, documentary or otherwise, required of
him m a y tend to incriminate him or degrade him or to subject him to a penalty
or forfeiture a n d shall notwithstanding be directed by t h e superintendent or by
t h e person duly designated b y the superintendent to conduct any such inquiry
to testify or to produce such book, paper, or document, he m u s t none the less
comply with such direction, b u t in such event he shall not thereafter be prosecuted or subjected to any penalty or forfeiture for or on account of any t r a n s -




NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

1085

action, matter, or thing concerning which he may testify or produce evidence,
documentary or otherwise, pursuant thereto, and no testimony so given or produced shall be received against him upon any criminal action, suit or proceeding,
investigation, inquisition, or inquiry: Provided, however, No person so testifying
shall be exempt from prosecution or punishment for any perjury or other false
statement committed or made by him in his testimony given as herein provided
for.
Any individual, copartnership, unincorporated association, or corporation
which refuses to permit examination or investigation in accordance with the
terms of this section shall forfeit to the people of the State the sum of $200 for
every day, after the date of such refusal, that such individual, copartnership,
unincorporated association, or corporation continues to refuse to permit suchexamination or investigation.1
1

Section 39, as amended by chapter 678, Laws of 1930.

X




Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102