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61ST CONGRESS \

2d Session

j

SENATE

J

DOCUMENT

I

N o . 589

NATIONAL M O N E T A R Y COMMISSION

Bank Loans
and

Stock Exchange Speculation

BY

JACOB H. HOLLANDER
Professor of Political Economy in the Johns Hopkins University




WASHINGTON
1911

NATIONAL MONETARY COMMISSION.
NELSON W. ALDRICH, Rhode Island, Chairman.
EDWARD B. VREELAND, New York, Vice-Chairman.
J U L I U S C. BURROWS, Michigan.

J O H N W. W E E K S , Massachusetts.

E U G E N E H A L E , Maine.

R O B E R T W. BONYNGE, Colorado.

PHILANDER C. K N O X , Pennsylvania.

L E M U E L P . PADGETT, Tennessee.

THEODORE E . BURTON, Ohio.

GEORGE F . BURGESS, Texas.
ARSIJNE P . Pujo, Louisiana.
ARTHUR B. SHELTON, Secretary.

H E N R Y M. TELLER, Colorado.
HERNANDO D. MONEY, Mississippi.
J O S E P H W. BAILEY, Texas.

A. PIATT ANDREW, Special A ssistant to Commission,




BANK LOANS AND STOCK
SPECULATION.

EXCHANGE

Attention has been repeatedly called to the vicious
circle in which the American money market moves; how
the volume of banking credit is rigidly inelastic, being
determined as to circulation by bond security and as to
loans and discounts by a fixed ratio to legal reserve;
how the surplus funds which pile up with seasonal fluctuation in the interior flow inevitably to New York City,
there to stimulate speculation at times when general
economic conditions suggest quiescence, and how, conversely, when returning activity draws back funds to the
interior, the recovery is impeded by the strain and cost
of speculative liquidation.
This sequence, as often as it has been stated, has not
been really accepted by the public mind. There has been
much more disposition to invert the relation and to hold
speculative manipulation responsible for monetary strain.
To the extent that blind prejudice and willful ignorance
figure here, nothing in the way of enlightenment is possible. But some considerable part of the prevailing sentiment is not to be so dismissed and proceeds from valid
doubt. It is this condition which invites an attempt to
supplement the general terms in which the argument has
heretofore been phrased with a more detailed account of
the relation of credit and speculation.




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In the United States the money market, in the form of
bank loans, may be regarded as impinging upon the stock
exchange at five distinct points:
(i) Stock-exchange securities are used as collateral to
secure mercantile discounts and personal loans in the
insufficiency of commercial or personal credit.
(2) In the interval between original sale and ultimate
absorption by investors newly issued corporate securities are used by underwriting syndicates and syndicate
participants to secure bank advances.
(3) Banking institutions invest in stock-exchange securities such part of their resources as are not employed in
loans and discounts in consideration of interest return
and in anticipation, semispeculatively, of appreciation in
market value.
(4) Bond houses and stock brokers engaged in the sale
of investment securities obtain bank loans as working
capital upon unsold holdings.
(5) Speculative purchases of stock-exchange securities
are financed partly by time loans, but in the main by
demand loans obtained from banking institutions and
secured by such securities as collateral.
It is proposed to consider the nature and effect of each
of such contacts from the standpoint of present banking
organization and of proposed change. Such an inquiry
is impeded by the paucity of statistical data and by the
intimate or informal quality of many of the operations
involved. But enough is ascertainable to permit a fair
and reasonable judgment as to the adequacy of existing
methods and as to the effect of possible amendments.




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Bank Loans and Stock Exchange Speculation
I.
The occasion for temporary advances of credit upon
adequate collateral is directly connected with the dawn
of modern banking. Commercial activity is subject to
varying capital requirements. Unless business operations are to be restricted within unnecessarily narrow
limits or a wastefully idle reserve fund is to be kept at all
times available, that quota of capital for which there is
brief or exceptional business demand will find productive
employment in independent investment. The same is
true of individual economics. Private capital is converted,
as accumulated, into productive investment—less only
that part required for current requirements.
Such an economical arrangement is obviously possible
only when the machinery exists for securing credit
advances upon investment reserves at the time and for
the period required. This is the service of the banking
organization. Reserve investments take on many forms—
bank deposits, real estate, staple commodities, evidences
of indebtedness. The widespread extent of corporate
organization and the readiness of international markets
for corporate obligations, might be expected to make
stocks and bonds, and, in particular, those more actively
traded in and distinguished as stock exchange securities—
a convenient object of such investment and a common
collateral for business loans.
But as a matter of fact, credit advances upon stock
exchange collateral play a relatively small part in American
business life, meaning by this term ordinary industrial,
commercial, and mercantile activity as distinct from corporate promotion and speculative enterprise. The aver-




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age merchant or manufacturer keeps his reserve in his bank
book not in his safe-deposit box, and seeks to meet the
strain of sudden or increased financial requirement by
further recourse to commercial loans and discounts. If
he owns stock-exchange securities, his impulse will be to
sell them when the occasion arises rather than to borrow
upon them, and if, because of unfavorable markets or
other considerations, he hesitates at accepting this loss,
his banker is likely to be less reluctant. Any pressure to
secure further advances upon such collateral may threaten
his existing credit and result in the diversion of the securities to fortifying earlier loans rather than securing new
ones. Anticipating such procedure the business man
who owns securities and wishes to borrow upon them
inclines to hypothecate them with a different financial
institution rather than to seek further accommodation
from his usual bank, unless indeed the occasion for the
accommodation sought be personal rather than commercial, in which event a more cordial banking attitude may
be anticipated.
In so far, therefore, as stock-exchange securities serve
as business collateral they represent in the main: (a) Individual loans by those who are without commercial or
personal credit or who are unwilling to use it even though
they possess it; (b) supplementary business loans by those
who have exhausted the maximum commercial credit
which their customary banks have found it possible to
accord, and (c) loans made by corporations who have
been imwilling or unable to market their own obligations
and are driven to use these in part to secure urgently
needed borrowings.




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Bank Loans and Stock Exchange

Speculation

No question has ever been raised as to the utility of
this feature of our banking system. It is obviously
advantageous that those engaged in business activity,
or individual effort, who happen to be owners of stocks or
bonds, should be able upon proper occasion to secure
temporary advances of credit thereon without the waste
and friction of forced sale. The banks here simply serve
as pawnshops for securities. Capital is made more mobile
without sacrifice of productivity, and both the business
community and the investing public are benefited.
In all this speculative activity plays no part. There is
some complaint that commercial banks are disposed to
discriminate, either as to percentage of collateral or as
to general acceptability in favor of particular securities to
the detriment of others of equal intrinsic worth but of
less marketability; but this is either prudence or ultraconservatism, as the case may be, reflecting the personal
equation of the bank directorate or the business temper of
the particular community. In the case of "controlled"
institutions this discrimination is commonly charged to
be inspired by less justifiable considerations, and recent
exposures have shown some startling instances in point.
But for this as for the related practice of imprudent corporate loans secured by the borrowing corporation's own
securities, or, indeed, for any other form of reckless commercial discounting, there is no other safeguard than rigid
supervision and relentless accountability. Such unwholesome conditions might exist utterly irrespective of speculative activities, and, indeed, find their exact counterpart
in small one-bank localities completely removed from
monopolistic influences.
14119°—11




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But in another direction the use, however limited, of
stock-exchange securities as business collateral brings us
face to face with a signal defect of the American banking
system—the hard and fast limit set upon the credit facilities of business enterprise.
The business man in the United States—merchant,
manufacturer, or trader—secures his banking accommodations upon the strength of personal credit; that is, by
the discount of indorsed commercial paper or of his own
promissory note, if necessary, fortified by further indorsement. The amount which he can so borrow is not, as
might be expected, the discounted present value of prospective payments based upon actual mercantile deliveries f
but a definite maximum calculated as a multiple of his
average bank balance and fixed by the bank executives
with respect to the estimated resources and requirements
of the borrower in relation to similar demands and resources of the bank's other customers. It takes the form
of discounted notes of stated maturity and varies from
month to month with business requirements, largely at
the borrower's option. The bank is virtually obliged,
save at the risk of exciting resentment, to grant and
renew such loans if within the maximum; on the other
hand, the ordinary borrower must not expect, save under
circumstances of unusual stress, increased credit facilities
beyond the maximum informally agreed upon.
If the maximum line of credit which a single banking
institution can grant be normally insufficient, either by
reason of its own limited resources relative to aggregated
patrons' demands or by reason of the positive loan limitations of the national-bank act, the ordinary business man




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Bank Loans and Stock Exchange Speculation
will have established analogous relations with one or more
other banking institutions; but in each of these an identical policy will prevail. The borrower will be accorded a
maximum line of credit, all of which he can upon occasion
properly demand, but beyond which he can not hope to be
accommodated.
We have here a mischief-making failure of the American
banking system to respond to legitimate business requirements. It is not speculation but production that is halted
and ultimately stopped by the rigidity of our obsolete
credit mechanism. The experience of every other great
industrial country of the world makes clear that an unlimited discount, though at rising cost, of valid commercial bills, a credit fabric based upon and varying with the
volume of commercial paper, a mobilized gold reserve, and
an open discount market are, from the standpoint of the
producers of wealth, indispensable requisites of sound
mercantile banking.
II.
In the United States, as in the other great industrial
countries of the world, the intervention of banking institutions has become an indispensable element in corporation financiering. The capital requirements of industrial
enterprise can only be ultimately satisfied by the response
of the investing public. That is to say, those who have
accumulated capital by saving or transfer become creditors
of or participants in such enterprise. When the undertaking is organized in corporate form this involves the
issue and sale of certificates of ownership or evidences of
indebtedness, stocks or bonds.




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In the early days of corporate financiering, b o t h public
and private, the method of open popular subscription a t
fixed terms was employed, the list being exposed at designated places, and t h e general public invited to respond.
B u t with the tremendous increase in public and corporate
borrowing and the wide fluctuations in market credit, the
method of public subscription was gradually abandoned
for a more certain procedure. The transition is probably
to be associated with P i t t ' s bold financial policy in England's contest with Napoleon. In the early days of t h e
British funding system subscription lists to public loans
were posted a t t h e Exchequer and after 1714 at t h e Bank
of England. B u t P i t t ' s financial necessities could brook
neither delay nor uncertainty, and in t h e war t h e great
Chancellor of t h e Exchequer developed the prototype of
modern underwriting syndicates—a company of " l o a n
contractors," with whose rise, indeed, the beginnings of
England as t h e capital center of the world are directly
associated.
Modern corporate financiering makes use in the main
of t h e loan-contracting method, ordinarily in association
with underwriting guaranty. The older open-subscription
practice survives in occasional examples, such as t h e issue
of additional corporate obligations by t h e grant of subscription " r i g h t s " to existing security holders, the direct
offering of corporate emissions to general subscription, and
the flotation of public loans b y sale " o v e r t h e counter."
The ordinary procedure is for t h e borrowing corporation t o enter into an engagement with a banking institution, public or private, for the guaranteed
flotation,
commonly a t a stipulated price, of the proposed issue.




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Bank Loans and Stock Exchange Speculation
To make effective this guaranty or underwriting, or to
distribute its risk, the institution in question will generally have associated with itself other institutions and
individuals as a syndicate to share in designated percentages the underwriting obligation with its resultant
gains or losses. Thereafter subscriptions to the issue will
be invited by public tender, ordinarily by the contracting
institution acting as syndicate manager. It is an unwritten law that every participant in the underwriting
syndicate shall assist in the absorption of the loan by
sales through its distributing agencies or by purchase on
independent account. Any residue not taken will ultimately be charged to the syndicate members in proportion
to respective participation.
With the great increase in resources and the wider
range of connection the great banking institutions of
the country, and in particular a powerful group of international banking houses, have tended to eliminate the
syndicate feature of underwriting and to become their
own guarantors by directly engaging to purchase the issue
at contract terms. In the interval, however, between
the preliminary engagement and the consummated
arrangement, the purchasing institution will have secured
from other institutions or individuals—"allotted" is
the term more in consonance with actual practice—subscriptions to participate in the purchase covering all
but such part as it may itself desire to retain. Such
subscriptions will have been made to some extent by savings banks, insurance companies, and trustees for direct
investment purposes, but in the main by junior banking
and brokerage houses to meet customers' demands, in




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consideration of a brokerage arrangement and in anticipation of an early rise in the market price over the
issue price.
Whether the transaction involve a syndicate underwriting or not, the banking outcome is the same in that the
new securities will ultimately pass into the possession of
purchasers or participants. If times be favorable and the
securities popular the issue is likely to be absorbed by the
public in response to the advertised offering made by the
contracting house or the syndicate manager if for no other
reason than to accredit the issue and reenforced by the
elaborate selling organization that the ordinary bond
house has developed. In such event, prompt absorption
of the issue by actual investors, there will be no occasion
for banking intervention. The funds requisite will be
withdrawn from individual savings accounts and bank
deposits and the purchased securities will find their way
into strong boxes.
If, however, general economic conditions are unfavorable, either the trade purchasers or the underwriting participants, or both, will find themselves with unsold blocks
of securities on hand. These may be taken up at once by
those ultimately responsible, or, more likely, the unsold
quota will remain under the control of the manager until
with the expiration of an agreed or reasonable time—often
extended and reextended—the distribution of the unsold
remainder among the subscribers is consummated.
Under such circumstances prompt recourse will be had
to banking institutions for advances of credit upon the
unsold or undistributed securities. The business of selling
investment securities is organized on essentially the same




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Bank Loans and Stock Exchange Speculation
basis as any other form of merchandising. The agencies
who acquire securities from the producer, in this case the
issuing corporation, do so in the expectation not of keeping but of selling them. Their own resources represent
working capital pure and simple, no appreciable part of
which is expected to find fixed investment in the securities
so bought. The profit of the transaction will therefore be
very materially affected by the quickness of the turnover,
or the rapidity with which the capital employed becomes
reavailable.
The stage at which recourse is had to the banks and the
extent to which credit advances are sought varies with
the nature of the contract, the resources of the purchasing house, and the progress of the distribution. If the
issuing corporation requires early payment, the obligations in temporary form, or even the purchase option, may
be used by the purchaser as collateral for a bank loan.
If the loan be undersubscribed, the part left over will
be similarly hypothecated; or if the subscription be full
but the absorption incomplete, the undigested parts,
either in the custody of the syndicate manager or distributed among the separate participants, will be used as banking collateral. Ordinarily such advances are made by the
banks at the rates prevailing for call money, or upon even
more favorable terms in the case of underwriting syndicates having strong banking connection.
If corporate enterprise is to secure with economy the
additional capital necessary from time to time for growth
and expansion, if accumulated savings are to find productive employment with promptness and certainty,
some such relationship between corporate borrowing and




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banking accommodation must necessarily exist. Practical experience in public and private financiering has
made clear that, save in exceptional circumstances, direct
sale in the form of public subscription is attended with
uncertainty and risk. To be successful the corporation
must require its money at the very moment that the saving
public has reached the psychological state of investment,
and such coincidence is necessarily unusual.
An intermediary is obviously desirable to bridge the
interval, to supply the corporation with funds at the time
needed and to make delivery to the investor at the time
desired—precisely as the tradesman serves as an economically necessary middleman between producer and consumer. This is the function of the underwriter or loan
contractor. Like the successful merchant, he seeks to
reduce the interval between purchase and sale. He will
be reluctant to enter into an engagement to take over a
loan at a time when he deems the investment demand
inadequate or sluggish. And, on the other hand, he will
be keen to anticipate returning confidence, by offering
tempting investments before his competitors have embraced the opportunity and skimmed the cream ofif the
market.
For such transactions great resources are in any event
needed. But so huge are the amounts involved in corporate borrowings that were the loan contractors dependent solely upon their own capital, any unforeseen check
in the sale of the issue, indeed, the inevitable delay in its
absorption, would result in congestion. The case would
be exactly parallel with that of a merchant, who, having
invested his own limited capital in desirable wares, would




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Bank Loans and Stock Exchange Speculation
be unable to make further purchases, however favorable
be the terms offered or certain the future demand, until
customers had taken off his hands a sufficient amount of
those things with which he was already stocked.
The existing banking organization of the United States
meets this requirement of business enterprise with moderate success. Such evils as from time to time disclose
themselves seem inevitably incident to the alternating
fever and quiescence of modern economic organization.
In flush times, when promoters abound and banks become
less prudent, the availability of corporate securities as
bank collateral undoubtedly serves as an artificial stimulus to evoke projects that are unnecessary or unwise.
The way is opened for a perilous process of pyramiding
that leads swiftly to reckless involvement.
A further criticism is that such bank loans tend to
encroach upon the accommodations that can be afforded
ordinary business activity. The times in which the banks
are most heavily involved in syndicate underwritings are
periods of business activity rather than quiet. It is then
that corporate projects take amplest shape and flotation
follows quickly upon flotation. During the upswing the
absorption is so rapid, the profits so alluring, and the
public service so plausible that banking conservatism is
put to the test merely in distinguishing accommodation
from excess and enterprise from venture. A bank's
mercantile customers ordinarily have the first claim upon
its facilities. But in periods of business calm not all of
its resources will be so employed and—in lieu of the even
less profitable avenue of employment in stock-exchange
loans—advances upon syndicate collateral are very accept-




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able. Such loans are nominally payable on demand, but
in reality they are much less liquid than the ordinary call
loan. This is especially the case with interior banks, whose
relation to the debtor broker and even to the securities
involved is likely to be less impersonal than of a New
York bank. The consequence is that expanding business
requirements may encounter less preparedness from banks
so encumbered than would otherwise occur.
These are unwelcome contingencies incident to modern
business daring, from which no form of banking organization will be always and entirely immune. Greater publicity and closer supervision in operation, more direct
responsibility and more certain accountability in control,
with, perhaps, some legal maximum as to extent of participation, will serve as local correctives. But the real
cause of the disorder is that more fundamental defect of
the American banking system—the absence of an open
discount market.
As long as our banks are deprived of the usual and proper
investment for growing reserves, guaranteed commercial
paper of international validity, we may expect to suffer
periodically from undue and even unwise banking participation in corporate financiering.
III.
The investment of a considerable proportion of loanable
resources in stock-exchange securities is an almost invariable practice of American banking institutions. On September i, 1910, the 7,173 national banks in the United
States held $854,127,665 in ''bonds, securities, etc.,"
being in the main State, county, municipal, railroad,




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Bank Loans and Stock Exchange Speculation
public service, and other bonds, with a sprinkling of stocks
(presumably taken for debt), warrants, and judgments,
but including no part of the holdings of United States or
other bonds to secure note circulation or Federal deposits.
The extent of such investments is subject to seasonal
fluctuation, and, even more, to the irregular variation of
general economic and financial conditions. Here and
there particular banks have abstained from such investments, and in some cases this restraint has become an
avowed policy. But the ordinary practice is as described.
The motives leading to such investments are in some
cases specific and obvious. The financial institutions of
Baltimore find it profitable to invest largely in Baltimore
City bonds, because such securities are not only exempt
from State and local taxation but, by a curious series of
implied agreements, administrative rulings, and legal
enactments, carry with them a corresponding taxdeducting power, to the extent of largely relieving some
of the institutions from capital taxation. More common
is a bank's investment in a particular State's or municipality's bonds in the hope, or even as the condition of
becoming its public depositary or of securing some public
or semipublic account. This may even extend to a private
corporation, whose profitable banking account can be
more certainly retained by participation in its financing.
Finally, some part of a bank's securities represent the
foreclosure of hypothecated securities, acquired by the
institution for its own ultimate protection.
But these instances explain only a fractional part of the
aggregate holdings and do not touch the essential consideration, which is—that a bank buys securities because




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it can find no other profitable investment during recurring
periods when business is quiescent for such of its surplus
funds as it would otherwise employ in its regular channels.
When reserves become congested and the local demand
for money is exhausted, neither the call money market
in New York nor the masked rediscount of country bank
paper nor the availability through brokerage houses of
the promissory paper of a limited number of widely known
mercantile and industrial establishments will absorb the
excess, and recourse is had to the bond market.
From whatever point of view regarded this apparent
necessity under which American banks now labor of tying
up large parts of their loanable funds in stock-exchange
securities is unfortunate. It offers an unhealthy stimulus
to corporate financiering by supplying a temporary and
fictitious market for investment securities. It invites
speculative gains and losses by the fluctuation in market
price in the interval between purchase and liquidation.
It curtails mercantile accommodation by the bank's
reluctance to liquidate such securities in a declining market, and it injects an additional element of risk into
banking stability in the temptation to invest in less
seasoned and more productive bonds.
In making such investments under existing conditions
the banks, however, obey a perfectly sound economic impulse. Idle funds are as unhealthy for the community as
they are unprofitable to the banks. It is probably better
in the long run that investment be made in securities,
with all attendant uncertainties, than that unemployed
funds accumulate as swollen reserves or be applied to
questionable credits. But such a necessary alternative is




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Speculation

lamentable, and one with which the banking institutions
of no other industrial country of the world are confronted.
Everywhere else the banking surplus of one community
relieves the credit strain of another, and in so doing finds
safe and convenient investment for itself. Here again
we have the prime defect of our banking system—the
two-faced evil of localized commercial paper—driving the
banks on the one hand to inconvenient and uncertain investment of unemployed funds, and lessening, by wasteful
isolation of reserve, the maximum banking accommodation which the mercantile interest of the country might
enjoy. Finally, it is questionable whether the practice of
investing in securities ordinarily results in profit to the
banks. A not uncommon experience is for bonds to be
bought at the higher level incident to an easy money market and to be disposed of when there is competitive selling
and prices have weakened. Even when a profit might
have been realized, bonds so bought are likely to be held
until a loss is shown, then to be carried over and written
off, and finally to be sold at original cost when the next
easy money period begins.
IV.
The modern stockbroker is engaged in two kinds of
activity—the purchase and sale of investment securities,
and the conduct of speculative operations for principals or
in personal behalf. Ordinarily both classes of business
are conducted by the same house, but there are many
bond houses who do not invite speculative accounts and,
on the other hand, many commission houses figure inappreciably in the investment market.




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In connection with each class of business large banking
accommodations are involved. Such bank advances take
the form either of time or of call loans, according to the
prudence of the broker, the state of the money market,
and the disposition of the lending banks. The purpose of
a sagacious broker, as of a cautious merchant, is to make
sure of having at all times that amount, and no more, of
borrowed capital that he requires, and to pay for it the
lowest price for which it can be obtained at any time during
the period of its use. This end can never be completely
attained. If money be cheap and the prospect for any
stringency unlikely, there is yet reluctance to rely entirely
on demand loans because of the ever-present possibility
of an abrupt change in the general financial situation,
certain to send the call rate bounding, and to make further or even continued advances impossible. On the
other hand, time money ordinarily commands higher rates
than call money, and borrowers are unwilling in periods of
easy credit to tie themselves up, so as to be unable to
profit in the even easier money market likely to prevail in
the future, by call loans and by the sale of securities.
When the situation is reversed and the money market
restricted, there is nevertheless the same reluctance to
use call money exclusively, for conditions may easily become prohibitive; while, on the contrary, the exclusive
use of time money, even were it practicable, is checked
by the hope of improving markets and lower rates.
One striking feature of such loans, whether time or
demand, is to be noted. The merchant or manufacturer
is able to secure banking accommodations up to a certain
point upon his own personal credit—that is, by the dis-




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Bank Loans and Stock Exchange Speculation
counting of his own promissory note or single-name paper,
unsecured by pledge of collateral. Such is never the case
with the bond dealer or stockbroker. However ample his
resources or unquestioned his credit, the broker can only
obtain loans upon collateral securities. Any attempt to
secure credit on other terms is a confession of financial
weakness and is never resorted to save in straits. The
explanation of this seeming anomaly appears to lie partly
in the greater amounts, relative to resources, involved in
brokers'transactions as compared with mercantile business,
but even more in the fact that the wares of the merchant
and the unfinished products of the manufacturer, which
serve as the ultimate basis of mercantile loans, are either
immobile or inchoate, whereas the securities which represent the stock in trade of the broker are capable of easy
and convenient removal and possess immediate marketable
value, thus readily lending themselves to the cautious
impulse of the banker to protect his advances. Even in
those branches of mercantile activity where the stock in
trade is capable of reduction to marketable and movable
form by warehouse storage—cotton, grain, canned goods—
bank advances are ordinarily limited to collateral-secured
loans.
In so far as the activities of the stockbroker relate to the
purchase and outright sale of investment securities, he is
a dealer in merchandise. He buys securities of such kinds
as will appeal to the varying desires of his customers,
at prices which will permit sale at usual business profits.
Accordingly, his vaults, like the shelves of the merchant
or the warehouse of the manufacturer, are at all times
stocked with investment wares awaiting the demands of
his investing clientele.




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It is true that a considerable part of the stockbroker's
wares will consist of undistributed syndicate holdings or
unabsorbed underwriting participation, upon which credit
advances have been made in the manner already discussed
in a preceding section. But over and above such holdings
the ordinary bond house is the owner, by actual purchase
and payment, of blocks of securities acquired for purposes
of sale at profit, and the actual distribution of which is
pressed with all the energy and skill of commercial vending.
Advances of credit upon the unsold part of this stock
in trade are sought from the banks in supplement of
the broker's own working capital. The relation of the
stockbroker to the banks is, in this particular, like that
of any other business man. He conducts a certain kind
of business and has a certain amount of capital of his
own with which to conduct it. Restricted within these
limits, not only will his operations be meager and unprofitable, but the facilities which he can offer the investing public in variety and readiness of investment securities
and the advantage which corporate seekers of capital
can obtain from such middlemen, will be correspondingly
curtailed. To press the analogy, such restriction would
find exact parallel in the case of a merchant denied credit
upon unsold wares or a manufacturer upon undistributed
produce.
This service is rendered with reasonable adequacy by
our present banking system. Bond houses suffer something in common with all mercantile enterprise from the
inelasticity of bank credits in periods of economic expansion, but the treatment accorded is often preferential
and the discomfort on the whole less acute.




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Bank Loans and Stock Exchange Speculation
v.
There has been much controversy as to the function of
speculation in modern economic life. Those directly engaged therein have insisted upon its respectability and
dignity as a form of business enterprise. Radical attack
has denounced speculation as a parasitic activity, the
effect of which is legalized plunder and demoralization of
wholesome business method. The consensus of qualified
opinion is, however, that this latter sweeping condemnation can be applied, if at all, only to the extravagant
excesses of speculative fever and that the intelligent discounting of economic developments—the essence of
speculation—serves as a balance wheel of industrial life.
Such a discussion, however, smacks of the academic.
Whatever drastic measures may be taken to eliminate
speculative abuses, it is reasonably certain that large play
will still be left for those adventurous spirits who, by forsight, daring, or blind hazard, seek to gauge the course of
coming events and who reap profits or suffer losses according to the accuracy of their forecast or the accident
of their guess.
During the calendar year ending December 31, 1910,
there were bought and sold on the New York Stock
Exchange 164,051,061 shares of stock of an approximate
value of $14,124,875,879. Dealings on the stock exchanges of Boston, Philadelphia, Chicago, and Baltimore,
aggregated 21,179,574 shares. Allowing for trading in
other cities and in the outside markets of New York,
it is probably a conservative estimate to place the total
number of shares dealt in the United States at 225,000,000
of an approximate value of $20,000,000,000.




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National

Monetary

Commission

A substantial proportion of this trading consists of
outright purchases for investment purposes by corporations, institutions, trustees, and individuals. But the
overwhelming part of it, as well as an appreciable amount
of trading in active bonds, represents speculative commitments for the rise or fall by stockbrokers acting as
agents or trading for themselves.
Such operations are financed in the main by bank
advances. The ordinary procedure is for the operator
to supply 20 per cent of the purchase price—or if acting
through a broker 10 per cent and the broker another
10—and the banks to advance the remaining 80 per
cent on a demand loan upon a pledge of the securities
purchased, or their equivalent, as collateral. The quota
advanced by the broker will be drawn from existing
bank deposits created largely by time loans negotiated
to guard against possible market stringency, but likewise
secured by collateral.
The ready availability of banking funds for such
speculative operations is, as has so often been pointed
out, the direct consequence of unwholesome elements
in the banking system of the United States. Under the
provisions of the national-bank act interior banks are
permitted to deposit three-fifths of their legal (15 per
cent) reserves with correspondents in reserve and central
reserve cities, and reserve city banks in turn, up to the
extent of one-half of their legal (25 per cent) reserves,
may count their deposits with central reserve banks as a
part of such reserves.
The original motive of such provision was probably
the greater and more regular mercantile requirements




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Bank Loans and Stock Exchange Speculation
of the central reserve cities, notably New York, in contrast with the seasonal fluctuations of banking needs
in the interior cities.
To insure such remittance, the New York banks are in
the habit of allowing 2 per cent interest upon country
bank deposits subject to call. The consequence is that
the interior banks, failing any other avenue of profitable
short-time employment, remit to New York not only the
authorized quota of their reserves, but also the surplus
funds which accumulate with recurring business inactivity.
It is not possible for the New York banks to employ
all of such deposits in mercantile loans and discounts,
even were it sound banking to lend call money on time
loans. The only method of profitable use is demand
loans, and the only large market is offered by speculative
operators on the stock and produce exchanges.
We have here all the conditions favorable to artificial
stimulation of stock exchange speculation. At periods
of seasonal dullness, and, even more, at times of business
reaction, the irresistible lure of payment for idle money
attracts the surplus funds of the interior banks to New
York, there to be pressed upon the call money market for
what it will bring, and, finding regular employment only
in stock exchange operations, to encourage speculative
commitments at the very time when quiescence is in
order. As there is unwholesome stimulation, so there is
sudden and wasteful liquidation. When reviving business leads the interior banks to reduce their New York
balances, the depositary banks meet the strain by calling
loans, with the result that the speculative movement for
the rise is reversed and a repressive influence cast upon
general business.




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National

Monetary

Commission

The primary cause of this unwholesome sequence is
obviously again the inability of the interior banks to find
profitable employment for idle funds during recurring
periods of business calm. A part of the capital so disengaged is put, by the stronger or bolder banks, as has
been noted, into stock exchange securities; but that more
considerable part, likely to be required upon earlier or
more abrupt occasion, and all balances of many banks
reluctant to tie up any part of their resources in semispeculative investment, flow irresistibly to New York
depositaries.
It is certain that a measure of stock speculation would
persist, even if the resources of the New York banks were
alone available for financing it, but the extent of such
accommodation, even when supplemented by the demand
loans made available by individual capitalists, would be
limited and the cost of securing it would be greater.
Individual speculation would be less in amount and narrower in distribution. Most of all, the periods of speculation, in so far as determined by the cheapness of money,
would vary logically with the movement of general business, instead of, as at present, running in vicious opposition thereto.
Any reform in our banking system which will create
a logical form of investment for temporarily idle banking
resources may therefore be expected to discourage instead
of to promote speculative excesses. The banking experience of every other industrial country of the world
shows that guaranteed bills of short maturity constitute
such proper investment. Over and above all other advantages which would attend the acceptance of commercial




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Bank Loans and Stock Exchange

Speculation

paper, whether by a new central banking agency or by
powerful existing institutions, there would surely follow
through the diversion of periodically accumulating banking funds into this more healthful channel a marked
arrest of the wild course of American speculation.




O

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