concerns. But the temptation was irresistible. The invasion of the investment banker into the bank's field of operation was followed by a counter-invasion by the bank into the realm of the investment banker. Most prominent among the banks were the National City and the First National of New York. But theirs was not a hostile invasion. The contending forces met as allies, joined forces to control the business of the country, and to "divide the spoils." The alliance was cemented by voting trusts, by interlocking directorates, and by joint ownerships. There resulted the fullest "co-operation"; and ever more railroads, public-service corporations, and industrial concerns were brought into complete subjection. 223. EFFECTS OF INDUSTRIAL EXPANSION ON DEMAND DEPOSITS OF COMMERICAL BANKS1 BY FREDERICK A. CLEVELAND Between 1899 and 1902, owing to the tremendous expansion of business, deposit accounts of commercial banks increased over $4,000,000,000, or more than double the entire monetary stock of the country. During the same years the specie reserve of banks remained practically unchanged. Moreover, the capital of these institutions had not been proportionately increased. What has been the cause of this enormous expansion of bank credit? The answer must at once come to the mind of any observer of finance that the principal reason for the expansion of deposits (bank credit accounts) and the accompanying expansion of loans (commercial paper held by banks) is to be found in the great movement which has been the significant feature in financial affairs of the last half-dozen years, the movement to aggregate industrial establishments into single great corporate units and to convert the evidence of ownership into corporate securities which have entered actively into the stream of financial operations. Vast amounts of new securities have been created in these half-dozen years, based in a large measure upon properties which were before held as fixed investments by individuals; or, if standing in form of corporate property, the securities of these corporations were more closely held, and in but small measure entered into the financial operations of the day. This movement, tending to convert the evidences of ownership of a great 1 Adapted from The Bank and the Treasury, pp. 5-11. (Longmans, Green, & Co., 1908.) amount of fixed property into a form which has been considered as bank collateral, and which has been made the basis of loans and of corresponding increases of deposits, is undoubtedly the most important single cause for the increase of more than four billion dollars in bank credit obligations to depositors and a corresponding increase in commercial paper held by banks in this country during the brief period of three or four years. Attention may be called to the fact that the depression from 1893 to 1896 was, as were other similar periods, one of financial reorganization-one during which new economies were introduced into our industrial establishments. During this period of depression also the water had been gradually squeezed out of previously inflated capitalizations; again the nation had come to rely, for its "cash" as well as for its income, on profits from legitimate business. With this better industrial equipment we were able to sell pig iron at a profit at $10 to $12 a ton; steel rails were sold with liberal return to capital at $17.50 per ton, and bar iron entered a profitable market at 95 cents per hundred. After business had been reorganized on a lower basis of capital liabilities, thousands of commodities were produced with profit at prices such that they began to find their way into foreign marts and, in competition with foreign-made goods, undersold them. Europe was startled at our newly developed commercial strength. Our appearance with shiploads of products that others could not manufacture at competitive prices made the world realize that in the Western continent were resources and industrial establishments that in an open market with free competition might bid defiance to all Europe. Under such circumstances bills of exchange drawn against the sale of American goods formed a true basis for commercial bank loans. What was the result, however, when the commercial bank extended its support to the capitalization of new promotions and became the chief factor in the "industrial speculation" that grew out of this sudden national awakening? Instead of limiting the commercial banking business to the service of a commercial constituency, instead of devoting the funds of commercial banks to the accommodation of producers and merchants, a system of underwriting new flotations was inaugurated. This was not a novel experience. Similar practice is recalled by the ex-Assistant Secretary of the Treasury, by reference to the "real estate" restriction in the National Bank Act. Back of the law forbidding the banks to loan on real-estate securities may be seen the long periods of industrial depression and financial reorganization following the panics of 1825, 1837, and 1847. Each period of prosperity immediately preceding these crises had been one of capitalization of new promotions. At that time, however, speculation was based on the possibilites of increasing profits to be derived from the development of agricultural resources. Westward immigration had appropriated for use large areas, a new empire of grain lands for which new transportation development had opened a market to the seaboard. New cotton, tobacco, and hemp lands enlarged this area to such an extent that the territory appropriated but still undeveloped was larger than the old Atlantic slope to which capital had before confined its investments. In these new areas all other demands gave way to the clamor for new capital, and the commercial banks attempted to supply this demand. The failure of some eight hundred commercial banking institutions during 1837 and 1838 was the result of this kind of bank-credit employment; the failure of nearly fifteen hundred banks during the next three decades of State banking based on investment securities brought to the mind of practical bankers the character and purpose of the commercial bank. In 1903 and 1904, while Europe was going through the throes of financial reorganization, our farmers were blessed with large crops and high prices; a kind and bountiful Providence filled the granaries and the storehouses of the great West and South, permitting us to levy tribute on a distressed world. Temporarily judgment of our financial folly was suspended, but the instruments of self-destruction were still in the hands of an unthinking speculative public. These instruments of destruction were placed in the hands of speculators by commercial banks in the great financial centers. They were not used alone in self-destruction, but they carried merchant and manufacturer with them. 224. RESULTS OF INVESTMENT LOANING BY COMMERCIAL BANKS BY WILLIAM A. SCOTT When commercial banks create their own demand obligations, either in the form of checking accounts or notes against investment securities, they are creating an obligation which they may not be 1 Adapted from “Investment vs. Commercial Banking," Proceedings of the Second Annual Convention of the Investment Bankers' Association of America, 1913, pp. 81-84. able to meet. When they exchange credit accounts for commercial securities, the ordinary processes of commerce bring into their possession day by day the means of meeting the obligations which they create; but when they create such obligations against investment securities the funds regularly coming into their possession for the meeting of such obligations are quite inadequate for the purpose. The enterprises which these investment securities represent, however productive they may be, bring into existence only after a series of years an amount of produce sufficient to offset the original investment. If such an enterprise produces a profit of 10 per cent a year, it takes ten years to reproduce itself. If only 5 per cent profit per annum is produced, twenty years are required. The demand obligations created by the banks, however, must be met long before these periods of time elapse. The result of such loans is overexpansion or inflation of credit, that is, the banks have created obligations against themselves which they are not able to meet in the normal course of business. So long as business is prosperous all goes well; but as soon as there is a break somewhere in the industrial system and borrowers for investment uses are unable to pay, serious trouble follows. The only means by which the banks can meet such obligations when they mature is by the sale on the market of the securities in their possession not yet due, and while an individual bank may be able to transfer such securities to another institution, and the banks of a country as a whole sometimes may be able to transfer them to the banks of other countries, the danger is always present that such transfers cannot be made, and even if they can be, only at a great sacrifice. Forced liquidation, in other words, is a necessary outcome of overexpansion of credit caused by the exchange of investment securities for checking accounts, and if such forced liquidation is general throughout a country and attempted on a large scale, it can only be accomplished through the agency of the bankruptcy courts, and when these function on a large scale, commercial crisis is inevitable. The fact that the paper of customers is drawn for thirty, sixty, ninety days, four or six months enables the banker to force this liquidation process upon customers, but this fact does not protect the country from the consequences of such liquidation. Sacrifice of property, fall in prices, commercial failures on a large scale, and a general readjustment of commercial and industrial relations cannot thus be avoided. B. The Federal Reserve System and Investment Operations 225. EFFECT OF THE NEW SYSTEM ON STOCK BY THOMAS CONWAY AND ERNEST M. PATTERSON The effect of the Federal Reserve Act upon stock exchange speculation in New York City will be watched with the greatest interest by everyone interested in banking. Some will look with concern lest the new law, by suddenly depriving stock and investment markets of funds, will create disorganization, palsying new construction which must be financed through sale of securities, and unsettling the value of collateral upon which thousands of business men have negotiated loans to carry on their enterprises. Others will be interested to see whether New York's power and prestige will be diverted to other centers with the localization of funds in these new districts. Everyone will be interested to know whether it will destroy the efficacy of the so-called "Money Trust," which is founded primarily upon the control of a comparatively small number of banking institutions that hold these bankers' deposits from the other sections of the country. It is impossible to answer any of these questions authoritatively. It would appear that the day of exceedingly cheap money for stock exchange uses is past. Without a law which renders an enormous amount of money idle, thereby enabling the New York banks to attract it to New York with a 2 per cent interest rate, it will be impossible for the New York institutions to offer call money at an average rate of about 2 per cent, as has been the case within the last ten years. The stock speculator and the investment banker who are carrying securities until such time as they can dispose of them will have to pay rates of interest approximating those which have prevailed abroad and which are determined by commercial borrowers. Call loans will probably be offered at attractive rates in limited amount, but the great bulk of money will probably be secured at interest rates of 4 per cent or over. Certain New York bankers expressed the opinion before the Congressional committee that it would be impossible to deprive New York of funds for stock exchange uses so long as the borrowers were willing to pay a good rate of interest. A compara I Adapted from The Operation of the New Bank Act, pp. 364-66. (J. B. Lippincott Co., 1914.) |