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LOANS AND INVESTMENTS 
 
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 CONTRIBUTORS 
 
 O. M. W. SPRAGUE 
 
 Professor of Banking and Finance in Harvard University 
 
 E. W. KEMMERER 
 
 Professor of Banking and Economics in Princeton University 
 
 H. PARKER WILLIS 
 
 Secretary Federal Reserve Board 
 
 THOMAS B. PATON 
 
 General Counsel American Bankers Association 
 
 HAROLD J. DREHER 
 
 Assistant Cashier National City Bank of New York 
 
 C. W. ALLENDOERFER 
 
 Assistant Cashier First National Bank of Kansas City 
 
 GEORGE E. ALLEN 
 
 Educational Director American Institute of Banking Section 
 American Bankers Association 
 
 Messrs. Sprague, Kemmerer, Dreher, Allendoerfer and 
 Allen are members of the Institute Board of Regent* 
 
 American Institute of Banking 
 
 Section American Bankers Association 
 Five Nassau Street New York City 
 
Copyright 1916 
 
 By 
 American Institute of Banking 
 
CONTENTS 
 
 Chapter Page 
 
 I. Commercial Loans 5 
 
 II. Agricultural Loans 51 
 
 III. Stocks and Bonds 97 
 
 IV. Collateral Loans 137 
 
 V. Seasonal Demands for Money 177 
 
 VI. International Exchange 216 
 
 VII. Bonds and Circulating Notes 255 
 
LOANS AND INVESTMENTS 
 
 CHAPTER I 
 Commercial Loans 
 
 BANKS are commonly thought of as being 
 chiefly eng^ed in the business of lending 
 money, but l ^)a matter of fact money loans 
 make up a small part of their business. The invest- 
 ments of savings banks are indeed limited to the 
 funds which they have received from depositors, 
 together with such amounts as have been set aside 
 from profits as surplus, and also in the case of 
 stock savings banks the amount received from 
 subscriptions to capitaLstock. Other banks, includ- 
 ing the banking departments of trust companies, 
 while they must always be prepared to furnish 
 money on demand, do not limit their loans and 
 other investments to the funds received from de- 
 positors and shareholders. They lend their credit 
 as well, and thus create a large part of the funds 
 utilized by borrowers. Banks other than savings 
 banks might well therefore be called credit banks. 
 Unfortunately a somewhat less descriptive term is 
 in common use Commercial Banks. 
 
 2. BANK NOTES AND CHECKS. Com- 
 mercial banks are able to lend their own credit and 
 thus manufacture a large part of the funds which 
 
 5 
 
6 LOANS AND INVESTMENTS 
 
 they furnish borrowers, because they provide a 
 more or less generally acceptable substitute for 
 coined money as a circulating or purchasing 
 medium. The bank note, the promise of a bank 
 to pay money on demand, is quite obviously a 
 credit instrument which is a substitute for money; 
 and in the absence of legal restrictions upon issue 
 the volume of such notes in circulation would 
 clearly depend upon the willingness of people to 
 accept them in payment for goods and services. 
 Partly because of legislation limiting the power to 
 issue notes, and even more because the check has 
 been found more convenient for most purposes, 
 the bank note has become a subordinate and 
 rather special means of extending credit. Banks, 
 of course, do not extend credit directly by issuing 
 checks, since the check is an order on a bank to 
 pay money, not a bank's promise to pay money. 
 Such orders are based upon obligations to pay 
 money recorded on the books of the bank, known 
 as deposits. This term deposits is a misnomer. 
 It suggests to most people that the bank has at 
 some time or other received from depositors the 
 amount of their deposits in money. Banks are 
 often spoken of as lending their deposits. This 
 is a most inaccurate and misleading use of lan- 
 guage, since deposits are obligations already in- 
 curred, an existing liability, which, moreover, is 
 largely due to loans granted. Clearly a bank can- 
 not lend its already existing obligations to pay 
 
LOANS AND INVESTMENTS 7 
 
 money on demand. It may indeed happen that a 
 bank receives, let us say, $1,000 in money from a 
 depositor, and is on that account in position to 
 lend more than might otherwise have been advis- 
 able. But even here it is not the deposit which 
 it lends, but either the $1,000, or, and this is far 
 more likely, a new right to draw $1,000. Both 
 transactions, the receipt of the $1,000 and the loan 
 of $1,000, will then have created absolutely similar 
 deposit obligations. 
 
 3. LOANS AND DEPOSITS. It is the gen- 
 eral use of the check that makes it possible for 
 banks to create deposits through their lending 
 operations. If borrowers made all payments with 
 money it would be necessary for them to withdraw 
 the proceeds of their loans from the banks in the 
 form of money. The business of commercial banks, 
 like that of savings banks, would then be limited 
 to the funds secured from depositors and share- 
 holders, and possibly some slight amounts in 
 addition thereto, since borrowers would presum- 
 ably not immediately draw out the entire proceeds 
 of their loans. It may, however, be objected that 
 even though the borrower does use checks the bank 
 will be obliged to make payment almost as speedily 
 as if money was used. Checks do not circulate 
 indefinitely; they are quickly presented for pay- 
 ment over the counter or by other banks in which 
 they have been deposited. Assuming that a bank 
 were abruptly to double its deposit obligations by 
 
8 LOANS AND INVESTMENTS 
 
 granting many new loans, it would be confronted 
 almost at once with heavy demands for payment 
 on account of the largely increased number of 
 checks that would certainly be drawn upon it. 
 Objections of this sort are frequently raised against 
 the possibility of the creation of deposits by banks 
 in excess of the momentarily unused proceeds of 
 their loans. If it is a question of the possibility 
 of extending credit by a single bank, such objec- 
 tions are valid. A bank which should suddenly 
 increase its deposit obligations would begin to lose 
 cash almost at once because more checks would be 
 drawn, and most of them would be deposited in 
 ether banks, thus occasioning a succession of un- 
 favorable balances against it. If, however, all the 
 banks of a locality increase their loans, with a con- 
 sequent expansion of deposits, to something like 
 the same extent relative to the scale of their past 
 obligations, each bank will have a greater number 
 of checks drawn upon it, but will also receive from 
 its depositors a greater number of checks drawn 
 on the other banks. There will be a greater num- 
 ber of checks drawn but not a correspondingly 
 greater amount of cash needed in making settle- 
 ments between the banks. This increase of accom- 
 modation to borrowers by the banks of a single 
 locality would probably lead to increased pur- 
 chases from producers elsewhere, thus occasioning 
 a balance of indebtedness against the local banks. 
 Sooner or later currency would have to be shipped 
 
LOANS AND INVESTMENTS 9 
 
 to banks in other parts of the country, and this 
 would put a check on further expansion, and might 
 make contraction necessary. But again if expan- 
 sion of bank loans were countrywide this difficulty 
 would not be experienced, except from the possi- 
 bility that gold exports might be stimulated, and 
 even this contingency would not present itself if 
 the expansion of credit were worldwide. Finally 
 it should be observed that even when the expansion 
 of deposits and the increased drawing of checks are 
 confined to a few banks they cause merely a shift- 
 ing of cash among the banks; it does not diminish 
 the cash foundation of the credit structure. 
 
 4. CASH AND CREDIT. The conclusions 
 regarding deposits outlined above rest for their 
 validity upon the assumption that the checks used 
 by depositors in making payments are generally 
 received by persons who deposit them to the credit 
 of their own accounts. This is very largely true, 
 at least in English speaking countries, in which 
 something like 90% of payments seem to be made 
 with checks. For wages and for a variety of mis- 
 cellaneous payments money or bank notes are 
 required; but certainly an overwhelmingly large 
 proportion of payments made with the proceeds of 
 bank loans are made to persons who have bank 
 accounts, so that the entire subsequent series of 
 operations is made without the use of money, aside 
 from the shifting of cash among the banks them- 
 selves. But while the creation of deposits by the 
 
10 LOANS AND INVESTMENTS 
 
 making of bank loans does not involve an equiva- 
 lent outflow of money from the banks, there is a 
 direct connection between the cash holdings of the 
 banks and their power to extend credit. Confidence 
 in the banks is the foundation on which rests the 
 structure of bank credit, and one important factor 
 in establishing and maintaining confidence is the 
 cash reserve. Whether this store of money is 
 largely held in a single central institution, as in most 
 European countries, or widely scattered among 
 many banks, as in the United States, in every 
 instance we find that some more or less definite 
 relation of money to deposit liability is regarded 
 both by bankers and the public as a necessary safe- 
 guard for the structure of credit. In the United 
 States a minimum ratio of reserve to deposits, 
 at first regarded as advisable, was later imposed 
 upon the banks by law. In no other country are 
 banks subject to similar restriction upon their 
 operations. Some legislation on this matter was 
 doubtless necessary, because in the absence of 
 branch banking, also generally prevented by law, 
 business is conducted in this country by many 
 thousands of banks, large and small, many of which, 
 as our early history made evident, were certain to 
 work upon utterly inadequate reserves. This legal 
 remedy, however necessary, has had some unfor- 
 tunate consequences. A rigid requirement of an 
 irreducible reserve ratio deprives the banking 
 system of all elasticity beyond a certain point in 
 
LOANS AND INVESTMENTS 11 
 
 the granting of deposit credits. It has tended also 
 to foster in the public mind an exaggerated idea 
 of the importance of this one, and by no means the 
 most important, element of banking strength. As 
 a consequence, the maintenance of the reserve has 
 exerted an enormous influence in shaping banking 
 practice, especially in the distribution of bank 
 resources among the various classes of loans. This 
 insistent attention given to the maintenance of 
 reserves would have comparatively little effect 
 upon the lending operations of the banks, if changes 
 in cash holdings were small and also predictable; 
 but for the ordinary bank this is far from being 
 the case. However universal the use of checks 
 may be, the individual bank continues to be subject 
 to variations in the demands upon it for cash. A 
 bank can exert no control over the use its depositors 
 make of their accounts from day to day; checks 
 deposited with it never exactly balance checks pre- 
 sented for payment. There will be wide variations, 
 sometimes favorable, sometimes unfavorable. In 
 the latter contingency reliance may be placed upon 
 a speedy change in favor of the bank, especially 
 if this may be presumed with some certainty from 
 knowledge of the customary action of impor- 
 tant accounts. More positive action designed to 
 strengthen its cash holdings, however, is certain 
 to become necessary from time to time in the ex- 
 perience of every bank. The requirements . of 
 depositors will occasionally result in a succession 
 
12 LOANS AND INVESTMENTS 
 
 of unfavorable balances; and further, every bank 
 must face the possibility that unfounded rumors 
 may subject it to a run. It is imperative, therefore, 
 that a bank be able to pay out large amounts of 
 money on demand and also be in position quickly 
 I to replenish depleted reserves. Its assets, or at 
 least a considerable portion of them, must be of 
 such a character that they can be quickly converted 
 into money. 
 
 5. ASSETS MUST BE LIQUID. Liquidness 
 of assets enables a bank to meet the actual needs of 
 its depositors for money and also by giving con- 
 fidence serves to limit withdrawals to actual needs. 
 This is with most people, and properly should be, 
 the fundamental basis for confidence in a bank. To 
 serve the purposes just mentioned the same degree 
 of liquidness in all assets is not required. Imme- 
 diate convertibility into cash of a portion of the 
 assets of a bank is sufficient for the building up of 
 reserves depleted on account of unusually large re- 
 quirements on the part of depositors, or even for the 
 exceptional contingency of a run upon the bank. 
 Experience shows that a bank all of whose assets 
 can be converted into cash within a few months 
 without loss is altogether unlikely to be disturbed 
 by lack of confidence, and should it be subjected 
 to unfounded rumors no difficulty is experienced in 
 securing the necessary funds from other banks. 
 
 6. LINES OF CREDIT. The investments 
 which best meet the peculiar requirements of com- 
 
LOANS AND INVESTMENTS 13 
 
 mercial banks are loans payable either on demand 
 or within a few months, seldom more than six 
 months. With a reasonably large number of short 
 time loans, so selected that some of them will be 
 maturing daily or at least nearly every day, and all 
 of them within a six months period, it might seem 
 at first sight that if a bank adopted the simple means 
 of refraining from making new loans, the payment 
 of these loans would automatically provide a bank 
 with funds to meet all ordinary requirements. But 
 the problem which confronts the banker is not of 
 this simple character, because there are other con- 
 siderations which must be given weight in handling 
 the loan account of a bank. If a bank is to continue 
 as a going concern engaged in profitable business it 
 cannot entirely discontinue the making of loans. It 
 holds its business depositors largely through its 
 readiness at all times to furnish them a reasonable 
 amount of accommodation. Within limits of safety 
 determined by the character of the depositor, the 
 nature of his business, the size of his account and 
 the size of the bank, lines of credit have been agreed 
 upon. These agreements clearly place a part of the 
 lending power and consequently a part of the assets 
 of the bank outside the field of practical every day 
 liquidness. For a bank regarded as a going concern, 
 therefore, a considerable proportion of its resources 
 are unavailable as a means of strengthening itself 
 for the purpose of meeting ordinary requirements. 
 Further, unless borrowers have in general already 
 
14 LOANS AND INVESTMENTS 
 
 fully utilized their lines of credit, the bank is subject 
 to the possibility of additional demands for accom- 
 modation, which it cannot refuse to grant, and which 
 may come just at a time when it is meeting un- 
 usually heavy payments to depositors either directly 
 or through unfavorable balances with other banks. 
 Even in periods of acute monetary stringency it 
 must be prepared to create new deposit liabilities by 
 making new loans. Striking instances are found in 
 the case of those banks which have accounts of stock 
 brokers who ordinarily borrow on the market, or of 
 business firms which place their paper with many 
 banks through note brokers. It is a common prac- 
 tice, and one dictated by sound business policy, for 
 such borrowers not to borrow from their own banks. 
 Lines of credit are kept open to fall back upon when, 
 as may happen, it becomes difficult, if not impos- 
 sible, to borrow in the open market. The borrower 
 has thus an anchor to windward. But, on the other 
 hand, banks that have such accounts have incur- 
 red obligations to extend credit just when it may 
 be most inconvenient for them to do so. 
 
 7. LIQUIDNESS OF LOANS TO DEPOSI- 
 TORS. Clearly then a bank should have assets 
 more liquid than its loans to its own clientele of 
 business depositors. The conclusion should not be 
 drawn, however, that the loans made to such regular 
 customers need not possess the quality of liquidness. 
 The analysis in the preceding paragraph was con- 
 cerned altogether with these loans taken as a class. 
 
LOANS AND INVESTMENTS 15 
 
 The individual loans within this class must be liquid 
 to enable a bank to extricate itself from threatened 
 failure or suspension, contingencies which would 
 inconvenience borrowers far more than the refusal 
 to allow them accommodation agreed upon under 
 lines of credit. Moreover, there is another and even 
 more important reason for insisting upon liquidness 
 in the case of these loans. A large part of the loans 
 made by banks is based upon personal security 
 alone, promissory notes with or without indorse- 
 ments. The underlying security rests very largely 
 upon the uses made by the borrower of the proceeds 
 of these loans. If the transaction in connection with 
 which the proceeds of the loan are used will be com- 
 pleted during its life the loan may be said to pay for 
 itself. It is to be presumed also that borrowers will 
 use the proceeds of loans which they are to repay 
 in a few months more wisely than might be the case 
 if the payment were indefinitely deferred. More- 
 over, conclusions based upon the analysis of the 
 statements of borrowers and upon other informa- 
 tion are a basis for short time credit only, since over 
 a long period conditions may change radically for 
 ic worse. Unsecured loans must therefore as a 
 * ale possess that quality of liquidness which comes 
 from short maturities to make them a proper in- 
 vestment for banks or indeed for any lender. One 
 common method of seeking not only to make cer- 
 tain that the loans made under lines of credit shall 
 be liquid, but also to determine whether credit may 
 
16 LOANS AND INVESTMENTS 
 
 be safely continued, is to insist that all borrowing be 
 cleaned up at least once a year. This is often an 
 effective requirement, though it may be more nomi- 
 nal than real, since borrowers may simply allow 
 accounts payable temporarily to pile up against 
 chem. The supply of credit which the banks are in 
 position to lend is, however, so large that the banks 
 quite generally do lend more or less continuously to 
 many borrowers. Concerns whose business is 
 growing and which show good earning power are a 
 reasonably safe basis for such loans pending a time 
 when they may be expected to secure additional 
 capital by means of more permanent obligations, by 
 an issue of additional capital stock, or by the grad- 
 ual process of putting profits back into the business. 
 Firms engaged in a few lines of business may per- 
 haps be regarded as satisfactory borrowers even 
 though they continue to rely indefinitely upon 
 banks for a part of their working capital. In such 
 cases it is essential that the firm shall be engaged 
 in a business the products of which are in constant 
 demand and therefore readily saleable for cash. 
 8. COLLATERAL LOANS TO DEPOSI- 
 TORS. Based upon knowledge of the amount 
 of loans made in former years, the future needs 
 of regular commercial depositors can be fairly well 
 determined; but, as in the case of the requirements 
 of depositors for cash, the estimate cannot be exact, 
 and for short periods may be wholly at fault. Evi- 
 dently, if it is regularly to keep its funds fully em- 
 
LOANS AND INVESTMENTS 17 
 
 ployed, a bank must invest a part of them in other 
 ways, in assets which can be converted into cash 
 without disturbing valuable relationships. The 
 banker may have made a considerable number of 
 collateral loans to his depositors. The greater part 
 of such are made on the security of stocks and 
 bonds; and, leaving out of view those made to 
 depositors who are engaged in the business of mar- 
 keting securities, these loans can be allowed to 
 mature and new loans can be refused with less 
 danger of loss of accounts than in the case of regu- 
 lar commercial borrowers. This is because the 
 proceeds of collateral loans are largely used to 
 enable borrowers to pay for purchases of securities 
 and for other purposes outside their regular busi- 
 ness. Moreover, the borrowers whose loans are 
 based on readily marketable collateral, can arrange 
 to borrow from other banks more readily than is 
 generally true in the case of the commercial bor- 
 rower. 
 
 9. REDISCOUNTS. Few if any banks are 
 likely to have made these occasional loans to 
 depositors to such an extent as to furnish them 
 speedily through contraction with a considerable 
 amount of funds. It is clearly necessary, therefore, 
 that a bank invest a part of its resources outside of 
 the circle of its own depositors, unless it is pre- 
 pared to borrow frequently from other banks. For 
 small banks, country banks and those in the small 
 cities, this has always been quite feasible by means 
 
18 LOANS AND INVESTMENTS 
 
 of loans from their city correspondents, but it is 
 a kind of business which has not been very largely 
 developed in this country. There has been a pre- 
 judice against it among many bankers, who feel 
 that it in some way reflects upon their credit. In 
 a community in which local requirements are at 
 certain seasons of the year decidedly greater than 
 the resources of the local banks, it would seem to 
 be a most desirable method of raising funds. 
 
 10. BANK BALANCES AND BONDS. Bal- 
 ances with city banks in excess of the amount which 
 can be counted as a part of the legal reserve are 
 another means of providing funds to meet unusual 
 needs. The rate of return on bankers' balances, 
 customarily 2%, does not make this a very profit- 
 able method of employing what may be called a 
 bank's secondary reserve, except during periods of 
 monetary ease when rates for loans are at a low 
 level. Bonds which are readily saleable may serve 
 this purpose also, but at no little risk of loss. In 
 periods of business inactivity following a crisis, 
 bonds are indeed a very satisfactory means of 
 utilizing some portion of the resources of a bank. 
 They can then usually be purchased at relatively 
 low prices, and if disposed of at the beginning of 
 a period of renewed business activity are likely 
 to have appreciated in value. In periods of con- 
 tinued activity, however, bonds are likely to fall 
 somewhat in market price, and in periods of general 
 strain may become almost unsaleable. Bonds in 
 
LOANS AND INVESTMENTS 19 
 
 general would seem to be satisfactory as a special 
 investment to meet serious contingencies of par- 
 ticular banks rather than as a resource in periods 
 of general financial strain. If a bank is threatened 
 by a run its holdings of bonds are apt to prove a 
 more speedy means of securing funds from other 
 banks than its ordinary loans to depositors. It may 
 also be added that bonds are required as security 
 for Government deposits and also in many States 
 for State, county and municipal deposits. These 
 requirements explain the large investment of many 
 banks in bonds. 
 
 11. COMMERCIAL PAPER. There remain 
 for consideration two additional profit earning 
 resources which may be relied upon for quick con- 
 version into cash. There are two classes of loans 
 insistence on payment of which, together with the 
 refusal to make new loans, does not subject a bank 
 to the danger of the loss of any business advantage. 
 These loans are commercial paper purchased from 
 note brokers and collateral loans made to stock 
 brokers and investment bankers who are not de- 
 positors of the lending bank. Note brokers are 
 resorted to by business concerns whose borrow- 
 ings are large, often too large to be granted by 
 one or more banks, even by those of the larg- 
 est size. Banks purchasing this paper incur abso- 
 lutely no obligation to take additional paper in 
 the future. They may buy regularly or intermit- 
 tently, as suits their own convenience; the relation 
 
20 LOANS AND INVESTMENTS 
 
 between borrower and lender is absolutely imper- 
 sonal. Commercial paper purchased from note 
 brokers has for many years been a favorite avenue 
 for the employment of a considerable portion of 
 the secondary reserve of the banks. A banker is 
 indeed less likely to know intimately the character 
 of this paper than that of loans made to his own 
 depositors. Here, however, the note broker, if 
 wisely selected, is a valuable safeguard. It may be 
 said without qualification that the losses of banks 
 from commercial paper purchased from note 
 brokers of high standing have been far less than 
 those from loans to their own depositors, and im- 
 measurably less than those from purchases of paper 
 from distant borrowers made directly in order to 
 save the broker's commission. The notes which 
 are sold to the banks by note brokers are generally 
 in round amounts of $5,000 and in multiples of 
 $5,000. Only very large banks will have sufficient 
 funds invested in this way to provide them with a 
 steady succession of maturities. For the small 
 bank, therefore, commercial paper is rather a means 
 of employing surplus funds which are not likely 
 to be needed during the continuance of the loan. 
 In this connection it should be noted that there 
 seems to be a tendency to lengthen the average 
 maturity of this class of loans, owing to the fact 
 that the borrower ordinarily pays the same com- 
 mission whether the paper is to run for three or 
 for the maximum period of six months. This 
 
LOANS AND INVESTMENTS 21 
 
 longer average maturity lessens the value of com- 
 mercial paper to most banks as a liquid asset for 
 ordinary working purposes. 
 
 12. LOANS ON SECURITIES. The favorite 
 investment for funds which may be needed at any 
 moment is the collateral loan to stock brokers and 
 to banking houses engaged in marketing securities. 
 A part of these loans is on time and has very much 
 the same utility as a means of employing banking 
 funds as commercial paper purchased from note 
 brokers with the further advantage that a greater 
 range of maturities is available. There is a broad 
 market for collateral loans maturing all the way 
 from one month to six months. A large part 
 of the total of collateral loans also is payable on 
 demand. Stock exchange dealings and the mar- 
 keting of securities are unlike all other kinda of 
 business in that they can be in part conducted on 
 the basis of call loans. The quick saleability of the 
 commodity handled makes this possible; conse- 
 quently, we have here a demand for loans under 
 such conditions as to enable banks to make full use 
 of their lending power right up to the limit set by 
 their reserve requirements. In the absence of the 
 call loan it would clearly be impossible for the 
 banks to keep their reserves intact and at the same 
 time lend close to the limit of reserve requirements. 
 Many considerations must be taken into account 
 in determining the relative amount of its funds 
 which shall be employed by a bank in the various 
 
22 LOANS AND INVESTMENTS 
 
 ways which have been outlined. Banks whose de- 
 posits fluctuate with some degree of regularity can 
 naturally invest in a different fashion from those 
 subject to large requirements which cannot be 
 foreseen. 
 
 13. ADJUSTMENT OF RESERVES. Let 
 us now assume that a bank which has invested in 
 all of the various ways above described finds itself 
 below reserve requirements. From knowledge of 
 the tendencies of the accounts of its depositors it 
 may perhaps be reasonably certain that within a 
 few days through deposits of cash or through de- 
 posits of checks giving it a favorable balance with 
 other banks its reserve will be restored. Many 
 bankers in these circumstances might be content to 
 allow affairs to take their own course. Others, 
 especially in cities where the banks publish a weekly 
 statement, would be likely to call some of their 
 demand loans but might continue to purchase com- 
 mercial paper and make time collateral loans to 
 an amount something like current maturities of 
 such loans. If, however, there was reason to be- 
 lieve that depositors were likely still further to 
 draw down their balances and if demands for 
 further accommodation from depositors were to 
 be expected, a much greater reduction in call loans 
 might be made and at the same time new invest- 
 ments in commercial paper, and in time collateral 
 loans, might be largely discontinued. No one of 
 these three kinds of loans would presumably be 
 
LOANS AND INVESTMENTS 23 
 
 liquidated before a beginning was made with the 
 other two. Some weight would of course be given 
 to the relative rates prevailing for each of these 
 three kinds of loans. Bonds would probably not 
 be disposed of unless a pronounced change in the 
 conditions surrounding the employment of its funds 
 was foreseen or unless a bank were confronted with 
 a serious change for the worse in its affairs. While 
 there are neighboring banks with surplus funds 
 to lend a bank whose loans are liquid experiences 
 no difficulty in securing additional funds by means 
 of contraction. Aside from loans to its own de- 
 positors, payment for which will ordinarily involve 
 a cancellation of its own deposit obligations, it 
 is important to observe that the additional funds 
 which a bank thus secures come from other banks. 
 When banks loans are paid by borrowers, money 
 to an insignificant amount is drawn from general 
 circulation. The total money holdings of the banks 
 are not appreciably increased; there is simply a 
 shifting of cash holdings among the banks. 
 
 14. GENERAL CONTRACTION OF LOANS. 
 In periods of active business, however, banks can 
 and generally do lend all that their reserves will 
 support. If during such a period any considerable 
 loss of cash occurs, the foundation of credit is 
 weakened and the banks generally may desire to 
 strengthen themselves. A policy of contraction 
 of loans may then be adopted by most of the banks 
 at the same moment. The results of contraction 
 
24 LOANS AND INVESTMENTS 
 
 in such circumstances are far less effective in 
 strengthening the banks than those which follow 
 contraction by one or a few banks. Just as when 
 loans increase more checks are drawn in payment 
 for increased purchases, so when loans are being 
 generally reduced more checks are drawn in favor 
 of the banks with no corresponding inflow of 
 money. The payment of loans does not increase 
 the amount of money in the possession of the banks 
 taken as a whole; it simply reduces deposit obli- 
 gations. Let us suppose, for example, that the New 
 York banks have exactly the amount of reserve 
 required by law, 18 per cent, of their net de- 
 posits. One million dollars is shipped to the in- 
 terior, reducing deposits by a like amount and 
 reserve requirements by $180,000. There is now 
 a reserve deficiency of $820,000. Will the liquida- 
 tion of $820,000 of loans bring in the desired amount 
 of cash? By no means. The loans will be paid 
 with checks on the banks and will reduce deposits 
 by $820,000 and reserve requirements by 18 percent, 
 of that amount. In order to restore the reserve 
 ratio it will be necessary to reduce loans by some- 
 thing like four times the amount of cash loss, 
 that is, by four million dollars. It will thus be 
 seen why the loan market is at times exceedingly 
 sensitive to a seemingly small loss of cash. When 
 surplus reserves are low, it may involve a contrac- 
 tion of loans several times the amount of the cash 
 lost. If the cash lost is due to gold exports the 
 
LOANS AND INVESTMENTS 25 
 
 advance in rates which is certain to accompany 
 general loan contraction may make it profitable to 
 borrow in foreign markets. Such borrowings often 
 bring about the cessation of a gold export move- 
 ment. It is seldom possible, however, so com- 
 pletely to reverse the exchanges by this means as 
 to secure additional cash by means of gold imports. 
 15. ULTIMATE EFFECTS OF CONTRAC- 
 TION. Ultimately if contraction entails lessened 
 business activity, money will flow into the banks 
 from general circulation; but this is a slow and 
 uncertain resource of little use in meeting the 
 pressing needs which usually occasion the general 
 liquidation of loans. The reduction of deposit 
 liabilities through contraction will, of course, bring 
 the reserve ratio of the banks to a satisfactory 
 point if it can be carried far enough. But it cannot 
 be carried very far. Business cannot be suddenly 
 deprived of that amount of credit which it has been 
 receiving without disastrous consequences. When 
 the volume of business declines, the volume of credit 
 can also be correspondingly reduced but not before, 
 except within narrow limits. The credit granted 
 to those engaged in one of the last stages of the 
 production of some commodities can generally, it 
 is true, be reduced without much difficulty. Con- 
 sider, for example, the meat and provision business. 
 Packers reduce their purchases of cattle and hogs. 
 The necessary daily consumption of the people 
 soon reduces the stock on hand and as cash pay- 
 
26 LOANS AND INVESTMENTS 
 
 ments are the rule in this line of business the 
 packers will shortly be able to liquidate their loans 
 and would require no new accommodation. It 
 seems at first sight as if a large amount of com* 
 .mercial loans would have been eliminated. But 
 5 consider the situation of the large number of 
 farmers engaged in the business of raising cattle 
 and hogs. Unable to sell as much as usual to the 
 packers they would be obliged to fall back upon 
 their own banks, from which they would be com- 
 pelled to borrow more largely than usual. Even 
 call loans are much less liquid than is gen- 
 erally supposed. When a few banks demand pay- 
 ment of these loans brokers to whom they are 
 principally made secure loans elsewhere and the 
 banks calling the loans are paid. The total volume 
 of call loans is not much changed. Within narrow 
 limits it may be possible to reduce the aggregate 
 of such loans by sales of securities to persons able 
 to pay for them outright. It is also possible to 
 secure additional margins from customers for 
 whom brokers are carrying securities. But when 
 all banks call loans they soon cease to be convert- 
 ible. Purchasers who might be able to pay for 
 securities outright become frightened, while alarm 
 and even panic may become general. In order to 
 prevent disastrous failures among brokers and 
 consequent loss to themselves the banks find it 
 necessary to refrain from insisting upon general 
 loan contraction. 
 
LOANS AND INVESTMENTS 27 
 
 16. GENERAL LOAN CONTRACTION TO 
 BE AVOIDED. In European countries the banks 
 never find it necessary to attempt to strengthen 
 themselves by sudden and general contraction of 
 loans. Slow contraction of loans is of course some- 
 times insisted upon when it is thought that the 
 business situation will thereby be improved. If 
 it is merely a question of strengthening the banks, 
 however, recourse is had to the central banking 
 institutions found in all European countries. Un- 
 like other banks these central banks in ordinary 
 times never lend to the full extent of their power 
 to grant credit. They are therefore always in 
 position to take over a part of the load of loans 
 from the other banks. This makes the situation 
 in emergencies in European countries analogous 
 to what it has been with us when some, but not all, 
 of the banks were seeking to strengthen themselves 
 by means of contraction. It cannot be expected 
 that each one of the many thousands of banks 
 in this country will reserve part of its lending 
 power for emergencies which after all come but 
 seldom. Somewhere in every banking system a 
 reserve of lending power is required, and it is 
 primarily to meet this requirement that the Federal 
 Reserve banks were established in 1914. 
 
 17. ALDRICH-VREELAND ACT In addi- 
 tion to central banking arrangements there is 
 another possible method of meeting emergency 
 requirements. All banks may be authorized to 
 
28 LOANS AND INVESTMENTS 
 
 issue a special variety of bank notes subject to a 
 tax onerous enough to deprive the banks of all 
 inducement to issue them in ordinary times. This 
 was the method adopted in the Aldrich-Vreeland 
 Act of 1908. This measure proved of the very 
 greatest advantage during the crisis of 1914. 
 Nearly $300,000,000 of the emergency notes were 
 issued, thus enabling the banks to meet all demands 
 for currency without entrenching upon their cash 
 reserves, and at the same time to aid the business 
 community by the granting of additional accom- 
 modation. 
 
 18. FEDERAL RESERVE ACT. Before the 
 occasion for testing this legislation, and following 
 European example, the Federal Reserve Act was 
 passed on December 23, 1913. The Federal Re- 
 serve banks were opened for business on November 
 16, 1914, just after the crisis of that year had been 
 overcome. The primary purpose of the reserve 
 banks and the Aldrich-Vreeland notes is similar. 
 Both were designed to meet periods of severe finan- 
 cial strain, but it is rightly believed that the reserve 
 banks will prove more serviceable for this purpose, 
 and that they will also be of much advantage in 
 ordinary times. In particular, the reserve banks 
 are expected to be able to exert a restraining in- 
 fluence during the periods of rapid credit expansion 
 which always precede crises. It is also believed 
 that they will contribute much to the standardiza- 
 tion of banking practice, and that they will improve 
 
LOANS AND INVESTMENTS 29 
 
 methods of making settlements between the banks 
 in different parts of the country. 
 
 19. RESERVE BANKS AND LIQUIDNESS. 
 If the reserve banking system works well it may 
 reasonably be expected that the course followed 
 by banks in making adjustments to variations in 
 demands for cash will be materially different from 
 what it has been in the past. It will be just as 
 necessary as formerly for a bank to keep itself 
 in a liquid condition, but the relative liquidness of 
 different classes of assets will be somewhat changed 
 and the liquidness of all assets will be enhanced. 
 The liquidness of all assets will be enhanced if the 
 reserve banks maintain themselves in a condition of 
 such strength as to be able at all times to supply 
 additional credit and currency to meet emergencies. 
 The process of conversion of assets into cash will 
 then be the simple matter which we have already 
 seen it to be when only a few banks experience 
 the need of conversion. The process of conversion 
 will be a simple matter since it will not involve 
 contraction but merely the transfer of assets to 
 reserve banks, in exchange for cash. Loan con- 
 traction will, no doubt, from time to time occur 
 when the volume of business falls off or when there 
 is evidence of an over-extended condition of affairs. 
 Contraction will be carried through gradually, 
 however, so as to conserve all interests so far as 
 may be possible. Contraction will not be resorted 
 to merely to strengthen the banks. 
 
30 LOANS AND INVESTMENTS 
 
 20. RESERVE BANKS AND COMMER- 
 CIAL LOANS. As an indirect consequence of 
 the operation of the reserve banks it may be an- 
 ticipated that all bank assets will be more steadily 
 liquid than in the past. Bonds, for example, will 
 be more steadily saleable, and the possibility of 
 shifting call loans will be always present. But 
 obviously those assets will gain most in liquidness 
 which can be used as a basis for loans from the 
 reserve banks. Most of the European banks may 
 make loans of all kinds both to individuals and to 
 banks. In the case of the reserve banks the field 
 of operation has been somewhat narrowly pre- 
 scribed, though it may be added it includes those 
 classes of business which make up the bulk of the 
 investments of the European central banks. The 
 normal lending operations of the reserve banks 
 are limited to the purchase of commercial bills of 
 exchange and the rediscounting for member banks 
 of commercial loans of all kinds maturing within 
 ninety days and of agricultural loans maturing 
 within six months. The rediscounting of loans 
 secured by stocks and bonds is specifically pro- 
 hibited. Commercial loans are generally defined 
 in the act as "notes, drafts and bills of exchange 
 rising out of actual transactions. That is, notes, 
 drafts and bills of exchange issued or drawn for 
 agricultural, industrial, or commercial purposes, or 
 the proceeds of which have been used or are to be 
 used for such purposes." The Federal Reserve 
 
LOANS AND INVESTMENTS 31 
 
 Board was authorized to define more precisely the 
 nature and character of eligible paper. In the 
 exercise of this power the Reserve Board has de- 
 fined commercial loans in such a way as to include 
 all loans to borrowers engaged in production and 
 marketing of goods whose current liabilities are 
 not in excess of their current assets. Loans of 
 this character are everywhere the backbone of the 
 banking business. 
 
 21. SOURCES OF PAYMENT OF BANK 
 LOANS. Borrowers derive the means of pay- 
 ment of bank loans from a variety of sources. 
 The liquidation of many loans is dependent upon 
 the sale of property, such as real estate and 
 buildings, or of stocks or bonds. Some loans are 
 gradually reduced and ultimately paid in full with 
 savings made from income and especially from the 
 profits of a business. The floating indebtedness 
 of a successful business may be liquidated by se- 
 curing additional capital, either through the issue 
 of new stock or the sale of bonds. Payment of 
 particular loans may be accomplished by borrowing 
 elsewhere or by postponing the payment of current 
 accounts with those from whom goods have been 
 purchased. Finally, means of payment may be 
 secured during the life of the loan as a natural 
 result of the regular operations of a business. In 
 the case of particular loans, any one of these various 
 means of payment may be regarded as of primary 
 importance by the banker, but the bulk of all bank 
 
32 LOANS AND INVESTMENTS 
 
 loans are based mainly either upon collateral or 
 upon the expected results of natural business opera- 
 tions. Some loans possess both these elements of 
 strength, but more commonly credit is granted 
 upon one of them alone rather than both in com- 
 bination. 
 
 22. COLLATERAL LOANS. The business 
 of making collateral loans is of a comparatively 
 simple nature. The quality of such loans depends 
 mainly upon the marketability of the collateral 
 pledged as security. Of course there may be sud- 
 den unforeseen changes in the value of any given 
 security; and in periods of acute financial strain 
 there may be a sharp decline in the value of all 
 securities, and difficulty may be experienced in 
 finding purchasers at any price. Lending can never 
 be made a routine mechanical business. But with- 
 out minimizing the hazards involved in making 
 collateral loans, it is certain that the problems en- 
 countered in making loans based on the current 
 results of business operations are far more numer- 
 ous and complicated. 
 
 23. COMMERCIAL LOANS. Loans, the 
 means of payment of which become available dur- 
 ing the life of the loan as a result of the regular 
 operations of a business, are commonly known as 
 "commercial loans." The instrument in which the 
 obligation is embodied may be either a bill of 
 exchange or a promissory note. The lender may 
 rely for payment upon the borrower alone or re- 
 
LOANS AND INVESTMENTS 33 
 
 quire additional security either a lien on tangible 
 property or the endorsement of one or more third 
 parties. There is, then, much variety among com- 
 mercial loans, but they all possess one feature in 
 common which overshadows these differences. To 
 be a commercial loan, the proceeds must be used 
 in financing the production and marketing of goods, 
 operations from which the means of payment will 
 ordinarily be derived before it matures. The limits 
 within which banks may safely finance these opera- 
 tions, and the terms on which accommodation shall 
 be granted, constitute the complex problem of the 
 commercial loan. The financing of fixed assets 
 land, buildings, and machinery is entirely outside 
 the limits of commercial borrowing. No part of 
 the indebtedness of a borrower in excess of his 
 current assets can be regarded as commercial in 
 character. Moreover, to finance anything like all 
 of current assets by means of short time loans 
 would in almost all instances involve the speedy 
 insolvency of the borrower and loss to the banks. 
 24. CURRENT ASSETS. Current assets con- 
 sist of materials, work in process, finished goods, 
 accounts and notes receivable, and cash. In the 
 ordinary course of business all the other current 
 assets are in process of conversion through one or 
 more stages into cash. At the same time, however, 
 it is to be noted that unless a business is being 
 wound up, new current assets of each kind are con- 
 stantly being acquired. The materials of today 
 
34 LOANS AND INVESTMENTS 
 
 become the finished goods of tomorrow and the 
 receivables of a more distant future. Current assets 
 are revolving assets. 
 
 25. CURRENT LIABILITIES. An analogous 
 process is to be observed in the current obligations 
 of a business. Indebtedness to banks and to those 
 from whom goods are purchased is constantly 
 maturing and being paid, but new obligations are 
 at the same time being incurred in connection with 
 the operations which will result in future sales. 
 There must be a constant inflow of cash to a busi- 
 ness to meet these obligations as they become due, 
 and this inflow must be sufficient, not merely for 
 this purpose, but also to provide for the current 
 running expenses of the business, to say nothing of 
 provision for up-keep and earnings. But since new 
 obligations are constantly being created, there is 
 always the possibility, in the case of a business 
 which is losing ground, that an inadequate inflow 
 of cash is being met by using proceeds of new cur- 
 rent obligations to meet the burdens of the past 
 rather than the operations of the future. Since 
 business is a continuing process, it cannot be con- 
 stantly subjected to the test of complete liquidation 
 of its indebtedness. The supply of cash, therefore, 
 may be sufficient to meet maturing obligations for 
 a considerable time after a concern is in an unsound 
 or even insolvent condition. 
 
 26. METHODS OF DETERMINING SAFE 
 LIMITS OF CURRENT LIABILITIES. Two 
 
LOANS AND INVESTMENTS 35 
 
 methods of determining whether the current liabili- 
 ties of a business are being kept within safe limits 
 may be distinguished. Under one method credit 
 is based upon the entire financial position of the 
 borrower as determined by the analysis of state- 
 ments of the condition of his business and other in- 
 formation. Under the other method specific trans- 
 actions, purchases and sales of goods, measure 
 borrowing capacity. Before considering the respec- 
 tive merits of these two methods, it is to be noted 
 that neither of them has validity indeed, they 
 may be positively misleading in the absence of 
 character and business ability in the borrower. The 
 most prosperous business may be quickly ruined 
 through mismanagement. Under no method of 
 determining proper limits for loans can the pos- 
 sibility of loss through dishonesty be entirely 
 eliminated. Judgment of men is fundamentally 
 essential for the successful conduct of commercial 
 banking. But definite rules and principles for esti- 
 mating the character and capacity of individuals 
 are of little service. In the final analysis, there- 
 fore, it will simply be assumed that the banker 
 has satisfied himself regarding these essential 
 qualifications. 
 
 27. STATEMENTS OF BORROWERS. The 
 honesty of the borrower is especially important 
 when statements of the condition of his business 
 are used in determining the amount of credit which 
 may safely be granted. An independent audit of 
 
36 LOANS AND INVESTMENTS 
 
 course reduces the danger from fabricated state- 
 ments, and such audits are becoming increasingly 
 common, although they can hardly be expected in 
 the case of borrowers of small or medium size. The 
 practice of requiring a statement of condition from 
 borrowers has grown during the last twenty years 
 until now it is almost universal in well-managed 
 banks. It is evidently an imperatively necessary 
 requirement where credit is granted on unsecured 
 single name paper. Statements of condition are 
 made with varying degrees of completeness. Often 
 only a balance sheet is available, but frequently a 
 statement of the amount of sales is also given, as 
 well as other information. The balance sheet alone 
 is commonly the only information furnished pur- 
 chasers of commercial paper from note brokers. 
 Borrowers naturally are unwilling that detailed 
 information regarding their affairs should be spread 
 broadcast throughout the country. To the note 
 broker, however, more complete information in 
 confidence is commonly given. When balance 
 sheets alone are available intimate knowledge of 
 the industry in which the borrower is engaged is 
 needed in order to interpret them. The relative 
 amount of various kinds of current assets and lia- 
 bilities shown in the balance sheet when compared 
 with statements of others engaged in the same line 
 of business will often indicate whether it is in a 
 sound or weak condition. A single balance sheet 
 is of very little significance, but a series of state- 
 
LOANS AND INVESTMENTS 37 
 
 ments extending over a period of years often throws 
 much light upon the conditions and tendencies of 
 a business. 
 
 28. RATIO OF CURRENT ASSETS TO 
 LIABILITIES. It is a common rule of thumb 
 that current assets ought to be twice the amount 
 of current liabilities. This is not a rule for lending 
 that should be followed blindly; it is merely a 
 suggestion, a sort of guidepost. If the current lia- 
 bilities are more than one-half the assets it naturally 
 puts the banker on inquiry to find out whether the 
 rather high proportion of current liabilities to cur- 
 rent rent assets is safe. A proportion of !*/ to 1 
 may in certain lines of business be a more satisfac- 
 tory proportion than a 2y 2 or 3 to 1 proportion in 
 other kinds of business. 
 
 29. LIQUIDATION OF ASSETS. It is 
 necessary, therefore, to know a good deal about 
 the nature of different kinds of business if one is 
 to grant credit wisely. There are some kinds of 
 business the products of which are universally con- 
 sumed and paid for in cash. Concerns engaged in 
 such business obviously can borrow more largely, 
 and can go along with a lower ratio of assets to 
 liabilities, than those engaged in other kinds of 
 business. Take a business like that of the packers, 
 for instance, who are large borrowers through note 
 brokers. It would be possible for such concerns to 
 liquidate many millions of dollars in a compara- 
 tively short time. All they would need to do would 
 
38 LOANS AND INVESTMENTS 
 
 be to purchase in the near future a smaller number 
 of cattle and hogs. The demand for their products 
 would quickly take off the existing supply and they 
 would largely be paid in cash. Moreover, they 
 would lose no valuable trade connections by cur- 
 tailing operations, and possibly they might take 
 advantage of the situation to add a few cents to 
 the price of their products. 
 
 30. SLOW LIQUIDATION. Let us consider 
 another kind of business, say a furniture manufac- 
 turer. It might be that just at the time when he 
 would like to reduce his obligations his obligations 
 will increase. Let us suppose circumstances in 
 which the demand for furniture suddenly falls off 
 on account of general reaction in the activity of 
 trade. Dealers in furniture would in those circum- 
 stances purchase less than the expected supply of 
 'furniture, and presumably, also, they would defer 
 more or less their payments on past purchases. In 
 the meantime the maker of furniture would find 
 himself loaded up with a large amount of it, for 
 the moment unsalable, and he would have no one 
 on whom he could fall back, as was the case with 
 the dealer. Of course, the furniture maker might 
 defer payments for materials to a certain extent, 
 but the value of the materials going into furniture 
 is small as contrasted with the value of the furni- 
 ture itself, as so much of the value of that product 
 is due to the labor employed upon the material. On 
 this account the delay on the part df the furniture 
 
LOANS AND INVESTMENTS 39 
 
 maker in meeting his payments for purchases would 
 not by any means offset delays on the part of fur- 
 niture dealers in making payments to makers of 
 furniture. Clearly, then, the furniture maker is a 
 concern from which one would demand a higher 
 ratio of quick assets to quick liabilities than from 
 a packing-house concern. In a general way it may 
 be said that those engaged in the last stages of 
 production, if they are producing an article which 
 enters into necessary and general consumption, can 
 extricate themselves from critical credit situations 
 more easily than any other class of producers in 
 the community. 
 
 31. VOLUME OF SALES. In the interpreta- 
 tion of balance sheets the amount df net sales is 
 of great assistance. A rapid turn-over of current 
 assets, as compared with that of others engaged 
 in the same line of business, is ordinarily an indica- 
 tion of a capable and successful management. It 
 implies that stocks are wisely purchased; it also 
 indicates that dead stock is not inflating the inven- 
 tory, and that accounts long past due are not being 
 carried. An absolutely high turn-over is also sig- 
 nificant. Here there is a wide variation owing to 
 differences in the nature of various lines of business. 
 The process of production may be long, or the 
 terms of payment may be customarily liberal, as in 
 the case of agricultural implements. Where these 
 conditions are found the ratio of current assets to 
 current liabilities should be high in other words, 
 
40 LOANS AND INVESTMENTS 
 
 a large part of the current assets should be financed 
 by those conducting the business. 
 
 32. LIMITED SIGNIFICANCE OF BAL- 
 ANCE SHEETS. All the information derived 
 from balance sheets and other sources is designed 
 to determine the liquidating ability of borrowers. 
 From balance sheets, however, this ability can only 
 be inferred. A balance sheet simply presents a more 
 or less accurate statement of the condition of a 
 business at some one moment of time. It does not 
 give any assurance of the ability of a concern to 
 meet its obligations as they mature. It is quite 
 possible, however, to secure information about a 
 business which will give a clear and direct indica- 
 tion of its liquidating possibilities. Moreover, this 
 can be done without divulging information which 
 might prove helpful to competitors. This method 
 of estimating liquidness is also extremely simple, 
 but it has as yet been applied by only a few lenders. 
 
 33. RATIO OF COLLECTIONS TO MA- 
 TURITIES. As we have already seen, the inflow 
 of cash to a solvent business must be sufficient to 
 meet its various maturities and all the other ex- 
 penses of the business, and in the case of a pros- 
 perous concern, there must be something left for 
 profits. A high ratio in cash receipts to the pay- 
 ments which must be met, evidently, then, affords 
 the strongest possible basis 'for the conclusion that 
 a business will be able to liquidate its obligations 
 in the future. Suppose, for example, that during 
 
LOANS AND INVESTMENTS 41 
 
 the two previous years the average monthly collec- 
 tions of a given manufacturing business have been 
 $100,000 ; that the average monthly maturities have 
 been $50,000, and average payments on account of 
 rent, interest, insurance, taxes and office salaries, 
 have been $30,000. By the discontinuance of its 
 manufacturing operations it is certain that this 
 concern could liquidate its indebtedness unless 
 there should be a most severe falling off in the 
 demand for its product. As in the analysis of the 
 balance sheet, account would necessarily be taken 
 of the nature of the business. A higher margin of 
 collections would be requisite in some industries 
 than in others. This method of testing credit does 
 not take the place of balance sheets and other 
 sources of information. It simply supplements 
 them, though it is believed that in the course of 
 time this ratio between collections and maturities 
 and fixed charges will come to be regarded as the 
 most important single factor in credit analysis. 
 
 34. CREDIT ANALYSIS AND SINGLE 
 NAME PAPER. Analysis of the financial posi- 
 tion of the borrower is clearly a necessary safeguard 
 in granting credit when a bank relies for payment 
 solely upon the unsecured notes of the borrower. 
 Under a system of adequate credit analysis a bank 
 is able to determine with a reasonable degree of 
 certainty not only that the borrower is using the 
 proceeds of his loans to finance current assets, but 
 that also the amounts of loans are within his 
 
42 LOANS AND INVESTMENTS 
 
 liquidating capacity. In these two respects, at 
 least, single name paper can be quite as satisfactory 
 as any other method of borrowing. 
 
 35. TRADE PAPER. Obligations of the pur- 
 chasers of goods to sellers have always been 
 regarded as a solid basis for bank credit. The ob- 
 ligation may be expressed either in the form of a 
 note given by the purchaser and endorsed by the 
 seller, or as a bill of exchange drawn by the seller 
 and accepted by the buyer. There is no funda- 
 mental legal difference between these two instru- 
 ments. The principal advantage possessed by the 
 bill is that as the initiative is taken by the seller, 
 it may be sent with bills of lading attached through 
 a bank with instructions to retain the ladings until 
 the bill has been accepted or paid. ' 
 
 36. TRADE AND SINGLE NAME PAPER 
 COMPARED. The commercial character of 
 trade paper is obviously more directly evident than 
 in the case of single name paper. Names of two 
 concerns engaged in businesses which would 
 naturally make one a purchaser of the product of 
 the other, provide fair evidence that the paper is 
 commercial in character. In the case of single 
 name paper it becomes necessary to analyze the 
 assets and liabilities of the borrower, but this 
 method, though indirect, offers equally clear evi- 
 dence of the nature of the transaction. Double 
 name paper is not infrequently accommodation 
 paper, and this fact is not always evident. In cer- 
 
LOANS AND INVESTMENTS 43 
 
 tainty that a loan is commercial in character there 
 is no appreciable difference between single and 
 double name paper. The respective merits of the 
 two methods o{ borrowing must clearly be de- 
 termined by other considerations. At first sight 
 it might seem that the risk of loss to lenders must 
 be less where trade paper is the basis for loans. 
 Tradition is all in favor of the specific transaction, 
 and at first sight it would seem self-evident that if 
 the maker's own note is good the addition of an- 
 other signature could hardly fail to make it still 
 better. This conclusion, though equally true in 
 the case of any single loan, does not necessarily 
 hold good when the character of all current busi- 
 ness obligations is to be determined. The two 
 kinds of borrowing are the outcome of different 
 methods of conducting business. That method of 
 lending which is most conducive to the mainte- 
 nance of sound and healthy conditions in trade and 
 industry will, in final anaylsis, provide a superior 
 quality of commercial loan. 
 
 37. CASH PAYMENTS. Single name paper 
 and the bank acceptance have to an increasing 
 extent taken the place of double name mercantile 
 paper all over the world, except in France, where 
 three names are required at the Bank of France, 
 The payment of cash for commodities has brought 
 this change about. In some lines of business, be- 
 cause of the marketable nature of the product, and 
 in others because of the strong position of pro- 
 
44 LOANS AND INVESTMENTS 
 
 ducers, cash payments have been insisted upon. In 
 many other lines of business the obvious advantage 
 of speedy payment has been sufficient to lead to 
 the offer of discounts for cash much above ordinary 
 rates for bank loans. When purchasers pay cash, 
 obviously the double name mercantile bill or in- 
 dorsed note cannot come into existence. Pur- 
 chasers must either have enough capital of their 
 own to make payments or must borrow directly 
 from their banks. 
 
 38. ADVANTAGES OF TRADE ACCEPT- 
 ANCES. There is a sharp difference of opinion 
 at the present time among bankers with regard to 
 the respective merits of single name paper and the 
 trade acceptance. The advantages of trade paper 
 have been ably presented by B. D. Harris, Vice- 
 President of the National City Bank of New York, 
 who says: "Under our present account system the 
 merchant is compelled to conduct the operations 
 of his business involving carrying the accounts of 
 his customers to an unreasonable extent. He is 
 compelled to do this usually solely on his own 
 credit and through the medium of his single name 
 paper discounted with his bankers or sold through 
 brokers in the open market. Owing to lack of 
 accurate knowledge or visible means 6f knowing 
 the character of credits extended by him and to 
 the inconvertibility of the latter it has come to 
 be quite a settled principle that in order to have 
 a satisfactory credit footing his statements should 
 
LOANS AND INVESTMENTS 45 
 
 show a large margin of safety in quick assets of 
 this character over liabilities usually in the pro- 
 portion of two for one, or more. No matter how 
 sound his credits, he must preserve this proportion 
 to float his single name paper successfully, whereas 
 were these credits converted into liquid double 
 name paper through the medium of acceptances 
 or notes, if all conditions were sound they would 
 be immediately available and all this large degree 
 of lost motion eliminated. If they were unsound 
 or of inferior quality, it would become manifest, 
 with the result of properly curtailing his credit 
 accordingly. For that reason merchants would be 
 more careful in extending credits to customers, 
 there would be less loss and fewer failures; it 
 would to a large extent correct an evil which has 
 come frequently under my observation, viz.: that 
 in active competition of business many wholesalers 
 and jobbers extend unreasonable lines of credit to 
 a certain class of small retail merchants, particu- 
 larly in small country towns, who operate princi- 
 pally on the credit extended them by rival firms, 
 and with little or no visible capital of their own. 
 This means slow collections and bad debts, and this 
 class of customers invariably assign short crops, 
 poor collections, the European war, or any other 
 conceivable excuse, which may seem most plausi- 
 ble, for their inability to pay, and have to be carried 
 over. It would strongly curb the pernicious prac- 
 tice of over-selling and over-buying. Buyers, 
 
46 LOANS AND INVESTMENTS 
 
 knowing that their obligations would be discounted 
 and their credit put to the test, would be more alive 
 to the necessity of meeting their obligations; 
 would be more prudent in selling on credit; more 
 careful in taking on no larger lines of merchandise 
 than they could sell; more certain of their collec- 
 tions, and therefore more able to pay their debts. 
 Hence the curse of over-expansion, and the grow- 
 ing mass oif credits which do not liquidate at times 
 and seasons when they should liquidate, would 
 receive a salutary check. The strain on the mer- 
 chants and bankers would be diminished, and the 
 credits of the entire country placed on a safer and 
 sounder footing." 
 
 39. ADVANTAGES OF SINGLE NAME 
 PAPER. That these desirable results will cer- 
 tainly follow the re-introduction of the use of trade 
 paper is, however, not universally admitted. In 
 favor of single name paper the following argu- 
 ments are advanced: "Business is altogether likely 
 to be kept in a stronger condition when cash pay- 
 ments are the rule than when each producer and 
 dealer owes for \yhat he has bought and is owed 
 for what he has sold. Many, nay most, men are 
 so constituted that in periods of active business 
 and general optimism they will buy far more on 
 credit than they would have bought if required or 
 expected to pay cash. Mercantile credit is far more 
 likely to be extended beyond safe limits than bank 
 credit, partly because the rate of return on sales 
 
LOANS AND INVESTMENTS 47 
 
 is greater than that on bank loans, and even more 
 because bankers, comparatively speaking, are a 
 highly conservative class of business men. Where 
 purchasing ability is limited by cash payments, it 
 is to be expected that the danger of a generally 
 overextended condition of business will be some- 
 what lessened. Even where cash discounts are not 
 taken, dealers selling goods to numerous pur- 
 chasers scattered over a wide territory would find 
 the handling of mercantile bills and notes far more 
 expensive and troublesome than book accounts 
 and direct borrowing from the banks. Moreover, 
 on account of the various explicit or implied war- 
 ranties generally customary when goods are sold 
 from samples by traveling salesmen, many bills 
 and notes would not be negotiable instruments, and 
 would therefore be unavailable for discounting 
 purposes. When this problem is considered from 
 the standpoint of the banks the same conclusion 
 emerges. If credit is based upon specific transac- 
 tions, there is no means of determining whether 
 the amount of borrowing on the sales made hasj 
 been kept within safe limits, having regard both 
 to the character of the purchasers and to the obli- 
 gation of the borrowers to those from whom they 
 have purchased. Many notable failures in banking 
 history have been due to excessive discounts of 
 paper representing actual sales of commodities, 
 because purchasers had overbought and the bor- 
 rowing sellers were overburdened with obligations 
 
48 LOANS AND INVESTMENTS 
 
 on account of what they themselves had purchased. 
 Borrowing on sales made on a time basis creates 
 contingent liabilities, and notoriously, contingent 
 liabilities are likely to be regarded as no liability at 
 all. Cash payments tend to diminish the contingent 
 obligations of borrowers. They free the banks to 
 a large extent from the necessity of going behind 
 the borrower to the persons to whom he has sold 
 his product. In the early years of the evolution 
 of borrowing on single name paper it was perhaps 
 less safe than double name paper. As the practice 
 has become more general, statements from bor- 
 rowers and credit analysis have become customary, 
 and they are proving potent safeguards. Grad- 
 ually a more exact knowledge of the limits within 
 which credit can be safely granted to particular 
 persons and in different lines df business is being 
 developed. This knowledge can never be developed 
 satisfactorily if the specific transaction is made 
 the basis for credit. Much of course remains to 
 be done in the field of credit analysis, and the devel- 
 opment of more systematic and frequent business 
 statements." 
 
 40. DANGER FROM BORROWING IN 
 BOTH WAYS. Experience alone can decide 
 when opinions so radically unlike are advanced with 
 reference to the respective advantages of single 
 name paper and the bank acceptance. It may, 
 however, be stated with confidence that either of< 
 these methods of borrowing alone is far more 
 
LOANS AND INVESTMENTS 49 
 
 satisfactory than both in combination. If a bor- 
 rower discounts trade acceptances the quality of 
 his single name paper must evidently be changed 
 for the worse. In discounting his trade paper the 
 borrower has hypothecated the main source from 
 which cash flows into his business. During the 
 immediate future while both methods of borrowing 
 are being tested, the banker must carefully guard 
 against the danger that many concerns will attempt 
 to borrow in both ways. 
 
 41. BANK ACCEPTANCES. A bank accept- 
 ance is a bill of exchange drawn on and accepted 
 by a bank. It is a method of borrowing which 
 possesses many of the advantages of both single 
 name paper and the trade bill. National banks, 
 under an amendment to the Federal Reserve Act 
 passed in 1916, are permitted to accept not only 
 foreign bills but also domestic bills, accompanied 
 by shipping documents or secured by goods in 
 warehouses, or a lien on goods sold. In a number of 
 the States trust companies and State banks are also 
 permitted to enter the acceptance field. The bank 
 acceptance is unlike the trade acceptance in many 
 important respects. The accepting bank bases its 
 readiness to accept upon very much the same con- 
 siderations which are taken into account in dis- 
 counting single name paper the character and 
 financial position of the borrower, as shown by 
 financial statements and other information. It is, 
 however, by no means certain that the bank 
 
50 LOANS AND INVESTMENTS 
 
 acceptance will come to be commonly used in 
 domestic business in this country. In Germany it 
 is a method of borrowing favored both by banks 
 and the business community. In other countries, 
 notable England, the use of the bank acceptance 
 is confined almost entirely to foreign business. 
 This difference in banking practice is apparently 
 in large measure a consequence of differences in 
 the available supply of funds at the disposal of 
 banks. In England, where the supply of funds! 
 which the banks would willingly employ in do- 
 mestic commercial loans has far exceeded the 
 demand, the banks have naturally preferred to dis- 
 count rather than to accept for their customers. 
 A similar disinclination among bankers, coupled 
 with the greater complexity of acceptance arrange- 
 ments, as contrasted with the discount of notes 
 and payment by checks, will work against the 
 general adoption of the bank acceptance in do- 
 mestic business in this country. In parts of the 
 country where the lending capacity of the banks 
 is insufficient to meet local requirements, it is not 
 unlikely that much use may be made of the bank 
 acceptance. The acceptance of a bank gives to 
 the obligation a currency which neither trade bills 
 nor single name paper can contain. The purchase 
 of acceptances may well prove a profitable and 
 satisfactory investment for banks in those parts 
 of the country where there is regularly a surplus 
 of available funds. 
 
CHAPTER II 
 
 Agricultural Loans 
 
 42. COMMODITY PAPER. Agricultural 
 loans are not essentially different from industrial 
 loans. Both are made to assist in producing ma- 
 terial for market, although farm products are, for 
 the most part, not ready for human consumption 
 when they leave the grower's hands, but form the 
 basis for industrial operations that make them 
 usable. Farming with live stock raising is the 
 characteristic occupation of this country, and this 
 is recognized by the Nation and the various States 
 in the creation of agricultural departments in their 
 plans of administration, by the establishment of 
 agricultural colleges, and by various special enter- 
 prises intended to promote better farming. The 
 Federal Reserve Act and rulings of the Federal 
 Reserve Board wisely contain provisions granting 
 special privileges to agricultural and live stock 
 paper. Few things marketed from the farm can 
 be produced in ninety days, which is the maximum 
 maturity for other paper eligible for purchase by 
 Federal Reserve Banks. Agricultural and live stock 
 paper having more than three but less than six 
 months to run, however, may be received for dis- 
 count by Federal Reserve banks to an amount to 
 be fixed from time to time for each Federal Reserve 
 bank by the Federal Reserve Board. The market- 
 Si 
 
52 LOANS AND INVESTMENTS 
 
 ing of staples such as cotton and wheat is a diffi- 
 cult problem. The time they are ready for sale 
 cannot be controlled and distributed throughout 
 the year, as in the case of manufactured articles, but 
 is regulated by seasons and weather conditions; 
 and, with moderate variation, each crop is ready 
 in all sections at about the same time. Transporta- 
 tion facilities are inadequate to move such vast 
 quantities immediately, storage room can not be 
 provided at the various mills which will consume 
 it, and prices would of course be demoralized if the 
 entire crop were thrown on the market at one time. 
 Thus much of these staples remains in the hands 
 of producers for a time, and is sold gradually. 
 When properly stored and otherwise complying 
 with regulations, such goods may be used as se- 
 curity for "commodity paper," which is eligible for 
 discount by Federal Reserve banks at favorable 
 rates. 
 
 43. GRAIN CROPS. The leading crops are 
 wheat, corn, oats and barley. The term "grain," as 
 used in banking and commodity exchange circles, 
 usually applies to these four products, but it may 
 be used to include flaxseed, rye and buckwheat. 
 About 200,000,000 acres of land are devoted to the 
 production of the country's grain crops. The prin- 
 cipal wheat growing States are North Dakota, 
 Kansas, Minnesota, Nebraska, Washington, Illi- 
 nois, Indiana, Missouri, Ohio, South Dakota, Penn- 
 sylvania, Montana, Oklahoma, Iowa and Oregon. 
 
LOANS AND INVESTMENTS 53 
 
 The country's wheat crop, in recent years, has 
 varied from about 635,000,000 bushels to about 
 900,000,000 bushels. Over 70 per cent, of the 
 world's annual corn crop is grown in the United 
 States. In recent years the American crop has 
 varied from 2,447,000,000 bushels to about 3,125,- 
 000,000 bushels. The principal corn producing 
 States are Iowa, Illinois, Missouri, Ohio, Indiana, 
 Kansas, Nebraska, Texas and Oklahoma. The 
 annual oats crop of the United States ranges from 
 about 953,000,000 bushels to 1,419,000,000 bushels. 
 It is equal to from 20 to 30 per cent, of the world's 
 crop. The annual barley crop of the United States 
 varies from 136,500,000 bushels to 233,800,000 
 bushels. Generally speaking, grain is shipped in 
 bulk. This is true of interior shipments when made 
 by rail or water carriers, and of shipments for 
 export. The only exceptions are grain handled 
 on the Pacific Coast, where it is usually packed in 
 sacks, and in special export shipments to Africa 
 and Australia. 
 
 44. GRAIN ELEVATORS AND WARE- 
 HOUSES. "Grain elevator" is a term applied to 
 a storage warehouse for grain. Elevators are 
 either owned by grain producers, by jobbers, by 
 warehouse companies, or by railroad carriers. 
 Some elevators are privately owned and used by 
 the owner for storing the grain purchased by him. 
 Others are operated as public warehouses. Usually 
 the grain of various owners is placed in the same 
 
54 LOANS AND INVESTMENTS 
 
 bin, care being taken that all of grain deposited 
 in a particular bin is of the same grade and quality. 
 Where grain is thus placed in elevators, the identity 
 of individual lots is lost. Special arrangements 
 may be made in the case of public elevators for 
 the preservation of identity, but higher storage 
 rates must be paid under those circumstances. 
 Country elevators, relatively small in capacity, are 
 to be found all over the grain-producing sections 
 of the country. They serve the purpose of locally 
 concentrating the crop raised in each small district, 
 before the same is shipped to one of the central 
 markets. Each farmer hauls his grain to the near- 
 est elevator, where it is conveniently weighed and 
 then dumped into the elevator. The owners of 
 these country elevators usually purchase for cash 
 the grain delivered by the farmers, and they in turn 
 sell the accumulated supply to dealers located in 
 the larger centres. There are four principal 
 classes of country grain elevators: first those 
 operated by "line companies" ; second, those owned 
 by local grain dealers; third, those operated by 
 farmers' co-operative associations or companies, 
 and fourth, those run by mill owners and malting 
 concerns. "Line companies" are corporations 
 which own and operate a chain of elevators along 
 one or more railroad routes, and which have head- 
 quarters in primary markets, to which shipments 
 are made of the grain bought and collected from 
 farmers. 
 
LOANS AND INVESTMENTS 55 
 
 45. MARKETING GRAIN. Owners of 
 country elevators pay the farmer for his grain as 
 soon as it is weighed and deposited. Owners of 
 local country elevators, whether they be small 
 dealers or line companies, obtain financial assist- 
 ance by borrowing money from banks on shipping 
 documents covering the grain sent to primary mar- 
 kets. Money is also borrowed on grain stored in 
 the elevators, insurance certificates being required. 
 The grain which is not consumed locally finds its 
 way, sooner or later, to one of the primary markets, 
 which are large distributing centres for domestic 
 and export trade in wheat, corn, oats and barley. 
 The sixteen leading primary grain markets are 
 Chicago, Minneapolis, Kansas City, St. Louis, 
 Duluth, Milwaukee, Omaha, Peoria, Louisville, 
 Cincinnati, Indianapolis, Toledo, Cleveland, De- 
 troit, Wichita and Little Rock. The aggregate 
 receipts of these markets are greatly in excess of 
 1,000,000,000 bushels and the shipments amount to 
 from 60 to 65 per cent, of the receipts. Not only 
 are large supplies of grain concentrated at these 
 primary markets, but facilities are afforded in these 
 cities for cleaning, mixing, weighing, grading and 
 storing the grain gathered from the numerous local 
 markets. There are grain exchanges in these 
 centres, and many milling and malting establish- 
 ments are located there. The elevator warehouse 
 facilities are naturally larger than those found in 
 the smaller cities, and usually these warehouses 
 
56 LOANS AND INVESTMENTS 
 
 are subject to inspection and supervision by State 
 authorities, or by the exchange authorities, or by 
 both. Elevators located in the primary markets 
 are equipped with machinery for loading and un- 
 loading grain on and from water and rail carriers. 
 Some of these elevators are "floating" warehouses, 
 and may be moved close to ships bringing in 
 grain. They are also equipped with hoppers, clean- 
 ing machines, dryers, blowers and scouring plants. 
 The leading seaboard markets are New York, Bal- 
 timore, Philadelphia, Boston, New Orleans, San 
 Francisco, Puget Sound points, and Portland, Ore. 
 Grain is also exported by lake through the Welland 
 Canal and via the St. Lawrence river from Chicago, 
 Duluth, Detroit and other Great Lake ports. 
 
 46. STATE AND FEDERAL REGULA- 
 TION. Some of the States have laws governing 
 the operation of public grain elevator warehouses. 
 Many of the laws specifically prohibit discrimina- 
 tion in charges and services and require licensing 
 and bonding of warehouse proprietors. Provisions 
 are also made for the issuance of reports showing 
 the amount of grain stored, and in some cases it 
 is required that the grain should be graded and 
 weighed and certificates issued by State grain in- 
 spectors. The warehousemen are authorized to 
 issue negotiable receipts upon which must be 
 stated the quantity and grade of the grain stored. 
 Public elevators in Chicago, for instance, are also 
 required to register all receipts issued. Under the 
 
LOANS AND INVESTMENTS 57 
 
 Federal Grain Standards Act, passed in August, 
 1916, the Secretary of Agriculture was vested with 
 authority to prepare standards of various grades 
 of grain that may be traded in. The law also 
 authorizes Government supervision of the work of 
 State inspectors and inspectors engaged by grain 
 exchanges. 
 
 47. GRAIN EXCHANGES. The grain ex- 
 changes operate inspection departments or bureaus, 
 the function of which is to inspect the grain stored 
 in the terminal elevators. All the grain which is 
 received in Chicago or New York is inspected and 
 certificates are issued. Exchanges usually publish, 
 a list of approved elevators. The inspection by the 
 exchanges prevents the delivery of unmerchantable 
 grain or of grain of a quality inferior to the one ; 
 called for. The exchanges establish the grades, 
 regulate the mixing, and weigh all the grain re-* 
 ceived. Small fees are charged for the inspection. 
 Canadian grain received "in bond" for trans-ship- 
 ment to foreign ports is not inspected, but is only 
 weighed. Members of the grain exchanges trans-: 
 act business both in "spots" and in "futures." The 
 relative prices at the different markets are largely 
 influenced by the cost of transporting the grain, 
 but also by other factors, such as the local supply 
 and demand, the world's supply and demand, and 
 other considerations governing price fluctuations 
 in commodities. Dealers in grain, and the millers 
 who produce flour, utilize the machinery of the 
 
58 LOANS AND INVESTMENTS 
 
 exchange for "hedging" purposes just as cotton 
 merchants and spinners use the cotton exchanges 
 to protect themselves against price movements. 
 
 48. GRAIN LOANS. Grain stored on the 
 farm may be covered by a mortgage and thus 
 form the basis for a loan by a country bank. The 
 farmer sells his grain for cash to a local buyer. 
 The buyer usually owns or leases a grain elevator, 
 which he fills as the farmers haul in their products. 
 He may have sufficient capital to carry on his busi- 
 ness, but as a rule borrows some money from his 
 local bank. The loan may be made on his general 
 assets or secured in some way, but as the grain he 
 buys is not in a public warehouse and is constantly 
 coming in and going out, it is not the most desirable 
 class of collateral. He will ship out about as rap- 
 idly as possible, using the capacity of his elevator 
 to take up the slack between receipts from the 
 farmers' wagons and shipments as freight cars are 
 furnished by the railroads. 
 
 49. SALES MADE BY GRAIN BUYERS. 
 The buyer will sell mostly to grain dealers in the 
 nearest grain center. Sales will be made on con- 
 tract or on consignment. If on contract, the buyer 
 agrees to furnish a given quantity of grain of a 
 certain kind and quality at a certain price and 
 within a certain time. If on consignment, the 
 buyer sends the cars to grain dealers who sell 
 to the best advantage on the open market, and 
 account for the proceeds to the local buyer, less 
 
LOANS AND INVESTMENTS 59 
 
 tne commission. In either case the grain dealer 
 finances the local buyer during the time the grain 
 is in transit from the country elevator to the city. 
 Assuming that he is satisfied as to the buyer's 
 character and financial responsibility, the grain 
 dealer will authorize him to draw a sight draft on 
 him, with shipper's order bill of lading attached, 
 for nearly the full value of the car of grain. The 
 buyer deposits the sight draft in his local bank, 
 which may or may not charge him something for 
 making the proceeds immediately available, and 
 thus enabling him to pay for more grain. The 
 draft will be presented to the grain dealer in the 
 city one day or several days before the car of grain 
 arrives by freight. On the evidence of the attached 
 bill of lading, the grain dealer pays the draft on 
 presentation, and when the car arrives adjusts with 
 the buyer any difference between its net value and 
 the amount of the draft. 
 
 50. CREDIT GRANTED BY BANKS. It 
 is evident that a grain dealer doing a large business 
 will soon have a considerable sum of money ad- 
 vanced on cars in transit. He will probably arrange 
 with his bank for a loan up to a certain amount on 
 his unsecured note, called his "open line," and for 
 a Certain additional amount to be secured by bills 
 of lading or warehouse receipts. Order bills of 
 lading are receipts from railroads or other common 
 carriers covering given quantities of certain goods 
 to be transported and delivered only on the order 
 
60 LOANS AND INVESTMENTS 
 
 of the shipper. The country buyer endorses the 
 bills of lading before attaching them to these drafts. 
 While lacking some qualities which would make 
 them perfect negotiable instruments, the order bills 
 of lading are so regarded in practice, and are read- 
 ily accepted as collateral to loans to grain dealers. 
 Such loans are nearly always made payable on 
 demand, as the total amount being used by the bor- 
 rower varies from day to day. Substitutions of 
 collateral are made daily also, as some cars arrive 
 and the bills of lading are taken out, and others 
 given the bank on new cars in transit. It is not 
 uncommon for a bank to deliver to the borrower 
 on his trust receipt collateral of this kind for which 
 he will return substitutes later in the day. 
 
 51. WAREHOUSE RECEIPTS AS COL- 
 LATERAL. The grain dealer may sell the grain 
 he receives to mills or other dealers locally, in which 
 case he receives immediate payment. Or he may 
 sell to mills or dealers in some other city, in which 
 case he will draw sight draft with bill of lading 
 attached, much as the country buyer did in ship- 
 ping to him. If public warehouse facilities permit, 
 some dealers and mills will store grain for future 
 sale or use. While theoretically warehouse receipts 
 cover particular grain in certain bins or tanks, it 
 is necessary to move wheat frequently to prevent 
 spoilage, and thus different lots of wheat in some 
 places become mixed with other lots of the sam^ 
 grade. Where delivery of grain in Exchanges or, 
 
LOANS AND INVESTMENTS 61 
 
 Boards of Trade is made by means of warehouse 
 (elevator) receipts, it is customary to require that 
 bond be furnished to the Board of Trade by elevator 
 operators and that weighers for the Board check 
 all grain in and out, on whose reports receipts 
 issued by the elevator are registered by the secre- 
 tary of the Board. Elevators so bonded and con- 
 trolled are called "regular." Warehouse receipts 
 accompanied by insurance policies are thus good 
 collateral. Banks loan on them freely with mar- 
 gins of, say, ten to twenty per cent. Loans on ele- 
 vator receipts are more likely to be time loans, and 
 are frequently sold through brokers or to banks 
 in other cities who are seeking investments. This 
 is particularly true when the local banks are carry- 
 ing full lines for the borrower or are loaned up 
 closely. As substitution of collateral is often de- 
 sired, it is a common arrangement for the local 
 bank to hold the collateral on notes sold elsewhere, 
 issuing collateral trust certificates to accompany 
 properly identified notes. These certificates show 
 that the local bank holds collateral of estimated 
 value sufficient to cover the loan and is authorized 
 to exchange same to the borrower for others of 
 equal value. Notes of good firms so secured are 
 desirable investments. Loans on grain stored in 
 public warehouses are classed by Federal Reserve 
 Banks as "Commodity Paper" and given a prefer- 
 ential discount rate. 
 52. COTTON AND ITS PRODUCTION. 
 
62 LOANS AND INVESTMENTS 
 
 The principal cotton-growing States are Texas, 
 Georgia, Alabama, Mississippi, Oklahoma, South 
 Carolina, Arkansas, North Carolina, Louisiana, 
 Tennessee, Florida, Missouri and Virginia. Some 
 cotton is also produced in the States of California, 
 Arizona, Kansas, New Mexico and Kentucky. The 
 planted acreage in recent years has totaled from 
 31,500,000 to 37,500,000 acres, the first four States 
 named contributing about two-thirds of the aggre- 
 gate. The production of cotton in the United 
 States during the past ten years has varied from 
 about 10,300,000 bales of 500 pounds each, to more 
 than 16,900,000 bales. The yield per acre averages 
 from about 187 to 194 pounds, or slightly less 
 than four-tenths of a bale. The United States pro j 
 duces about 60 per cent, of the world's crop of cot- 
 ton which is available for mill consumption. About 
 sixty per cent, of each American crop is exported, 
 nearly four-fifths of the foreign shipments going 
 to Great Britain, Germany and France. 
 
 53. COTTON RAISERS. Cotton is raised in 
 the South either by the homeowner, to whom the 
 plantation belongs, or by the tenant farmer, who 
 rents the cotton field from the landowner. The 
 payment of money rent is sometimes, but not gen- 
 erally, practiced, and the tenant farmer usually ar- 
 ranges to pay his landlord on a percentage basis 
 of the crop. The two main methods are (1) the 
 landlord and tenant agree that the proceeds of the 
 crop shall be divided evenly, the land-owner fur- 
 
LOANS AND INVESTMENTS 63 
 
 nishing the land, houses, horses, feed and the tools, 
 and the tenant supplying the labor; (2) the land- 
 lord agrees to furnish only the land, in which case 
 the terms provide that the tenant shall pay over 
 to the landlord only one-quarter of the net pro- 
 ceeds of the crop. The Southern States have 
 stringent lien laws which protect the landlords. 
 Arrangements for renting cotton farm land are 
 usually perfected before Christmas, and the tenant 
 assumes occupancy on the first of the year. Be- 
 sides the land, he is given possession of a small 
 house, fitted with a stove, a barn and pasturage. 
 A tenant farmer is supposed to have the necessary 
 implements and live stock. 
 
 54. MONEY NEEDS FOR PLOWING. 
 Having possession of the land, the tenant-farmer 
 begins plowing. Whatever little money he may 
 have saved up from the previous year's cotton crop 
 is soon spent for food, and the farmer is soon 
 obliged to buy on credit. He opens an account 
 with a local supply house. The store may give him 
 an open credit, or it may require the farmer to 
 give his note, payable in the Fall. In certain cases 
 the store insists that the notes be secured by a 
 chattel mortgage on the farmer's implements. 
 Frequently the farmer, in order to obtain credit 
 from the supply house, is obliged to mortgage his 
 interest in the growing crop. Sometimes he goes 
 to his bank and obtains credit by executing such 
 a mortgage. The money borrowed from the bank 
 
64 LOANS AND INVESTMENTS 
 
 he uses to buy for cash instead of opening credit 
 at the supply house. The owner of the supply 
 store in the South, having received little cash from 
 his customers, is obliged to buy his goods also on 
 credit. The usual practice is for him to either 
 discount his note at the bank, depositing as col- 
 lateral a bundle of notes he had received from his 
 tenant-farmer customers, or else to present his 
 own note to the wholesaler with the bundle of 
 customers' notes. 
 
 55. PLANTING AND PICKING. The 
 planting of cotton begins either in the latter part 
 of March or early in April. The plant begins to 
 grow in May or June, and then it is time to begin 
 "chopping," that is, to cut out the surplus growth, 
 reducing the sprouted stalks to a "stand," remove 
 the weeds and clean up the soil. To do this work 
 the farmer will hire labor, but in most cases he and 
 his family will do their own "chopping." After 
 the "chopping" and until picking time the farmer 
 devotes his efforts to cultivating the field, and this 
 process keeps him busy during the months of July 
 and August. In Texas, cotton picking begins in 
 the middle of July, but in other parts of the cotton 
 belt the picking season does not start until about 
 the first of September. Men, women and children, 
 many of them colored, are employed in picking 
 cotton. They are mostly piece-workers, few being 
 paid on a weekly wage basis. The cotton farmer, 
 having waited many months for the fruits of his 
 
LOANS AND INVESTMENTS 65 
 
 labor, uses all haste to rush his first bale to market 
 in order to get cash for it. The rush to market of 
 first bales invariably creates a currency strain, be- 
 cause the small country banks are suddenly called 
 upon to pay out a large sum of money in cash. The 
 farmer needs the money to pay his laborers. 
 
 56. GINNING OF COTTON. Cotton, as it 
 is picked, is hauled in loose shape by the farmer 
 to the gin, where the lint is separated from the 
 seed. In some cases the owner of the gin retains 
 part of the ginned cotton as compensation for his 
 services, but in other cases the ginner is paid in 
 cash, so much per hundred pounds. After ginning, 
 the cotton is put through the press, from which 
 it comes out in neatly packed and strapped bales. 
 
 57. MARKETING COTTON. After the cot- 
 ton is packed in bales the farmer takes it to market, 
 where he disposes of it to "cotton factors," or to 
 "cotton buyers." Cotton factors act as selling 
 agents for the farmer. Sometimes they sell the 
 cotton immediately, sometimes they hold it, and 
 sometimes they ship it to a central market, where 
 better opportunities are presented for disposing of 
 the staple at advantageous prices. These cotton 
 factors charge the farmer for storage, for trans- 
 portation, for insurance, and a commission for their 
 services. In recent years the cotton factorage busi- 
 ness has become proportionately less important 
 than heretofore. Cotton buyers are representatives 
 of cotton merchants and cotton exporters whose 
 
66 LOANS AND INVESTMENTS 
 
 principal offices are located in the larger cities in 
 the South or in New York. Cotton buyers are 
 stationed in small towns throughout the South 
 where it is convenient for the farmers to bring 
 their cotton. The farmer hauls his few bales to 
 a local market where he meets the buyer. The 
 latter inspects the cotton by cutting into the bale 
 to draw samples, and then quotes the price he is 
 willing to pay. The farmer, if dissatisfied with 
 the offer, may submit his cotton to sampling by 
 another buyer who may make a more attractive 
 offer. 
 
 58. COTTON TICKETS. If buyer and seller 
 agree upon a price the farmer is handed a ticket 
 upon which the purchaser marks the price per 
 pound that is to be paid. The farmer takes his 
 cotton to a designated weigher, who marks on the 
 ticket the weight of each bale. The cotton buyer 
 does not always give the farmer a check for the 
 cotton, but often expects him to take the "ticket" 
 to the bank after it is properly filled out by the 
 weigher. When the farmer presents the ticket to 
 the local bank, the bank figures out the money due 
 him, country banks being equipped with cotton 
 tables which facilitate calculating the value of each 
 bale. The farmer is paid in cash, or else he is 
 advised to permit the bank to put to his credit 
 the proceeds of the sale of the cotton. 
 
 59. BANK ADVANCES MONEY TO COT- 
 TON BUYERS. The cotton buyer arranges with 
 
LOANS AND INVESTMENTS 67 
 
 his bank that it should pay upon presentation of 
 the tickets, but at the same time the cotton buyer 
 usually does not have the necessary funds to his 
 credit in the bank, and consequently the bank is 
 called upon to make advances. The bank either 
 permits the cotton buyer to overdraw his account 
 during the day and give a note for same at the close 
 of day retaining the cotton tickets as security, 
 or else the cotton buyer is called upon to give 
 a draft on the cotton merchant or exporter, whose 
 agent he is. These cotton tickets are tantamount 
 to certificates of ownership, and cotton cannot be 
 moved without presentation of the tickets. The 
 financial strain in the South resulting from the 
 production of the cotton crop begins about June 1st 
 in Texas and reaches its height about August 1st. 
 The seasonal demand for money invariably necessi- 
 tates borrowing by Southern banks from their cor- 
 respondents in the East. In view of the fact that 
 during the cotton picking season producers are 
 in need of cash to pay their help, the Southern 
 banks not only require bank credits but they are 
 obliged to call upon their central reserve city cor- 
 respondents to ship them currency. 
 
 60. COLLATERAL FOR BANK LOANS. 
 The country banks borrowing in New York for 
 crop purposes usually forward to their correspond- 
 ents collateral in the form of notes, drafts and 
 chattel mortgages which have been received from 
 merchants and farmers. The Southern bank 
 
68 LOANS AND INVESTMENTS 
 
 usually executes its note and sends the collateral 
 in a large bundle. The New York bank examines 
 the same, but hardly ever has occasion to touch 
 it, inasmuch as the Southern bank is always ready 
 to take up its note at maturity. In the event that 
 it is not in position to do so, the New York institu- 
 tion will agree to a renewal of the note for another 
 month or two. Money borrowed by Southern 
 banks in August and September is usually paid 
 by the end of November. 
 
 61. LOANS ON COTTON IN WARE- 
 HOUSES. While the cotton buyers purchase 
 cotton from the farmers as soon as the cotton is 
 ginned and baled, they are not in a position to 
 dispose of the staple until they accumulate a sub- 
 stantial shipment. Consequently, pending the de- 
 livery of cotton to American mills and to foreign 
 spinners, the cotton merchant (for whom the buyer 
 has been acting) is obliged to place his cotton in 
 storage in warehouses, cotton yards and on com- 
 press platforms. Requiring funds to carry the same, 
 or to buy more cotton, the merchant obtains a loan 
 from his bank, secured by a warehouse receipt. 
 Bankers who are asked to advance money on ware- 
 house receipts for cotton do not only take into con- 
 sideration the character and responsibility of the 
 borrower but they examine into the safety of the 
 warehouse and the financial standing of the ware- 
 houseman. Warehouses, in issuing receipts, usually 
 inspect the cotton, weigh the bales and furnish a 
 
LOANS AND INVESTMENTS 69 
 
 receipt describing the quantity and quality of the 
 cotton placed in their care. Congress passed a bill 
 in August, 1916, which provides for the Federal 
 licensing and supervision of warehouses where 
 agricultural products, such as cotton and grain, 
 are stored. It is believed that banks will now be 
 willing to advance money on warehouse receipts 
 more freely than they have been in the past. 
 
 62. ASSISTANCE OF FEDERAL RESERVE 
 BANKS. Notes and drafts secured by approved 
 warehouse receipts for cotton are rediscountable 
 at the Federal Reserve banks. A special rate for 
 this character of paper, lower than the trade ac- 
 ceptance rate for the same maturity, has been 
 established by the Reserve banks in the South with 
 the approval of the Federal Reserve Board. This 
 special "commodity rate" applies to paper not 
 having more than 90 days to run. The assistance 
 rendered by the Reserve banks has made it possible 
 for banks in the South to charge lower rates to 
 customers who elect to carry cotton in warehouses 
 pending the receipt of orders for the same, or in 
 the hope of obtaining higher prices for the staple 
 at a later date. By being able to rediscount paper 
 secured by warehouse receipts, the banks have been 
 placed in a position where they have a larger supply 
 of funds available to borrowers. In recent years it 
 has been customary for the Secretary of the Treas- 
 ury to make deposits of Government funds with 
 Southern banks during the crop-moving seasons. 
 
70 LOANS AND INVESTMENTS 
 
 This has had the effect of instilling confidence in 
 growers and merchants, and has helped in prevent- 
 ing or abating money stringencies. Since Decem- 
 ber 31, 1915, instead of depositing Government 
 funds with National banks, the Secretary of the 
 Treasury has made deposits with the Federal Re- 
 serve banks in the South. 
 
 63. COTTON MERCHANTS AND EX- 
 PORTERS. Concerns which buy cotton from 
 farmers and factors are known as "spot houses." 
 They deal in all grades of cotton and sell to do- 
 mestic as well as foreign spinners. Many of these 
 houses maintain offices or headquarters in New 
 York and some operate from New Orleans, Dal- 
 las, Galveston, Memphis and other cities in the 
 South. The price offered the farmer by the 
 buyer who examines the cotton largely depends 
 upon the quality of the cotton. The merchant or 
 exporter is very much concerned with the grade 
 and length of cotton, for the reason that spinners, 
 in making purchases, usually specify in detail the 
 character of cotton they require. One grade may 
 be available for one mill and be practically of no 
 value to another. 
 
 64. CLASSIFYING COTTON. The work of 
 grading or classifying cotton is a specialty. Ex- 
 perts are not common. In many instances a single 
 bale of cotton will contain several grades, but as 
 a rule some one particular grade is found in pre- 
 ponderance. Moreover, cotton varies according to 
 
LOANS AND INVESTMENTS 71 
 
 the place of production, and it is the function of 
 the spot dealer to be familiar with all grades and 
 markets, and to be able to supply the exact grade 
 required by particular customers. When a spot 
 house receives an order for 100 or 1,000 bales of ai 
 particular grade, it must gather the necessary 
 quantity together from all parts of the South if it- 
 finds that it has not the required cotton in its store 
 or warehouse. 
 
 65. FINANCING EXPORTS OF COTTON. 
 When the cotton exporter in the South receives 
 an order to ship 1,000 bales to Liverpool at a fixed 
 price, he delivers the cotton to a railroad or to an 
 ocean carrier, if he happens to be located at a sea- 
 port, and secures a through bill of lading. The 
 price determined upon is usually what is known as 
 "C. I. F. & 6%," i. e., cost, insurance and freight, 
 and 6 per cent, for tare deducted. The shipper has 
 the cotton insured. He draws a 60 or 90 day draft, 
 payable to himself, for the invoice value of the 
 cotton. This he indorses on the back in blank. 
 The draft or bill of exchange is drawn either upon 
 the foreign cotton merchant or spinner to whom the 
 cotton is being shipped or upon a foreign banfe 
 which has an arrangement with the purchaser to 
 accept his bills. The Southern cotton shipper sells 
 the draft with the attached bills of lading and in- 
 surance certificate to his bank, or sends the draft 
 with the documents to a broker in New York, who 
 sells the draft to some New York institution. The 
 
72 LOANS AND INVESTMENTS 
 
 shipper must pay a small commission to the bank 
 and a commission to the broker. The bank buying 
 the draft pays for it in dollars, according to current 
 rates of exchange, the equivalent of whatever 
 foreign money the draft may call for. The bank 
 buying the bill forwards it to a correspondent 
 abroad, who presents it for the purposes of "ac- 
 ceptance" to the purchaser of the cotton or to the 
 latter's bank. After the bank stamps its acceptance 
 upon the bill the same is sold and bought in the 
 open market until maturity, when it is paid. 
 
 66. COTTON EXCHANGES. In the United 
 States there are only two markets for "cotton 
 futures," one in New York and the other in New 
 Orleans. Members of the cotton exchanges lo- 
 cated in these two cities deal in contracts for the 
 future delivery of cotton. The contract traded in 
 is a basic one, that is, it provides for the delivery! 
 of cotton of a basic grade, middling, and provision 
 is made for adjustments in cases where the cotton 
 actually tendered for delivery is not of the basic 
 grade but consists of a number of bales of a higher 
 grade and a number of bales of a lower grade* 
 Under the form of contract traded in, the seller has 
 the option to deliver any of the established grades, 
 price adjustments being made for differences in 
 grades in accordance with relative prices for the 
 various grades established by the "fixed differences" 
 of the exchange. The functions of the exchanges 
 are to provide a continuous market, to disseminate 
 
LOANS AND INVESTMENTS 73 
 
 trade and crop information, and to afford an organ- 
 ization where future conditions and events may 
 be systematically discounted, all of which tend to 
 establish world prices for the commodity. More- 
 over, the exchanges are used for speculation. Ac- 
 tivity along those lines helps to establish a proper, 
 price level and incidentally aid in distributing the; 
 money losses and profits involved in assuming the 
 inevitable economic risks of changes in value. 
 
 67. PROCESS OF HEDGING. Besides fur- 
 nishing means for establishing market prices, one 
 of the chief services rendered by cotton exchanges 
 is that of providing the necessary machinery for 
 hedging. Hedging is in the nature of insurance or 
 protection against loss occasioned by price fluctua- 
 tions. The hedging practice is resorted to by cotton 
 merchants, by spinners and by manufacturers of 
 cotton goods. A Southern cotton merchant, con- 
 tracting in July to deliver 1,000 bales of cotton to 
 a spinner in January, will frequently instruct his 
 broker on one of the exchanges to buy for him a 
 "future contract" for the same quantity of cotton 
 deliverable in January. If by the time the merchant 
 delivers the cotton to the spinner the price has 
 advanced two cents a pound above that at which the 
 contract was made, the merchant stands to lose two 
 cents a pound. He, therefore, instructs his broker 
 to sell out his "futures" on the exchange. Inas- 
 much as the price of "futures" and the price of 
 "spots" usually fluctuate in unison, it is safe to 
 
74 LOANS AND INVESTMENTS 
 
 assume that the loss the merchant suffered in the 
 one transaction he will have wholly or partially 
 recouped by the profit on the other. The prices 
 paid to growers and the prices at which cotton is 
 sold to domestic and foreign spinners are based 
 largely upon the price of futures quoted on the 
 exchanges. 
 
 68. UNITED STATES COTTON FUTURES 
 ACT. As amended by the Act of August 11, 1916, 
 the United States Cotton Futures Act of February 
 18, 1915, provides for Government regulation of 
 trading in contracts for the future delivery of cot- 
 ton. Briefly, it imposes certain requirements for 
 the conduct of business on the cotton exchanges, 
 and imposes a penal tax of two cents per pound 
 in the event that transactions are not carried on in 
 accordance with the specifications. The law vests 
 with the Secretary of Agriculture authority to pre- 
 pare and promulgate standard grades of cotton. 
 The law also makes provision for the settlement 
 by the Agricultural Department of disputes arising 
 between buyer and seller. The amendment to the 
 act provides for trading in specific contracts. 
 
 69. LIVE STOCK LOANS. Live stock rais- 
 ing is one of the most important factors in the 
 economic life of our nation. Horses and mules as 
 work animals are almost indispensable to agricul- 
 ture; sheep and hogs produce great wealth in meat, 
 wool, lard, etc. ; but cattle are the greatest source 
 of income, giving us beef for ourselves and for 
 
LOANS AND INVESTMENTS 75 
 
 export, hides for leather, milk, butter, cheese and 
 the innumerable by-products of packing houses 
 which increase returns so largely. They are the 
 basis for many loans and of great interest to bank- 
 ers. Farmers are realizing more keenly and more 
 generally than ever that the best way to market 
 corn, hay and other feedstuffs, is on the hoof, or as 
 dairy products, and that by so doing they not only 
 obtain the greatest return for their salable crops, 
 and use some which would otherwise be worthless, 
 but they can return to the soil much of its fertility. 
 Cattle are raised in every State in the Union, both 
 for beef and for dairy purposes. It is claimed that 
 no breed of cattle combines satisfactorily milk and 
 beef qualities, and for convenience we will consider 
 them divided into these two classes. 
 
 70. DAIRY CATTLE. Scientific dairying is 
 highly developed in Wisconsin, Minnesota, Ohio, 
 Pennsylvania, New York, Iowa and certain other 
 States, where it has been carried on successfully 
 for many years, and herds of registered and other 
 high grade cattle are the rule. The income from 
 animals of this type can be anticipated with reason- 
 able certainty. Loans to owners are commonly 
 made on their showing of assets, including cattle, 
 and not on chattel mortgage security. Such loans 
 to experienced and responsible men are most de- 
 sirable. Dairying is a growing industry in many 
 States in addition to those named. The rapid 
 increase of population m cities, and the stronger 
 
76 LOANS AND INVESTMENTS 
 
 demand universally for milk and milk products of 
 high sanitary standard, have made it increasingly 
 profitable. The establishment of creameries and 
 condensaries has helped greatly. In some sections, 
 such as Kansas and Oklahoma, bankers have 
 brought in good young cows from well-known dairy 
 herds and sold them, one or two or three to a man, 
 lending him the whole amount of the purchase price 
 with a mortgage on the cows as security. When 
 care is used in selecting the men with whom this 
 arrangement is made, it soon results in a profit to 
 both banker and farmer, and, better still, helps in 
 the upbuilding of the community from which the 
 bank draws its support. In new countries the wife's 
 few cows (with the help of the chickens) have often 
 brought in the only cash income the family had 
 while they established themselves and raised a crop. 
 Agriculture received the man's thought and effort 
 for a few years because it required less capital and 
 brought quicker returns than livestock raising. 
 When his finances permitted he branched out into 
 fattening some cattle on his grain and thus making 
 two profits. Dairying came much later on, when 
 the price of milk advanced, its marketing became 
 convenient and the continuous income offered at- 
 tractions. So all through the farming section of 
 the central plains States will be found these stages 
 of evolution; not that dairying crowds out feeding, 
 but it finds its own place, stays, and adds to the 
 growing wealth of our nation. Bankers may sus- 
 
LOANS AND INVESTMENTS 77 
 
 tain losses on loans for pretentious attempts in 
 dairying by inexperienced men with high-priced 
 cattle, but loans of moderate amounts to capable 
 and industrious men for the purchase of dairy cows 
 are thoroughly sound. 
 
 71. BEEF CATTLE. The raising of cattle 
 for beef purposes is likewise a science. It must be 
 remembered that while a great many animals in 
 the aggregate remain in the hands of their first 
 owners until sold for slaughter in a local abbattoir, 
 others are sold half a dozen times and are shipped 
 to and from market three or four times before killed. 
 These markets are the stockyards where packing 
 houses are located. The large packing houses will 
 buy at all times cattle of any age or weight, whether 
 young calves for veal or old ("canner") cows and 
 ("bologna") bulls. The prices offered fluctuate 
 constantly, but a man who wants to sell is sure 
 when he ships cattle to the stockyards that he will 
 find a buyer. Nor are the packing houses the only 
 buyers at the stockyards. A farmer or cattle man 
 who wants a certain number of a certain kind of 
 cattle goes in person or instructs a commission firm 
 in whom he has confidence to buy them for him 
 on the market. It not infrequently happens thaU 
 he will buy and ship back home cattle which were 
 sent in from his own neighborhood. One man may 
 bring in steers which he thinks are thoroughly fat. 
 Another man sees them and believes that by 
 judicious feeding he can put more weight on them 
 
78 LOANS AND INVESTMENTS 
 
 in a short time, and profit by a fancier price as 
 well as the added number of pounds. There are 
 speculators there, too, ready to buy nearly any- 
 thing on which they have a chance to make money. 
 Scattered animals of quality unlike others in the 
 same lot, when brought into a bunch similar to 
 themselves, sell to better advantage. Shipments 
 received late in the day may sometimes be bought 
 cheap enough to pay to carry them over night and 
 leave the speculator a profit. The market price 
 is affected by the number of cattle offered for sale. 
 This in turn is affected by the time of year and 
 by the season's weather conditions. Drought re- 
 sulting in lack of stock water, dried up pastures, 
 and short feed crops, will send cattle to market; 
 a favorable season will keep them away longer. 
 Conditions which are only local do not make 
 much difference in the price, as the market re- 
 flects the average for the whole tributary terri- 
 tory, but the general crop situation has quite an 
 influence. Cattle have gradually gone higher in 
 price for several years. Meanwhile most of the 
 largest ranches have been broken up, some into 
 smaller pastures, some partly put to agricultural 
 purposes. The class of cattle, notably in Texas, 
 has improved so greatly as to fully equal those in 
 older States. Farther north the agricultural col- 
 leges have taught that balanced rations will reduce 
 the time and cost for fattening. It must be con- 
 sidered that in every step of handling cattle, breed- 
 
LOANS AND INVESTMENTS 79 
 
 ing, raising, fattening, marketing, there is constant 
 change, and that no rules except of the most general 
 nature can be laid down as to the practice of loan- 
 ing money on them. It takes about four years to 
 produce a beef animal; and while there is a market 
 for it all the time, to sell too soon or to hold too 
 long means a loss to its owner. Money can be 
 loaned for only a few months at a time to complete 
 some one of the processes in its production. 
 
 72. DEVELOPMENT OF THE INDUS- 
 TRY. It has not been many years since the 
 buffalo roamed the plains of Nebraska, Kansas, 
 Oklahoma, Texas, New Mexico and parts of Col- 
 orado, Wyoming and Montana. It was an ideal 
 place for stock raising and was soon put to that 
 use by the white man. The public land was leased 
 for almost nothing, or used, as it frequently was, 
 without making any payment at all. Gradually 
 much of it passed into the hands of a relatively 
 small number of men, each of whom controlled 
 many thousands of acres. There were no fences, 
 and for purposes of identification each owner had 
 his mark or "brand," which was burned into the 
 hide of each animal with a hot iron. Effective as 
 this method is, it did not satisfy the New York 
 money lender of a generation ago, who is reputed 
 to have said "I would just as soon have a mortgage 
 on a school of herring in the Atlantic Ocean as on 
 a herd of cattle in Texas." The breeding grounds 
 of the buffalo were mostly in the warm climate 
 
80 LOANS AND INVESTMENTS 
 
 of the South and Southwest and in the spring of 
 the year a migration set in northward with the 
 growth of the grass. So with the cattle. They 
 were bred in the South and Southwest and grad- 
 ually drifted north toward the markets through 
 the range country as spring and summer advanced. 
 When the free ranges were finally fenced into huge 
 ranches, the handling of cattle continued much as 
 before, except that where conditions were not 
 favorable to the breeding of cattle but were better 
 adapted to the feeding and completion of them, 
 cattle were shipped in from the great southern 
 breeding grounds. As the larger ranches were 
 divided into smaller ones, specialization became a 
 little more advanced, so that shipments and changes 
 in ownership were more frequent. With the influx 
 of population that required and demanded land 
 for farming purposes, there was a conversion into 
 farms of those ranches which appeared adapted 
 to the purpose. These first farmers were not cattle 
 raisers. It seemed foolish to compete with men 
 producing cattle so cheaply on the ranches. Many 
 failed to farm successfully because of ignorance of 
 the soil, climatic conditions, and related natural 
 laws which must be followed. Gradually this 
 knowledge was acquired and corn and other feed 
 became plentiful. Cattle prices were advancing 
 and it was seen to be profitable to put a bunch of 
 them in the feed lot for fattening in the fall and 
 sell them in the spring. Thus the territory be- 
 
LOANS AND INVESTMENTS 81 
 
 came divided roughly into sections corresponding 
 with the steps in the production of the beef animal. 
 73. QUARANTINE LINE. Bred in the 
 South, the animals remain there until about a 
 year old, then they are moved north into Texas 
 and Oklahoma and some counties in Kansas and 
 Colorado, where the winters are a little more 
 severe, and when three to four years old they 
 are taken into the feeding sections of Kansas, 
 Missouri, Nebraska, Iowa, Illinois, etc. In this 
 movement northward the quarantine line is 
 crossed, where each animal must be "dipped" to 
 prevent carrying fever contagion to uninfected 
 districts, or else shipped direct to separate "quar- 
 antine" pens at the stockyards for killing. The 
 purchaser in each northward movement may go 
 south and search for such a bunch of cattle as he 
 wants, or he may go to a central market where 
 there are many sellers. Cattle will be owned on the 
 average by four stockmen before sold for killing. 
 On any of the trips to market the packer's offer 
 may be higher than that of any feeder, and the 
 cattle go for beef. Some of the calves will be taken 
 when still carrying the milk fat, and fed so as to 
 retain this, and reach a size and weight at about a 
 year old that enable them to be sold for "baby beef." 
 Thus the variations from the schedule given above 
 are numerous, and while it persists in the main it 
 is quite irregular. The plateaus and valleys of the 
 Rocky Mountain and Pacific Coast States produce 
 
82 LOANS AND INVESTMENTS 
 
 conditions quite similar to those in the Western 
 Plains States. 
 
 74. LOANS ON RANCH CATTLE. It is 
 evident that since ranch cattle are handled in rather 
 large herds the funds of small local banks are en- 
 tirely inadequate to carry the necessary loans. This 
 want was at one time largely met by commission 
 firms at the markets, who made loans to buyers 
 of cattle through them, endorsed the notes and 
 sold them wherever they could find buyers. As 
 the paper came to be in demand, the firm found^ 
 it possible to make a brokerage on the loans and 
 commissions on the purchase and sale of the cattle- 
 Desire to do a large volume of business and some 
 unfavorable seasons resulted in failure on the part 
 of some firms to protect endorsed paper and 
 brought these loans into disrepute. There are good 
 firms doing a conservative and profitable business 
 now in both commission and brokerage lines, but 
 in late years the tendency has been to make them 
 separate businesses. Live stock loan companies 
 have been incorporated with organizations equipped 
 to inspect the cattle mortgaged and all conditions 
 which influence the success of the undertaking. 
 
 75. STOCKER LOANS. A loan on aged 
 steers to finance their final fattening is about as 
 certain of natural liquidation at maturity as can 
 be found. Younger steers are practically always 
 in demand in some parts of the country and are 
 hardier than cows. Hence natural division of cattle 
 
LOANS AND INVESTMENTS 83 
 
 loans is into (1) those on steers one year or more 
 old and (2) those on stock cattle, consisting of 
 breeding cows, heifers, calves and bulls. Loans on 
 stock cattle, when made to reliable and capable 
 men, are about as certain of ultimate payment as 
 any othess, but it is not so certain that payment 
 can be forced at maturity without inconvenience 
 and possible loss to the borrower. Unfavorable 
 seasons, unusual death losses among the calves, a 
 bad market, etc., may leave the deal without profit, 
 or worse, if immediate sale must be made; but by 
 selling some, and perhaps extending the time an- 
 other six months or a year, to increase the calf 
 profit, the deal may eventually turn out very well. 
 Local banks may well make loans of this kind, as 
 they know the customers thoroughly, are on the 
 ground all the time, and can step in and take the 
 cattle if necessary before a serious loss occurs. 
 Such loans, with local bank endorsements, are 
 readily taken by bank correspondents to an extent 
 based largely on their balances. The steer loans 
 can be obtained from larger banks or from cattle 
 loan companies. The loan companies, however, do 
 make loans on stock cattle very frequently, and 
 when there is a surplus of money and the demand 
 for paper is great, buyers take the notes readily. 
 On the whole, "cow loans" are not quite so good 
 for the distant purchaser and should be kept as 
 close at home as possible. 
 76. STEER LOANS. The largest part of the 
 
84 LOANS AND INVESTMENTS 
 
 paper sold by the loan companies is secured by 
 steers. Without forgetting that loans on other 
 classes of cattle are handled similarly, a steer loan 
 may be considered as typical. In April or May a 
 cattleman of experience goes to the loan company 
 where he is acquainted and tells them he wants to 
 borrow thirty thousand dollars to buy two-year-old 
 steers, for which he has sufficient pasture with good 
 water to carry them until fall. If he has cash on 
 hand for part of the cost price, so much the better, 
 but a considerable margin will not be required, and 
 sometimes the whole purchase price will be loaned. 
 This is because the lender looks at some other 
 things in addition to the property to be mortgaged* 
 The man himself is the first consideration; his 
 record as a successful handler of cattle, and his 
 reputation for honesty and industry. There is a 
 saying that "the brand on the man is more im- 
 portant than the brand on the steer." The second 
 question is, are the cattle worth the money, and of 
 such a class as will increase in value through 
 natural growth and reasonably insure payment of 
 the debt when due? Third, has he made ample 
 provision for taking care of the steers during the 
 life of the loan? Fourth, what other assets has the 
 borrower? As a matter of record and to set these 
 points out in detail for consideration, a statement 
 will usually be asked for. Items to be found in 
 such statements include name, age, legal residence, 
 with Section, Township, Range, County, State and 
 
3 LOANS AND INVESTMENTS 85 
 
 Post Office; under assets, the personal property, 
 giving number of steers one year old, steers two 
 years old, steers three years old, steers four years 
 old and over, heifers one and two years old, cows, 
 calves (with year of birth), bulls, horses, mules, 
 sheep, and hogs, the per head and total value ofi 
 each class being shown, feed on hand (itemized), 
 cash on hand, and other personal property, and also 
 real estate, including homestead less exemption 
 and other real estate less encumbrance; under 
 liabilities, full details of any encumbrance on live 
 stock, other borrowed money, amount due relatives 
 and other debts; under general information, the 
 number of acres and kind of land under lease, the 
 rental price, statement as to any judgments or suits 
 pending, reference to other persons informed as 
 to borrower's financial condition, number of years 
 lived at present location, former residence, whether 
 surety on anv notes or bonds, etc. 
 
 77. PURCHASE AND DELIVERY. The 
 application having been considered favorably, the 
 cattleman arranges his purchase. The delivery of 
 the cattle to him, payment therefor to the seller, 
 inspection of the cattle by the agent for the loan 
 company, execution and delivery of the note and 
 mortgage, and filing of same for record in the proper 
 place or places, will be as nearly simultaneous as 
 possible. In this instance the loan company takes 
 six notes of five thousand dollars each, all secured 
 by the one mortgage. This is so that one or more 
 
86 LOANS AND INVESTMENTS 
 
 of the notes may be sold to customers who could 
 not carry as much as thirty thousand dollars of any 
 one maker's paper. These are called "split loans." 
 A few bankers will not buy notes unless all of the 
 loan is owned by them, as they believe there is a 
 possibility of loss due to the diverse interests, if 
 anything goes wrong, and quick action to a single 
 purpose is necessary. Other buyers rely on the 
 loan company's endorsement and accept "split 
 loans" without question. Banks and others seek- 
 ing investments write to the loan company for 
 paper. The notes are sold them, endorsed by the 
 loan company, at a lower interest rate than the 
 company charged the borrower. Copies of the 
 mortgage and of the maker's statement may or may 
 not accompany each note. The loans run about 
 six months, being chiefly made in April or May and 
 September or October. This is partly because 
 banks are unwilling to put their money out for 
 longer periods, and partly because these are the 
 seasons of change in cattle ownership, when one 
 man takes his profit to date and another begins the 
 next process in the growing of the animal. When 
 the notes come due the loan company must provide 
 for their prompt payment to the holders, and this 
 whether the cattle are sold and money paid by the 
 borrower or not. It must be prepared to carry 
 some paper for a short time with its own funds. 
 The company will have kept track of the cattle 
 during the six months, watching for any unfavor* 
 
LOANS AND INVESTMENTS 87 
 
 able condition or any dishonesty, and will know 
 when they can be sold. If the borrower wants to 
 keep them six months longer, the company may 
 consent, and so make a new loan on the same cattle 
 to the same man. Otherwise they are put on the 
 market and enough of the proceeds turned over to 
 the loan company to satisfy its claim. If the pro- 
 ceeds should be insufficient, the borrower must 
 make up the difference in some other way or the 
 company loses. 
 
 78. FEEDER LOANS. The paragraphs just 
 preceding refer to cattle in pastures where grass 
 is practically the only food they have except per- 
 haps some cotton seed cake in bad weather. Men- 
 tion has been made of cattle going to the feed lots 
 of Kansas, Iowa, Illinois, etc., when they have about 
 reached maturity, to be fattened for killing. In 
 addition to the Southern bred cattle brought in, 
 there are, of course, many which have been raised 
 in small bunches in these central States. Often 
 superior individual attention and careful feeding 
 matures them at an earlier age than the Texas 
 steer. Wherever they have been raised, they may 
 be fattened in pastures on grass in the spring and 
 summer, but those to be fattened in the feed lots! 
 through the winter must be fed corn, alfalfa, silage 
 or other roughness, and the like. Cows and 
 heifers (particularly spayed heifers), are sus- 
 ceptible to very profitable feeding of this kind, 
 and loans on them for that purpose are freely 
 
88 LOANS AND INVESTMENTS 
 
 made both by local banks and by loan com- 
 panies. But here again the steer loan has a little 
 the preference. His superior resisting power in bad 
 weather, if nothing else, gives him an advantage, 
 according to general opinion. Banks in the feeding 
 country are larger and more numerous than in the 
 South, and can handle a greater proportion of the 
 loans without outside help. The loans are likely 
 to be smaller, too, as the cattle will be handled 
 in bunches of moderate size. Nevertheless, the 
 loan companies do a considerable business with the 
 larger borrowers and with those in communities 
 where the number of feeders is too great for the 
 local bank. Loans by the companies are handled 
 in the manner already described. If the borrower 
 has plenty of feed and has provided water and 
 shelter, the full purchase price is often loaned. 
 There are no requests for renewal of this paper, for 
 the cattle must go for killing when ready, almost 
 regardless of prices. The advantage of certain 
 maturity is had, but at the sacrifice of any oppor- 
 tunity to work out of a bad situation. Hogs are 
 often put in the feed lot to follow the cattle, and 
 the profit in feeding is not infrequently in the hogs. 
 They are sometimes included in the mortgage ort 
 the cattle. Fertilizer from the feed lot, when 
 spread on the fields, is a most valuable return to 
 the farmer, which should not be overlooked in fig- 
 uring his earning on a feeding operation. 
 
 79. BUYING CATTLE LOANS. As already 
 
LOANS AND INVESTMENTS 89 
 
 mentioned, cattle loans bearing the endorsement 
 of local banks, for amounts proportionate to the 
 bank's business, are desirable investments by their 
 correspondents. Other cattle loans sold to in- 
 vestors serve the good purpose of bringing together 
 a wholesome industry and unemployed capital. 
 Well handled loan companies are profitable to 
 all parties. But there are dangers. The surplus 
 of money in recent years has made it very easy 
 to sell paper. Individual bankers situated where 
 they can loan to advantage have sold a great 
 deal of paper with their personal endorsement. 
 Most of this is undoubtedly good, but tight money, 
 and a bad cattle market when it is due, might em- 
 barrass the endorsers. Some bankers and others 
 have organized loan companies with very small 
 capital and used the companies' endorsement in- 
 stead of their own. Not that loan companies are 
 bad because they are small and good because they 
 are big, but the amount of paper endorsed in pro- 
 portion to capital must not be overlooked. Careful 
 attention must be given to the reputation of the 
 pianagement, and to the personnel, financial associ- 
 ations and history of the company. Purchasers of 
 cattle paper relying on endorsements should not 
 fail to familiarize themselves with the business to 
 the extent that they will know something at least 
 as to the values represented by the cattle security, 
 of the practices in their handling, and the general 
 conditions prevailing in the locality. 
 
90 LOANS AND INVESTMENTS 
 
 80. FARMERS' STATEMENTS. While ag- 
 ricultural loans are made in every State in the 
 Union, and therefore under a great variety of con- 
 ditions, those made on the general credit of the bor- 
 rower must be very like all loans which do not 
 carry any definite security. When satisfied as to 
 character, mental ability and experience, the banker 
 will consider the financial condition of the borrower. 
 In past years it has not been the rule to require 
 statements from farmers. This is perhaps due to 
 the fact that the land itself, the improvements, the 
 crops and the live stock, have market values which 
 can be pretty accurately determined by the banker; 
 and the quantity and quality of his customers' pos- 
 sessions are known to him either from personal 
 inspection or by information from neighbors. 
 Bankers in farming communities have prided them- 
 selves on knowing their customers, their families, 
 their implements, and even the individual animals 
 among their live stock. Such knowledge is mani- 
 festly more intimate and accurate than can be had 
 of other classes of borrowers. But while assets can 
 be determined fairly well, liabilities are not so 
 easily discovered or verified. A man of good stand- 
 ing may, even without misrepresentation, borrow 
 as much from each of several banks as he is war- 
 ranted in owing altogether. The Federal Reserve 
 banks urge that statements be obtained from bor- 
 rowers, and require that statements accompany 
 notes for large amounts. The agricultural colleges 
 
LOANS AND INVESTMENTS 91 
 
 are demonstrating the value of keeping accurate 
 records of farm operations, and are distributing 
 standard forms for the purpose. These influences 
 aid the banker in his purpose to make his credit 
 files confirmatory or independent of his memory. 
 Farmers for the most part are not accustomed to 
 detailed bookkeeping and if blank forms are handed 
 to them to be filled out they should not be compli- 
 cated. The principal items in most localities would 
 be the number of acres and value of land owned, 
 mortgage on same, value of town or city property, 
 mortgage on same, number of head and value of live 
 stock owned, grouped in kinds and ages, mortgage 
 on same, cash on hand and in bank, notes and 
 accounts receivable, indebtedness to the bank ob- 
 taining the statement, and list of other indebted- 
 ness not secured by mortgage. 
 
 81. TACT AND CO-OPERATION. Tact 
 must be employed to obtain even such a simple 
 statement from a man who has never signed one 
 before, and the wise banker will fill in the informa- 
 tion while talking it over with the customer; then 
 ask him to read it over; see if it is correct, and 
 sign it. It may even be best not to require a signa- 
 ture the first time, but let the practice of making 
 statements gradually become the custom. It is in 
 going over such statements from year to year with 
 customers that the banker may be most genuinely 
 helpful in warning them against financial errors, 
 borrowing money to carry grain for a better price 
 
92 LOANS AND INVESTMENTS 
 
 when they cannot afford to suffer a possible drop in 
 price, buying more land than they can work or pay 
 for in a reasonable time, buying live stock when 
 they haven't sufficient feed to fatten it; in fact, the 
 many temptations to enter speculative deals with- 
 out being able to absorb a loss. It is here also that 
 a banker may discover that his customer needs not 
 a short time loan for a particular purpose but a 
 more or less permanent loan for operating capital. 
 A real estate mortgage loan will relieve the bor- 
 rower of frequent renewals, and can be readily sold 
 if desired, so that the bank is left in position to loan 
 the money to other customers. 
 
 82. AGRICULTURAL PAPER FOR RE- 
 DISCOUNT. When a banker takes paper with 
 the intention of selling or rediscounting it, he may 
 ask for a more detailed statement, copies of which 
 will be sent with the loan. This may be a rather 
 formal instrument, setting forth the borrower's 
 name, age, legal address, with section, township, 
 range, county, State and post office. The assets 
 will include the homestead less exemption, other 
 real estate less encumbrance, personal property de- 
 scribed in detail as to number of yearling steers 
 and price per head, number two-year-old steers and 
 price per head, number of heifers, one and two years 
 old, with price per head, number and price per head 
 of cows, calves, bulls, horses, mules, sheep, hogs, 
 etc., amount and value of feed on hand, corn, oats, 
 alfalfa, other hay, sorghums, silage, other feed, etc., 
 
LOANS AND INVESTMENTS 93 
 
 cash in bank with name of bank, other grains or 
 staples, description and value of all notes and ac- 
 counts receivable, and other personal property. The 
 liabilities will include encumbrance on live stock 
 described in detail, with name of mortgagee, date, 
 property covered, due date, rate of interest, etc., 
 other borrowed money itemized, amount due rela- 
 tions itemized, all other debts itemized. The state- 
 ment will contain information about any leases to 
 which the borrower is a party, as to judgments or 
 suits pending against him, how long he has lived 
 at present address, where he formerly lived, names 
 and addresses of references, whether he is surety 
 on any notes or bonds of other makers. Such 
 declaration may even be sworn to before a notary 
 public. Such statements are not infrequently re- 
 quired from large borrowers even though the loans 
 to them are secured by chattel mortgages. A 
 strong showing outside of the property covered 
 by the mortgage helps the sale of the paper. 
 
 83. IMPORTANCE OF PURPOSE. When 
 satisfied as to the character, ability and financial 
 responsibility of the customer, the banker may still 
 hesitate before making a loan until he has learned 
 what the money is to be used for, and whether pro- 
 vision has been made for payment at maturity. It 
 is true that in localities where loanable funds in 
 banks regularly exceed the demand, notes of good 
 makers are renewed regularly with no suggestion 
 that they be paid. Just as in loans to merchants 
 
94 LOANS AND INVESTMENTS 
 
 or manufacturers, these may have grown out of 
 short time notes given to cover particular opera- 
 tions, but the makers finding it profitable to con- 
 tinue using the funds, and the banks being satisfied 
 the paper is good, more or less permanent loans 
 are the result. It is not contended that this prac- 
 tice is necessarily wholly bad, but loans of such 
 character should not be allowed to form too great 
 a proportion of the bank's investments. Particu- 
 larly in a community where the demand for funds 
 exceeds the local supply, continuing loans are 
 likely to cause careless planning on the part of the 
 makers, and to injure the bank by restricting its 
 ability to serve the whole community, or to liquidate 
 deposits when called on. The normal agricultural 
 loan is self-liquidating. Money borrowed to buy 
 cattle for fattening or to be used for seed or for 
 planting, cultivating, harvesting or marketing 
 crops, will be paid when the cattle or the crops are 
 ready for sale. Various expense items are naturally 
 included, such as cost of feed for work animals, 
 wages of employees, family living expenses, imple- 
 ments, etc. It is the part of the good banker to 
 judge whether the amount he is to furnish is justi- 
 fied by the probability of returns from the enter- 
 prise and the ability of the borrower to pay if it 
 proves unprofitable. Generally speaking, normal 
 loans to farmers and live stock men of responsibility 
 and experience are ideal from the banking stand- 
 point. When, however, cattle or sheep are bought 
 
LOANS AND INVESTMENTS 95 
 
 with the idea of catching a quick upturn in price, 
 or when staples are held for an advance and not 
 because of inability to dispose of them rapidly, then 
 a loan is no longer a normal one for agricultural 
 purposes, but a loan for speculation in agricultural 
 products, and should be treated accordingly. 
 
 84. COUNTRY BANKING PROBLEMS. 
 Loans are based in some States almost entirely 
 upon the borrower's general assets; that is, a mort- 
 gage on personal property is very rarely taken. In 
 other sections, chattel mortgages secure nearly 
 every loan made by banks. This is particularly 
 true in newly settled communities, where the bor- 
 rowers have limited means and have not established 
 records as to character. The laws aff ecting chattel 
 mortgages differ in the various States as to place 
 of filing for record, etc. It is always well to remem- 
 ber two things in handling this class of paper. 
 Have the wife sign the note and mortgage with 
 the husband, whether necessary under the law or 
 not, and describe the property in the mortgage so 
 accurately and minutely that identification will be 
 easy and unmistakable. Loans of this kind usually 
 pay a high rate of interest, are for small amounts, 
 and are troublesome as well as risky. They furnish 
 practically the only means, however, of financing 
 people who may later become good depositors. 
 Loans to tenants are similar to those just described. 
 Bankers who find it possible to keep sufficient funds 
 employed otherwise, often refuse to make tenant 
 
96 LOANS AND INVESTMENTS 
 
 loans. While they admit that tenant farming is 
 a growing menace, and that some of them may be 
 helped to become landowners by judicious as- 
 sistance from a bank, still the risk is something, 
 the annoyance is worse, the public criticism on the 
 foreclosure of a mortgage is embarrassing, and, as 
 one man said, "if they are any good, they don't 
 remain tenants long." Increasing land values is 
 making it harder every year for a man to rise to 
 ownership, and the problem of financing such ad- 
 vancement should be studied in broad and patriotic 
 spirit. Young men, sons of well-to-do parents, who 
 begin their independent careers on rented farms, 
 and with barely adequate equipment, are entitled 
 to a special classification. They may rely on some 
 parental assistance if it is absolutely necessary and 
 on an inheritance some time in the future. Prefer- 
 ring to set up their own households, they undertake 
 farming on their own account. If they show 
 good judgment in their undertakings, and bear 
 favorable reputations, the banker has an oppor- 
 tunity to help develop these young men in a busi- 
 ness way, and to cement them to his institution by 
 making them moderate loans without their fathers' 
 endorsement, or other security. 
 
CHAPTER III 
 
 Stocks and Bonds 
 
 85. OWNERSHIP AND INDEBTEDNESS. 
 The words "stocks" and "bonds" have until re- 
 cently been applied indiscriminately to the financial 
 obligations of governments. Some of the early 
 certificates of indebtedness of the United States 
 were known as "stocks," and the same name still 
 clings to certain obligations of the city of New 
 York. In the language of modern finance, how- 
 ever, bonds are certificates of indebtedness and 
 stocks are certificates of ownership. In incorpor- 
 ated companies bonds represent specific liens on 
 property possessed, and stocks represent the prop- 
 erty itself. In other words, the owner of stock 
 in a company is a part owner of the company, and 
 participates in the profits and losses, while an 
 owner of bonds issued by the same company is 
 interested in the success of the company only in 
 so far as the security and punctual payment of such 
 bonds, principal and interest, are concerned. The 
 bondholder has no part in the operation of the 
 company; ordinarily he has no voice in its man- 
 agement; in short, he is merely a creditor; while 
 the stockholder possesses a definite ownership 
 interest in the company in proportion to the amount 
 of stock owned by him. The bondholder is not 
 responsible for the success or failure of the'enter- 
 
 97 
 
98 LOANS AND INVESTMENTS 
 
 prise, while the stockholder, in addition to the 
 privileges which go with his stock, has that re- 
 sponsibility and obligation which attaches to 
 ownership. 
 
 86. STOCKS AND THEIR CLASSIFICA- 
 TION. When a company or corporation is or- 
 ganized, money or other things of tangible value 
 which are invested in or contributed to the enter- 
 prise by the organizers are known as capital. 
 Such capital is evidenced by proportionate shares 
 of value denominated capital stock. As a matter 
 of convenience this stock is divided into equal 
 parts, usually of $100 each, termed "shares of 
 stock." The total amount of stock which may be 
 issued is fixed by the charter of the corporation. 
 To evidence the ownership of these shares, cer- 
 tificates of stock are issued to holders in amounts 
 equal to the number of shares owned. Thus, a 
 stockholder owning $5,000 worth of the capital 
 stock will have a certificate or certificates repre- 
 senting 50 shares of $100 each. These certificates 
 specify the number of shares owned, the par value, 
 and certain other facts, as for instance, whether 
 the stock is common or preferred, assessable, full- 
 paid or not. Generally speaking, there are two 
 classes of stock, "common" and "preferred," and 
 the usual relation that each bears to the other is 
 indicated by their respective names. 
 
 87. COMMON STOCK. The control or man- 
 agement of a corporation, as a general rule, vests 
 
LOANS AND INVESTMENTS 99 
 
 in the ownership of common stock. Ordinarily the 
 possession of a share of common stock entitles the 
 registered holder thereof to a vote at recurring 
 stated periods for the legally constituted repre- 
 sentatives of the stockholders in the management 
 of the affairs of the corporation. Such representa- 
 tives are usually termed directors, and hold their 
 authority by reason of a preference expressed for 
 them by the owners of a majority in shares of the 
 common stock of the corporation. Directors, when 
 elected and during their term of office, have well 
 defined rights and powers as to the determination 
 of corporate policy and the appointment of execu- 
 tive officers, but being compelled at definite times 
 to relinquish office, are subject to the owners of 
 a majority number of shares of common stock. 
 The right of common stockholders to have a voice 
 in determining corporate policy usually makes 
 common stock more eagerly sought for in open 
 market and renders unnecessary the payment of 
 large dividends. Ordinarily the amount of divi- 
 dends paid upon common stock is less in amount 
 than that paid upon preferred stock. In some 
 instances, however, common stock dividends ex- 
 ceed in amount those of preferred stock. In some 
 great corporations, such as the Pennsylvania 
 Railroad Company, common is the only class of 
 stock issued, while in the Great Northern Railway 
 Company preferred alone is outstanding. The 
 rights of common stockholders are very minutely 
 
100 LOANS AND INVESTMENTS 
 
 defined by law and very zealously protected by 
 courts. Except where otherwise determined by 
 charter or contract provision, the ultimate rights 
 of common and preferred stock in a liquidation 
 of corporate assets are similar. 
 
 88. PREFERRED STOCK. Ordinarily pre- 
 ferred stock has no voting power, and is therefore 
 not of value in determining corporate policy. Pre- 
 ferred stock is primarily an investment stock, and 
 is issued in such form and with such preferences! 
 as to assets and dividends, over common stock, 
 as to cause its ready absorption by the purchasing 
 public, and thus provide funds for corporate ex- 
 tension and development. The rates of dividends 
 are usually fixed in amount and unearned divi- 
 dends are usually made cumulative. By cumula- 
 tive dividends are meant those dividends which, 
 if not paid one year, must be paid in some succeed- 
 ing year, at the fixed rate provided for, together 
 with all dividends which have subsequently ac- 
 crued. Oftentimes a minimum rate of dividend 
 is fixed with a provision for an increase in propor- 
 tion to and in common with the rate of dividend 
 declared on an outstanding issue of common stock. 
 Preferred stock is usually preferred as to assets 
 in corporate liquidation over common stock. In 
 case of failure to pay the fixed rate of dividend 
 for a stated period of time, the right of holders 
 of shares of preferred stock to vote, and of a 
 determined number of shares to control corporate 
 
LOANS AND INVESTMENTS 10i' 
 
 policy until resumption of dividends, is often ac- 
 corded in an indenture providing the terms under 
 which the stock is issued. Preferred stock has of 
 late years more largely assumed the nature of a 
 preferred investment, and sinking funds derived 
 from earnings have been created for the redemp- 
 tion of preferred stock in definite annual amounts 
 at a fixed price or such lower price as may be 
 determined by open market purchases. 
 
 89. FULL PAID STOCK. When a corpora- 
 tion has received, either in cash or other value 
 permitted by law, the full face of stock, such stock 
 is known as "full paid," and that fact is so indi- 
 cated on the certificates. If not full paid, the 
 holder may be held liable for the unpaid portion, 
 unless it is expressly stipulated by agreement that 
 the share may be sold for less than its face value 
 with the understanding that it may be considered 
 full paid. When a corporation has not received 
 its full value for stock which has been issued, al- 
 ways excepting a reasonable deduction for mar- 
 keting expense, such stock is known as "watered 
 stock." This term as usually employed applies to, 
 stock which has been issued in payment for prop- 
 erty or services which have been given a value 
 in excess of their true worth, or which represent 
 expected future value. 
 
 90. TREASURY STOCK. "Treasury stock" 
 is capital stock which has been authorized and 
 issued, but instead of being sold or disposed of in 
 
102 LOANS AND INVESTMENTS 
 
 some other way, is held in the treasury indefinitely; 
 or which, having been outstanding in the hands of 
 the public, has been purchased by the company and 
 not cancelled. Such stock is an asset of the com- 
 pany, but it cannot be represented by a vote in the 
 meetings of the company, nor does it ordinarily 
 draw dividends. 
 
 91. CERTIFICATES OF STOCK. A "cer- 
 tificate of stock" to be legal must be signed by the 
 authorized officials of the company and sealed with 
 the corporate seal. It must also specify the number 
 of shares represented and must bear the name of 
 the registered stockholder. The certificate of stock 
 is not capital, but merely the evidence of ownership 
 of capital, in the same sense as a deed to a piece of 
 land is the evidence of ownership of the land. Stock 
 certificates of a corporation are usually kept in the 
 custody of a proper official, generally the secretary, 
 and bound in a volume with a stub for recording 
 each certificate issued. This stub bears the essen- 
 tial facts concerning the certificate. If the certifi- 
 cate is cancelled it must be returned to the conn 
 pany and is attached to its original stub. Certifi- 
 cates of stock may be transferred the same as any 
 other evidence of ownership, but the voting power 
 of such new stock is not transferred until a record 
 of such transfer has been made on the books of the 
 company. 
 
 92. VOTING TRUST CERTIFICATES. In 
 the modern development of corporate finance an 
 
LOANS AND INVESTMENTS 103 
 
 instrument of practical value has come into wide 
 use. It is termed the "voting trust." The voting 
 trust is an agreement whereby the holders of the 
 common or other controlling stock of a corporation 
 agree to relinquish for a definite period their rights 
 of control in corporate affairs to one or more in- 
 dividuals, called voting trustees, who during the 
 life of the agreement act for them in the administra- 
 tion of corporate affairs, electing directors and per- 
 forming the ordinary functions of stockholders. A 
 voting trust is usually the corollary of internal dis- 
 sension or financial reorganization, and is used to 
 insure the restoration of confidence or the protec- 
 tion of money advanced to restore the credit stand- 
 ing of the corporation involved. Voting trust cer- 
 tificates have the attributes of stock certificates 
 and are assigned and transferred in similar ways. 
 93. SHARES WITHOUT PAR VALUE. It 
 has long been customary to issue stock of a fixed 
 par value, usually $100, the same having no rela- 
 tion to the intrinsic value of the shares or to their 
 selling price. In new companies, stock of fixed par 
 value has sometimes been sold at one-tenth of that 
 value, such transactions indicating depreciation in 
 the value of the stock or the fictitious nature of the 
 par value. In the last analysis, a share of stock is a 
 certificate of ownership of a specific part of a busi- 
 ness. The precise value of such specific part is 
 determined by an inventory and a financial state- 
 ment. The par value has no bearing upon its actual 
 
104 LOANS AND INVESTMENTS 
 
 value, except in so far as it represents a fixed unit 
 of proportional ownership. The market price of a 
 share of stock is dependent, in large measure, upon 
 supply and demand, irrespective of the intrinsic 
 value disclosed by the corporate books. To actu- 
 ally fix the true value of a share of stock and to 
 prevent as far as is possible the issuance of stock 
 having a value fictitious, and not intrinsic, confus- 
 ing in public service corporations the relation which 
 rates and earnings should bear to actual capital 
 investment, the certificate of stock having a par 
 value has been abandoned in some States and cer- 
 tificates bearing proportionate value issued in place 
 thereof. Such certificates are accorded a face value 
 of the actual original amount paid therefor, values 
 being determined by the proportion of value which 
 each certificate bears to the actual capital value of 
 the corporate enterprise. 
 
 94. MANAGERS' SHARES. A recent inno- 
 vation in corporate finance is the issuance of what 
 are termed "managers' shares." Such shares are 
 shares set aside by a corporation for purchase by, 
 or presentation to, persons who are engaged in the 
 active management of the corporation. These 
 shares, limited in amount, usually pay a larger divi- 
 dend after the regular dividend distribution than 
 do the ordinary shares of the company. Thus the 
 excess profits are in measure distributed among 
 the men who through their efforts created the 
 larger earning power of the corporation. In the 
 
LOANS AND INVESTMENTS 105 
 
 American International Corporation, a recent de- 
 velopment in American finance, provision is made 
 that if at any time one of the owners of the "man- 
 agers' shares" resigns from active management of 
 the company, or is dismissed by the directors, he 
 must sell his managers' stock to the corporation at 
 par or an appraised price, the same to be taken up 
 by the man who replaces him in the service of the 
 company. 
 
 95. TRANSFER OF STOCKS. On one side 
 of a certificate of stock there is a blank form of 
 assignment and power of attorney to transfer, 
 which may be filled out by the owner when the 
 stock is delivered to another person, with the name 
 of such person, or may be signed in blank and de- 
 livered. In most States stock so transferred carries 
 full legal title, although in a few States registry 
 must be made on the books of the company, to 
 protect the transferee against the claims of a sub- 
 sequent attaching creditor of the transferor who, 
 serving a writ of attachment upon the company 
 while the stock remains registered in the name of 
 the transferor, will acquire superior rights to the 
 prior unrecorded transferee. Furthermore, the 
 transfer of a certificate of stock is not complete so 
 far as the company is concerned until the transfer 
 is recorded on the books. Prior to that time the 
 transferee would have no voice in the management 
 of the affairs of the company and the latter would 
 be protected in paying dividends to the former 
 
106 LOANS AND INVESTMENTS 
 
 owner who would still appear as owner of record. 
 A further point to be observed by purchasers or 
 lenders of money upon shares of stock is whether 
 the stock is subject to any lien of the company for 
 indebtedness of the transferor. The laws on this 
 subject in the different States vary greatly; in some 
 States the company cannot acquire such a lien while 
 in other States the company is given a lien or right 
 to refuse transfer until the indebtedness of the 
 owner of record is satisfied. This right of lien is 
 sometimes expressly given by statute and some- 
 times created in other ways. The full negotiability 
 which attaches to bills and notes does not in all 
 cases attach to certificates of stock. For example, 
 the New York courts have held that where a stock 
 certificate has been signed in blank and lost or 
 stolen, the real owner does not lose his title to an 
 innocent purchaser from the thief or finder; but 
 where there has been unauthorized dealing with 
 such a certificate, the innocent purchaser is gener- 
 ally protected on the theory of estoppel if the real 
 owner's negligence contributed to the misappro- 
 priation. 
 
 96. STOCK TRANSFER AGENTS. With 
 the development of large business through corpo- 
 rate means, most of the larger corporations find it 
 expedient in fact quite necessary to appoint a 
 "transfer agent," who exercises entire supervision 
 of the issue and transfer of their stock; and because 
 of the predominance of New York City as a stock 
 
LOANS AND INVESTMENTS 107 
 
 market, a very large percentage of such agents are 
 located in that city. These transfer agents are 
 usually banks or trust companies, by whose selec- 
 tion the corporation is assured of responsibility, 
 reliability and accuracy, all of which are essential. 
 Indeed so thoroughly precise must the transfer 
 agent be that occasionally he is accused of being 
 unnecessarily technical. The reason for the exer- 
 cise of such extreme care may be found in the fol- 
 lowing extract from the court decision in a recent 
 case involving the transfer of securities: "It is the 
 duty of such a corporation, before making such a 
 transfer, to be satisfied of the genuineness of the 
 power presented. In so doing, it must act on its 
 own responsibility and incur its own risk of being 
 misled by forgery or fraud, and it is no answer to a 
 claim put forward by the true owner that the com- 
 pany acted in good faith upon what it supposed to 
 be genuine authority, and without negligence." 
 
 97. BONDS AND THEIR CLASSIFICA- 
 TION. A bond is a contract between one party 
 desiring funds and another party having funds to 
 invest. It is a promise by the borrower to pay to 
 the lender at a definite future time with interest a 
 certain sum of money. The proper classification of 
 bonds is difficult owing to their multiplicity and 
 the ingenuity displayed in inventing new kinds and 
 new names. Bonds may be classified according to 
 (1) the character of the obligor, (2) the purpose or 
 function of issue, (3) the_ character of security, 
 
108 LOANS AND INVESTMENTS 
 
 (4) the conditions of payment of principal and in- 
 terest, (5) the evidence of ownership and transfer. 
 98. CLASSIFICATION ACCORDING TO 
 CHARACTER OF OBLIGOR. In accordance 
 with the character of the obligor bonds are classi- 
 fied as "civil bonds" and "corporation bonds." 
 "Civil bonds" include Government bonds, National 
 and State, and municipal bonds. "Government 
 bonds" include United States bonds, bonds of 
 United States territories and dependencies, and 
 bonds of the various States that constitute the 
 nation. "Municipal bonds" include bonds of coun- 
 ties, cities, townships, villages, and tax districts. 
 "Corporation bonds" are classified as railroad 
 bonds, public utility bonds, industrial bonds, timber 
 bonds, shipping bonds, and miscellaneous bonds. 
 "Railroad bonds" consist of bonds of railroads, 
 steam or electric. "Public utility bonds" consist 
 of bonds of street railway, gas, electric light and 
 power, water, water power, and telephone corpor- 
 ations. The terms "industrial," "timber" and 
 "shipping" bonds are self-explanatory; "miscel- 
 laneous bonds" include corporate reclamation 
 bonds, real estate bonds and mining company 
 bonds. "United States Government bonds" are 
 those issued by the United States Government 
 for public purposes. Their purposes of issue are 
 naturally broader in scope than either State or 
 municipal bonds. Among the various purposes 
 for which Government bonds are issued are con- 
 
LOANS AND INVESTMENTS 109 
 
 struction and maintenance of interstate canals, cost 
 of wars, improvements in the Philippine Islands 
 and other territories and dependencies, and the 
 Panama Canal. Most United States bond issues 
 are purchased by bond houses, but occasionally 
 there has been a popular bond issue, subscriptions 
 to which have been extended to small purchasers. 
 There are certain public duties to be performed by 
 a State government, such as building highways, 
 canals, State schools for various purposes, and 
 charitable institutions, all of which may be the sub- 
 ject of bond issues, the payment of which may be 
 provided by taxation in the same manner as with 
 municipal bonds. 
 
 99. CLASSIFICATION ACCORDING TO 
 PURPOSE OF ISSUE. Among the bonds which 
 derive their titles from the purpose of issue, are ad- 
 justment bonds, income bonds, construction, equip- 
 ment trust, extension, improvement, purchase 
 money, refunding and terminal bonds. "Adjust- 
 ment bonds" are issued to enable a company to ad- 
 just its finances or for the purpose of adjusting the 
 interests of two or more corporations. "Income 
 bonds" are general obligations ranking in lien after 
 all specifically secured bonds, the interest on which 
 is payable only when earned as income, and in the 
 amount determined by the directors. "Construc- 
 tion bonds," as their name implies, are for the pur- 
 pose of erecting new buildings, or in the case of a 
 railroad, new trackage, and as a rule are secured by 
 
110 LOANS AND INVESTMENTS 
 
 a first mortgage on the property. A progressive 
 railroad is under constant necessity of increasing 
 its equipment, and therefore "equipment trust 
 bonds,'* or notes, are issued, and the money thus 
 raised is used for this purpose. Such bonds are 
 secured by the equipment purchased. "Extension 
 bonds" are issued primarily for the purpose of ex- 
 tending the main line of a railroad from one point 
 to another. "Improvement bonds" are issued for 
 the purpose of repairs and improvement on a prop- 
 erty. These, in the case of a railroad, may include 
 buildings, stations, trackage, rights of way, and 
 switch yards. "Purchase money bonds" are those 
 which are used as part consideration in the purchase 
 of properties. "Refunding bonds" are issued for 
 the purpose of procuring funds which shall be used 
 in retiring outstanding issues of bonds. Sometimes 
 this is done to secure a lower interest rate and 
 sometimes in order to take care of maturing obliga- 
 tions. "Terminal bonds" are usually issued by 
 subsidiary companies organized to hold title to 
 terminal stations and properties for one or more 
 railroad companies. 
 
 100. CLASSIFICATION ACCORDING TO 
 CHARACTER OF SECURITY. Based on their 
 security, bonds are divided into two classes, "unse- 
 cured" and "secured." Federal Government, State 
 and municipal bonds, while secured by legislative 
 lien on tax revenues, are generally termed unse- 
 cured bonds. They are unsecured because accom- 
 
 
LOANS AND INVESTMENTS 111 
 
 panied by no collateral contract, such as is the case 
 with the majority of railroad, public utility and in- 
 dustrial bonds. "Secured bonds" include such as 
 have back of them actual value, which may be ob- 
 tained by the bondholder through legal action in 
 case of default in payment of the bonds. Among 
 the various kinds of secured bonds may be men- 
 tioned "land grant bonds," the security for which is 
 a mortgage on the lands involved ; "real estate rail- 
 road bonds," secured by a mortgage on real prop- 
 erty not actually used in the operation of the road; 
 "sinking fund bonds," secured by a fund created by 
 a contract which is usually in the hands of a disin- 
 terested trustee; collateral trust bonds secured by 
 specifically pledged personal property of the bor- 
 rower, "prior lien," "first," "second," "third" and 
 "general" mortgage bonds, the security for which 
 is indicated by their titles. 
 
 101. CLASSIFICATION ACCORDING TO 
 CONDITIONS OF PAYMENT. Bonds which 
 are classified in this manner include "gold," "silver," 
 "currency," "legal tender," "callable," "convertible" 
 and "joint" bonds. "Gold," "silver," "currency" 
 and "legal tender" bonds are payable as indicated 
 by their titles in the kind of money described. 
 Practically all railroad bonds are gold bonds and 
 therefore payable in gold. Some Mexican and 
 South American bond issues are payable in silver. 
 Ohio, Southern, and Western municipal bonds are 
 frequently paid in currency or legal tender. "Call- 
 
112 LOANS AND INVESTMENTS 
 
 able bonds" are those which may be paid before 
 maturity at a rate specified in the bond, which is 
 usually above the par value. Fully three-quarters 
 of outstanding railroad bonds are callable. Union 
 Pacific First Lien and Refunding 4s, due in 2008, 
 are callable, for instance, in 1918, at 107^ and 
 interest. "Convertible bonds" are those which 
 permit the holder to exchange or convert them 
 at a specified rate into other forms of property, 
 usually into common stock of the issuing company. 
 "Joint bonds" are those whose security for payment 
 is the responsibility of two or more corporations. 
 
 102. CLASSIFICATION ACCORDING TO 
 OWNERSHIP AND TRANSFER. Under this 
 classification there are three kinds of bonds, "cou- 
 pon," "registered" and "registered coupon." "Cou- 
 pon bonds" are those which contract for the pay- 
 ment of interest by means of separate coupons for 
 fixed amounts payable at stated intervals. These 
 coupons may be detached and presented for pay- 
 ment the same as any promissory note. "Regis- 
 tered bonds" are those which are recorded with the 
 registrar of the bond issue, and transfer of the title 
 to same in order to be legal must be made with such 
 registrar. In the case of registered bonds interest 
 payments are made only to the registered holders 
 or upon their order. "Registered coupon bonds" 
 are those the principal of which is registered, the 
 coupons being made payable to bearer. 
 
 103. MUNICIPAL BONDS. Broadly speak- 
 
LOANS AND INVESTMENTS 113 
 
 ing, any bond issued by the general government or 
 any subdivision of the general government, such as 
 State, county or city, is a "municipal" bond, but in 
 the general acceptation of the term a "municipal" 
 bond is one issued by a county, city or town, for 
 the purpose of providing funds for public works or 
 improvements therein. Such bonds may be issued 
 for the erection of a schoolhouse, and be known as 
 "school bonds," but must be paid by taxes levied 
 upon the people in the municipality or school dis- 
 trict issuing the same. Bonds for street improve- 
 ment, sewers, waterworks, or drainage, issued by 
 a municipality or a subdivision thereof, come under 
 the heading of "municipal bonds," and their pay- 
 ment is provided for in the same way. In consid- 
 ering municipal bonds as an investment, the first 
 and fundamental consideration is that of legality. 
 It has sometimes happened, even after all legal 
 phases of an issue have been carefully scrutinized 
 by capable lawyers, that some hidden point has 
 been discovered which has invalidated the entire 
 issue. Generally speaking, a municipal bond issue, 
 in order to be legal, must be in accordance with the 
 constitution of the United States and must be auth- 
 orized by the constitution and statutes of the State 
 in which the municipality is located. Strict compli- 
 ance with all terms of statutes is absolutely neces- 
 sary. After the legality of a municipal bond issue 
 has been established, the investor should assure 
 himself that there is a sufficient amount of taxable 
 
114 LOANS AND INVESTMENTS 
 
 property within the district to insure the payment 
 of the interest and principal of the bonds. He should 
 satisfy himself also as to the financial record of the 
 municipality. The serial municipal bond is gradu- 
 ally displacing the long term bond of fixed exist- 
 \ence, and the sinking fund bond, and is in accord 
 with soundest principles of municipal finance. 
 
 104. RAILROAD BONDS. The railroads are 
 the highways of the nation and are absolutely nec- 
 essary to its development. The properly issued and 
 well secured bonds of well managed and honestly 
 financed railroads are premier corporate securities. 
 The classifications of railroad securities are most 
 numerous, and are the result of methods used in ob- 
 taining great sums of money demanded by rapid de- 
 velopment. "General mortgage bonds," last in lien 
 when originally issued, have become first mort- 
 gages on a majority in mileage of main line track, 
 and first mortgage bonds may be a lien on a limited 
 mileage of secondary trackage. Discrimination 
 and careful investigation are essential to safety, and 
 the last mortgage on a well established line is often 
 better security than a first mortgage on a newer 
 road, or one serving an undeveloped territory. Out- 
 standing bonds must bear a fixed ratio to mileage, 
 and when bonds have been issued at a rate in excess 
 of $20,000 per mile, care should be exercised in their 
 purchase. The value of bonds, in the last analysis, 
 rests upon the earning power of the railroad. Prin- 
 cipal and interest can only be met when net earn- 
 
LOANS AND INVESTMENTS 115 
 
 ings are ample, and railroad credit vanishes in in- 
 creasing ratio as net earnings decrease. The total 
 annual bond interest charge of a railroad should 
 not exceed one-half of the annual net earnings. 
 When net earnings are not in proportion of two to 
 one to interest charges on outstanding bonds, care 
 should be exercised. The interest charges on out- 
 standing bonds must be met when due or default 
 occurs and foreclosure follows. Such is not the 
 case with dividends on capital stock. Dividends are 
 payable only when earned and with the consent of 
 the board of directors. Dividends are not usually 
 fixed charges against earnings. Therefore the well 
 financed railroad has a larger amount of outstand- 
 ing capital stock than outstanding bonds. Con- 
 servative financing is reaching a critical point when 
 the proportion of outstanding bonds to capital stock 
 exceeds one-half. The railroad is then in a position 
 where it is compelled to pay too high a price for its 
 money, which, if long continued, weakens its re- 
 sources and causes collapse. In estimating the se- 
 security of railroad bonds, careful study should be 
 made of the territory served by the road, its popu- 
 lation, resources and capacity for development, as 
 well as of its past history. 
 
 105. PUBLIC UTILITY BONDS. Public 
 utility corporations are now well established, and 
 their securities are considered prime investments. 
 Recent legislation in the various States has been 
 favorable to the stability of public utility enter- 
 
116 LOANS AND INVESTMENTS 
 
 prises. Public utility commissions insure steady 
 earnings and prevent reckless and disastrous com- 
 petition. The extension of the use of electricity, 
 gas and the telephone, is in its infancy. Public 
 utility earnings have shown a steady increase, and 
 will undoubtedly continue to do so for some fur- 
 ther period of time. Bonds issued by public utility 
 companies are approved by public utility commis- 
 sions, and in most States can only be issued for the 
 actual cost, determined by investigation, of ttte 
 property upon which the bonds are a lien. High 
 grade public utility bonds bear a higher rate of 
 interest, and usually sell at a lower price, than rail- 
 road bonds of equal grade, thus insuring a larger 
 interest return. Statistics show that for a period 
 of years public utility earnings have exhibited a 
 steady increase in volume, irrespective of prosperity 
 or depression. Gas, electricity and the telephone 
 are no longer luxuries, but necessities, and with in- 
 creasing population and cheapness of service, the 
 public utility corporation is benefitting. Electric 
 street and interurban railroads, though carriers of 
 passengers and freight, are usually termed public 
 utility corporations. Their condition is not as a 
 rule as favorable as that of other public utilities, on 
 account of the greater expense entailed in carrying 
 on their functions, and because they are in most 
 cases subject to the legislative action of common 
 councils in cities, regarding terms of franchise and 
 regulation of service. In some States, however, the 
 
LOANS AND INVESTMENTS 117 
 
 indeterminate franchise, practically eliminating 
 competition and placing rate making under the 
 control of a State public utility commission, has 
 displaced the franchise, to the benefit of the cor- 
 poration. The investment restrictions applying to 
 the bonds of public utility corporations as to se- 
 curity, proportion of net earnings to interest 
 charges, ratio of capital stock to bonded debt, out- 
 standing bonds per mile in the case of railways, 
 territory and population served, are similar to those 
 applying to steam railroads. It should be noted, 
 however, that most public utility corporations oper- 
 ate under a franchise limited as to time, and care 
 should be taken to ascertain that the franchise does 
 not expire during the life of the outstanding bonds. 
 106. INDUSTRIAL BONDS. With the great 
 development of industrial corporations insuring, as 
 such growth does, enlarging fields for the sale of 
 goods and their manufacture at lowest cost, the 
 command of inventive genius to overcome the ad- 
 vantages gained by the inventions of others, the 
 control of the production of raw materials, and 
 diversity of output, the financing of their credit 
 needs by bond issues has become recognized as a 
 conservative method of finance. Industrial corpo- 
 rations always contend, however, with different 
 problems than do most other forms of enterprise, 
 and in a large measure their business, although a 
 fundamental one, sometimes involves risks ap- 
 proaching the classification of hazardous. Bond 
 
118 LOANS AND INVESTMENTS 
 
 issues of such type are to receive different consid- 
 eration than others. Good will and patent rights 
 must be carefully considered. A going plant may 
 have large cash value, but the salvage worth of such 
 a plant is small. If the management is not pro- 
 gressive, competition may soon eliminate its goods 
 from the market. The supply of raw materials 
 must not be entirely dependent upon the good will 
 of others, nor must it be so far removed from the 
 place of manufacture as to work a disadvantage in 
 competition. The quick assets of the corporation 
 must be carefully investigated and analyzed, and 
 the proportion of net quick assets to outstanding 
 bonds should be a fixed one, and always maintained. 
 Industrial bonds should mature at an early period, 
 and should have a sinking fund provision, or pre- 
 ferably should be serial in maturity. The propor- 
 tion of net earnings to interest charges should be 
 larger than in the case of railroads and public utility 
 corporations, on account of the rapid changes which 
 take place in business conditions. A first mortgage 
 bond of the United States Steel Corporation is un- 
 doubtedly good, but it cannot be placed in a similar 
 class or be used for similar investment purposes, as 
 the first mortgage bond of the Pennsylvania Rail- 
 road Company. 
 
 107. EQUIPMENT BONDS. By reason of an 
 unusual record of stability and safety, continuously 
 extending over a long period of years, "equipment 
 bonds" or "car trusts" deserve consideration as in- 
 
LOANS AND INVESTMENTS 119 
 
 vestments of the highest type. Equipment bonds 
 issued upon the security of rolling stock, including 
 locomotives, are in large measure preferred liens 
 upon the income of the issuing corporation, for a 
 continuance of earnings depends upon the use of 
 rolling stock, and a default in equipment bonds 
 would deprive the corporation of its chief means of 
 revenue. In times of receivership, courts have or- 
 dered the payment of interest and principal due 
 upon equipment bonds, in preference to other obli- 
 gations, and for a long period of years there has 
 been no default in equipment obligations. Equip- 
 ment bonds or notes are issued under what is legally 
 a lease or an agreement of conditional sale. These 
 agreements are usually recorded in the States ip 
 which the corporation operates, and are not can- 
 celled until payment in accordance with their terms 
 is fully made. The Philadelphia plan of equipment 
 trust provides for the creation of an equipment 
 trust by agreement between a trust company, on 
 or more designated individuals, and the corpora- 
 tion. The equipment is purchased by the equip- 
 ment trust and leased by the trustee to the corpora- 
 tion, at a rental sufficient in amount to meet the 
 principal and interest of the equipment bonds or 
 notes when due. Such bonds or notes are guaran- 
 teed by the corporation. 
 
 108. TIMBER BONDS. The issuance of "tim- 
 ber bonds" is a comparatively recent development 
 in finance. A great amount of these bonds in par 
 
120 LOANS AND INVESTMENTS 
 
 value has been absorbed by banks and the investing 
 public. Timber, standing, and of good quality, is 
 an asset which as time passes will increase in value. 
 Timber as security for a bond issue has been likened 
 to land. The analogy is not a correct one. A part 
 is never equal to the whole. Land is a fundamental 
 value. Timber is not. Standing timber is ordi- 
 narily not insurable. The fire hazard is therefore 
 of first importance. Timber bonds have usually 
 been issued for a fixed period of time of long dura- 
 tion. Provision has been made for a sinking fund 
 of a certain percentage in money of the amount in 
 feet of timber cut. Failure to provide this sinking 
 fund is a default in the provisions of the mortgage. 
 To prevent such default timber has been cut when 
 the market was so low in price as to cause inevitable 
 loss. Such loss exhausted the resources of the com- 
 pany obligated on the bonds, and in some cases re- 
 sulted in receivership. The sinking fund in timber 
 bond issues is not sound, and should be displaced 
 by the serial bond issue. The timber business is 
 not a stable one, and timber bonds are oftentimes 
 classed as hazardous investments. The rate of in- 
 terest paid on such bonds would seem to indicate 
 that they are so considered. In many timber bond 
 issues the security of the issue consists largely of 
 other assets than standing timber, such as saw 
 mills, pulp mills and paper mills. The bonds may 
 also bear an endorsement worth considerably in 
 excess of the debt guaranteed. 
 
LOANS AND INVESTMENTS 121 
 
 109. DRAINAGE AND RECLAMATION 
 BONDS. For the purpose of reclaiming fertile 
 land a large part of the time under water, political 
 subdivisions designated as "drainage districts" have 
 been created under constitutional authority, with 
 power to issue bonds and to assess and levy taxes 
 against real property for their payment, together 
 with the interest thereon accrued. Various methods 
 are used in carrying out this purpose and in provid- 
 ing for tax levies. In some districts taxes are levied 
 by county authorities, in others by judicial officers. 
 This type of bond often is little more than a special 
 assessment bond against benefitted property, and 
 its ultimate payment is secured by the value of the 
 property, and not by a general tax levy. "Reclam- 
 ation bonds" are similar in purpose and form, and 
 are issued for the redemption of arid lands, through 
 the use of water. Where municipal districts are 
 created for this purpose they are similar to drainage 
 districts in form and powers granted. Corporations 
 have endeavored to reclaim arid lands through 
 funds provided by bond issues, but the problems 
 involved have been so intricate and vast that 
 disaster in most instances has been the result. 
 
 110. LAND MORTGAGE BONDS. A type 
 of bond which will ultimately become more gener- 
 ally utilized is the "land mortgage bond" issued by 
 land banks under State authority, or by the various 
 associations created under the Rural Credits Act. 
 The distinctive features of these classes of bonds are 
 
122 LOANS AND INVESTMENTS ^ 
 
 long existence before maturity, amortization plan 
 of repayment, exemption from taxation, and legal 
 investment for fiduciary and trust funds. 
 
 111. BOND ISSUANCE. Bonds have been 
 described as a species of promissory note, being 
 a promise to pay a certain sum at a definite time 
 with interest at a fixed rate. The main distinc- 
 tions between bonds and promissory notes have 
 to do largely with proportions. The maker of a 
 promissory note, the promisor, may be an indi- 
 vidual, a partnership or at times a corporation. 
 The maker of a bond, or the obligor, is a govern- 
 ment, a State or municipality, or a corporation; 
 seldom an individual. The amount of the promis- 
 sory note, limited largely by the loaning capacity 
 of a bank, is usually less than one hundred thou- 
 sand dollars. The amount of a bond issue is 
 usually a matter of millions, split up into segments 
 that it may be absorbed by the investing public. 
 The promissory note is for a period of months, 
 the bond is due after a period of decades. It will 
 be of interest to trace briefly the process in finance 
 through which bonds are issued, taking for an 
 example the bonds of a large corporation making 
 steel rails. 
 
 112. PROCEDURE IN ISSUING BONDS. 
 There would probably be three or four plants of 
 such a company in operation, each located con- 
 veniently near its supply of fuel and raw products. 
 In the course of time, owing to the development 
 
LOANS AND INVESTMENTS 123 
 
 of a certain section of the country, conditions 
 might arise that would put the business of one, 
 of these plants on a much more profitable basis if 
 it could increase its share of the output, a result; 
 only to be attained through the erection of several 
 new buildings and the installation of costly ma- 
 chinery. To do this would require at least $2,500,- 
 000. The company, therefore, decides to issue that 
 amount in bonds secured by a first mortgage on 
 another part of the property. A special meeting 
 of the stockholders is held and the whole matter 
 is laid before them. A large majority of the stock- 
 holders, having full confidence in the officers of 
 the corporation, will, of course, send their proxies, 
 so that the meeting, perhaps, will be but little 
 larger than an ordinary directors' meeting. At 
 that time it is decided how long the bonds shall 
 run, what the rate ought to be, and what particular 
 part of the property shall be mortgaged as se- 
 curity for the issue. It will be shown that although 
 the interest on the new bonds will add to the fixed 
 expenses, yet the increased manufacturing facili- 
 ties will largely add to the profits and perhaps 
 reduce very materially the amount of money which 
 must be borrowed from time to time on short- 
 term notes. 
 
 113. BOND UNDERWRITING SYNDI- 
 CATES. The next step is to find a banking 
 house that will offer the best price for the entire 
 issue, that is, advance the money to the corpora- 
 
124 LOANS AND INVESTMENTS 
 
 tion, or "underwrite" the bonds. A price is finally 
 agreed upon and the bankers take over the issue, 
 say at 90 ; that is, they advance to the corporation 
 $2,250,000. In the meantime, a trust company has 
 agreed to act as trustee of the mortgage securing 
 the bonds, receiving a fee in payment for the ser- 
 vice, and also probably being appointed as a deposi- 
 tory for the payment of the interest on the bonds 
 as it falls due. A registrar will also have been 
 appointed. 
 
 114. BOND SELLING SYNDICATES. 
 Having received the issue of bonds and advanced 
 the money to the corporation, the banking house 
 will now undertake to dispose of them at a fair 
 profit, not, however, directly to the public. A syn- 
 dicate will be formed among several banking and 
 bond houses, each of which will take an allotment 
 at a certain price. These, in turn, act as distrib- 
 uting agents and through their salesmen and letters 
 to regular clients the issue is finally taken up by the 
 public. In buying the bonds, the ultimate pur- 
 chasers are largely influenced by the reputation of 
 the banking firm, since the bank's position is in 
 the nature of an intermediary between the corpora- 
 tion and the public. The net result is that the 
 corporation has borrowed from the general public 
 in small lots the sum of money needed for its 
 purposes. 
 
 115. STOCK EXCHANGES. Many of the 
 larger cities in all countries have found it necessary 
 
LOANS AND INVESTMENTS 12S 
 
 to organize stock exchanges for the purpose of 
 facilitating the buying and selling of the enormous 
 quantity of corporate stocks and bonds which now 
 exist. These exchanges are but the evolution of 
 a common meeting place, such as the old coffee 
 kouses, bank corridors, or certain street corners, 
 where it originally was the custom of those who 
 dealt in government or other securities to congre- 
 gate. A survivor of the old stock exchange locali- 
 ties is the modern "curb market" where are sold, 
 in the open air, those stocks and bonds which have 
 not been listed on any regular exchange. The curb 
 market in New York City, which has been in exist- 
 ence for more than thirty years, is probably the 
 most important one of its kind in the United States. 
 Its operations are conducted in Broad street. 
 
 116. SERVICE OF STOCK EXCHANGES. 
 The Stock Exchange gives to good stocks and 
 bonds a ready market and a known price. Without 
 these two features, bonds would lose their value 
 entirely as a temporary investment for the idle 
 funds of a bank. It is the ease with which they 
 may be converted into cash that makes bonds use- 
 ful as "secondary reserve." Stock Exchange prices 
 go over the "ticker" and are published in the news- 
 papers in every town of importance in the world. 
 Thus it is possible to keen in touch with the market 
 value of securities far from the centres in which 
 they are dealt, and the radius of their usefulness as 
 collateral for bank loans is greatly widened. Since 
 
126 LOANS AND INVESTMENTS 
 
 stocks in financial institutions are not as a rule 
 traded in very generally on any of the great stock 
 exchanges, this class of stocks does not figure as 
 prominently in the daily quotations as do railroads 
 and industrials. Nevertheless, the total of bank 
 stocks in the United States compares very favor- 
 ably with the totals of the other kinds. And in 
 spite of the fact that the personal element enters 
 into a consideration of bank stocks probably more 
 than in any other, it must be admitted that, judged 
 by the ordinary elements of strength, these are 
 quite as attractive as any other kind. The ease 
 which the Stock Exchange affords for the purchase 
 and sale of securities which, on account of economic 
 causes, are subject to fluctuations, has made it a 
 centre for speculation as well as investment. Au- 
 thorities find it hard to agree as to what extent 
 these two terms may or may not be synonymous. 
 117. GOVERNMENT OF STOCK EX- 
 CHANGES. The government of the Exchange 
 is vested in a committee, consisting of a president 
 and other officers, together with a number of mem- 
 bers. This governing committee has power to 
 draft rules for the conduct of business and is the 
 administrative body. In addition, there may be 
 several other committees, for example the commit- 
 tee on stock list, which, after investigation along 
 prescribed lines, has authority to list stocks on the 
 Exchange. The members of the Exchange have 
 "seats," which term means the privilege to con- 
 
LOANS AND INVESTMENTS 127 
 
 duct business on the "floor." This is the large 
 open space where the brokers congregate. At in- 
 tervals are posts which designate the particular 
 stock which may be bought or sold there. This 
 system is one of wheels within a wheel and makes 
 it unnecessary for a broker to search about the 
 room for a purchaser when he wishes to sell or buy 
 a certain stock. Sales are made practically at auc- 
 tion; that is, the seller asking for a price and the 
 buyers bidding usually a little below. As sales are 
 effected, memorandum notes are made by both 
 parties, which are checked up at the end of the 
 day. In the larger stock exchanges, settlement is 
 made through the stock exchange clearing house 
 for the more active stocks. This mechanism oper- 
 ates similarly to the ordinary bank clearing house 
 for the exchange of checks. Well-known active 
 stocks are usually listed on several stock exchanges 
 and this fact has led to what is known as the "arbi- 
 trage" business, that is, the purchase of stocks in 
 one city, London, for example, where for some local 
 reason prices may be low, the stocks being then 
 resold at a higher price in New York. 
 
 118. FINANCIAL TERMS. There are many 
 terms common to stock exchanges, a few of which, 
 although in everyday use, are not generally under- 
 stood by the public. Such are the following: 
 
 "Bear" One who is interested in having the 
 prices of one or more securities decline. 
 
 "Bull" One who wants prices to advance. 
 
128 LOANS AND INVESTMENTS 
 
 When a broker has bought more of a certain 
 stock than he has contracts to deliver, he is said 
 to be "long" of that stock. Selling "short" means 
 selling, or contracting to deliver, stock that the 
 broker does not own. A "short interest" is a group 
 that expects to buy stocks after a fall in prices. 
 If instead prices have advances, such brokers incur 
 a loss. 
 
 Another expression in common use, but not 
 clearly understood, is the term "watered stock." 
 Such stock is, of course, in disrepute, and means 
 that a larger issue of stock has been sold to in- 
 vestors than is represented by the actual value of 
 corporate property. This is not to be confused 
 with over-capitalization, which means a larger 
 capital has been subscribed than is necessary to 
 conduct the business on an interest or dividend 
 paying basis. 
 
 119. BANKS AND STOCK EXCHANGES. 
 For the purpose of buying and selling stocks and 
 bonds, the broker requires a vast amount of money, 
 since the purchaser may not settle until the securi- 
 ties are actually delivered or transferred. This 
 money is advanced by the banks on collateral by] 
 what is known as "call" or "demand" loans. The 
 bank is privileged to ask payment for such loans 
 on short notice, although custom has decreed that 
 a sufficient time must be given the borrower to 
 make a readjustment. Demand loans sometimes 
 run for long periods of time, the interest being 
 
LOANS AND INVESTMENTS 129 
 
 paid at certain intervals at varying rates. While 
 the call money market may be said to bring the 
 banks in closer touch with the speculative element 
 of the stock exchange than may be best, yet is un- 
 doubtedly an excellent medium through which the 
 inflexibility of reserve requirements may be ad- 
 justed. For example, a large part of the surplus 
 funds of all the banks in the United States has a 
 tendency to gravitate to New York. It is the stock 
 market which creates a demand for this money 
 and it is mostly all absorbed by the brokers on 
 call loans. 
 
 120. BONDS AS INVESTMENTS. As has 
 been stated, many banks now conduct a separate 
 department, the function of which is to pro- 
 vide proper facilities and advice for their customers 
 in the purchase of bonds. Such departments are 
 under the supervision of experts who are specialists 
 on bond issues and values. The average investor 
 has neither the capacity, experience nor time for 
 study to enable him to make a wise choice in the 
 purchase of bonds. Against fake investment 
 schemes and wild cat bond issues, State laws have 
 been proposed, such as the pioneer "blue sky law" 
 of Kansas. This law requires every investment 
 company, whether organized under the laws of the 
 State of Kansas or any other State, to file in the 
 office of the State Bank Commissioner a statement 
 showing in full detail the plan upon which it pro- 
 poses to transact business, a copy of all contracts. 
 
130 LOANS AND INVESTMENTS 
 
 bonds or other investments which it proposes to 
 make with or sell to its contributors, also a state- 
 ment showing the name and location of the invest- 
 ment company, and an itemized account of its 
 actual financial condition, with the amount of its 
 property and the amount of its liabilities, and such 
 other information as may be required. If condi- 
 tions are found to be satisfactory, the Bank Com- 
 missioner, in whom complete judicial authority 
 rests, will then issue a license for the vending com- 
 pany and its agents to do business in the State. 
 Certain institutions and certain securities are ex- 
 empt from the provisions of the statute, viz. : State 
 and National banks, trust companies, real estate 
 mortgage companies dealing in real estate mort- 
 gage notes, building and loan associations, and cor- 
 porations not organized for profit. The securities 
 excepted are bonds of the United States, State of 
 Kansas, or some municipality of the State of Kan- 
 sas, and notes secured by mortgage on property in 
 the State of Kansas. The interests of the pro- 
 spective investor are thus safeguarded by expert 
 advice and legislative statute. 
 
 121. ELEMENTS OF SECURITY. The ele- 
 ments of security in stocks and bonds have been 
 tersely formulated by Rufus Waples of Philadel- 
 phia in the following rules: 
 
 (1) Minimum liability of loss is secured in the 
 class of bonds authorized for the investment of 
 trust funds by such a State as New York. 
 
LOANS AND INVESTMENTS 131 
 
 (2) No reasonable likelihood of loss is incurred 
 in buying bonds that are legally issued and are 3 
 valid and binding obligation on all the taxable 
 property of a city of over 10,000 population, when 
 it is a long settled community and has many di- 
 versified sources of revenue, with a debt of about 
 5% of the assessed valuation or less. Smaller cities 
 are more apt to be negligent at times in paying 
 obligations at the date due. 
 
 (3) There is a very strong presumption of 
 safety in bonds of dividend paying transportation 
 companies enjoying right of eminent domain and 
 on those of public utility corporations (railroads, 
 street railways, gas, water works, etc.), when satis- 
 factory earnings have been maintained for several 
 years; when the amount of bonds authorized is 
 properly limited; when charter and franchise or 
 physical or other conditions offer a large measure 
 of protection from competition; and when the 
 franchise will survive the maturity of the bonds 
 for a satisfactory period. 
 
 (4) There is a fair presumption that interest 
 on an industrial bond will be earned and bond paid 
 at maturity, if the permanent, available assets (land 
 and buildings of a general character and property 
 that cannot be diverted or seriously depreciated) 
 offer foreclosure value sufficiently in excess both of 
 the bond issue and of all practicable depreciation, 
 and if the surplus earnings provide an adequate 
 sinking fund for the retirement of bonds. 
 
132 LOANS AND INVESTMENTS 
 
 (5) The probabilities strongly favor regular 
 dividends on a conservative issue of preferred stock 
 when a much larger issue of common stock has 
 long earned dividends and surplus, and when com- 
 mercial fluctuations cannot seriously unsettle the 
 average net business profit. 
 
 (6) There is a good business chance that com- 
 mon stock will maintain the average earnings of 
 the past ten years if the business is essentially of 
 a permanent nature ; and if the managers who built 
 up the business are in the prime of life, and have 
 accumulated large resources as surplus earnings of 
 said business; and if they retain both the active 
 management and their own interest in the business. 
 
 122. TEST QUESTIONS. An investor, when 
 offered full information about a security that is 
 new to him, and that does not at once command 
 his confidence, wishing to know the favorable 
 features, and to discover the points of danger, can, 
 with a little patience, act understandingly by apply- 
 ing certain well-established principles, taught by 
 the history of securities, and conveniently made 
 use of as test questions. 
 
 (1) Was the bond prepared by the best legal 
 talent, at the instance of experienced bankers, with 
 the single purpose of affording the greatest protec- 
 tion possible to the bondholders? 
 
 (2) Were all steps taken under honest, capable 
 experts (business, legal, engineering and account- 
 ing), and are the records available for examination? 
 
LOANS AND INVESTMENTS 133 
 
 (3) Is the capitalization conservative? Has the 
 cash cost or probable physical and franchise value 
 been closely approached or exceeded in the author- 
 ized bond issue? 
 
 (4) Is the security issued by a company that 
 furnishes all reasonable information to stock- 
 holders about its earnings and condition? 
 
 (5) If the security is issued by a company that 
 should prosper greatly by increasing population, is 
 the company's property so situated that local 
 growth in any portion of its territory will benefit it? 
 
 (6) Are the bonds and stock owned in good 
 part by men of financial strength whose self-interest 
 would lead them at all times to consider the welfare 
 of the company? 
 
 (7) If foreclosure became necessary, would a 
 creditor or bondholder be satisfied to become part 
 proprietor or property owner, on account of the 
 great value of the pledged property? 
 
 (8) Has the management ably, conservatively 
 and conscientiously worked out developments for 
 the good of the company? 
 
 (9) Are the employees contented, amenable to 
 discipline and working harmoniously with the 
 management? 
 
 (10) Has the earning power back of this se- 
 curity a broad dependence upon the patronage of 
 many customers well able to pay for service or 
 goods? 
 
 (11) Is the earning power of the company 
 
134 LOANS AND INVESTMENTS 
 
 fairly well protected from injurious competition 
 and likely to continue so, with a growing popula- 
 tion to serve or trade to rely upon? 
 
 (12) Is the earning power of the company de- 
 pendent upon the patronage of hoped-for cus- 
 tomers, or upon sub-companies organized to supply 
 a demand? Does it seem likely that profits are 
 only a future matter to be reached in "process 
 of time." 
 
 (13) Does the earning power depend upon any 
 expectation of unfair advantage over competitors, 
 such as reliance on a degree of official favoritism 
 that seems attractive to some men, though it 
 cannot permanently aid a true investment bond or 
 stock? 
 
 (14) Are the conditions of earning power grow- 
 ing unfavorable from (a) Insufficient capital? 
 (b) Increasing cost of operation? (c) Increasing 
 demands of employees, or strikes? (d) Substitu- 
 tion by competitors of new methods or materials 
 for old? (e) Depletion of products of mines or 
 quarries? (f) Depletion of products of forests? 
 (g) Depletion of products of agriculture? (h) Loss 
 of population? (i) Increasing cost of service or 
 distance of deliveries? (j) Increasing cost of se- 
 curing raw materials or fuel? (k) Obsolete equip- 
 ment or superior equipment of business competi- 
 tors? (1) Loss of tariff advantage? (m) Loss of 
 skill or prestige in management? (n) New or im- 
 proved or shorter competing railway lines? (o) 
 
LOANS AND INVESTMENTS 135 
 
 Larger tonnage in competing steamship lines? (p) 
 New rival methods of doing business? 
 
 (15) Is the price asked for the bond or stock 
 much greater or less than the usual quotation? 
 
 (16) Has the security been quoted higher or 
 lower in price because of some influence afterward 
 withdrawn? (Learn if there have been purchases 
 by a sinking fund, expectation that the issue would 
 be bought in and retired, accumulation in view of 
 acquiring voting control, or supposed important 
 advantage or disadvantage from new connections, 
 discoveries, trade expansion or loss, etc., and learn 
 exact facts.) 
 
 (17) Is the bond offered presented as a bar- 
 gain, at such a price, or with such prospects of 
 peculiar advantage to buyer as to disorganize the 
 investor's critical faculty and hasten him into a 
 purchase in the belief that he is securing great 
 value for much less than it is worth? 
 
 (18) Are the bond buyer and his associates fur- 
 nishing money for experiments to get 5% if a new 
 enterprise prospers and take all the loss if it fails? 
 
 (19) Is the bond issue large enough to secure 
 the best legal talent, if it should be needed to pro- 
 tect the issue, by levying a small percentage upon 
 each bond? 
 
 (20) Are the business affairs of the company 
 conducted on such a scale that a judgment for 
 injury or loss of life would probably be but a small 
 percentage of the net earnings of the company? 
 
136 LOANS AND INVESTMENTS 
 
 (21) Is the bond issue so large, or complicated, 
 or difficult to understand, that sales of timid 
 holders would be likely to cause great price fluctu- 
 ations? 
 
 (22) Is the vendor of the security a"ble, in behalf 
 of the bond or stock offered, to give satisfactory 
 replies to all questions above cited that properly 
 apply to it? 
 
 (23) Is the vendor, through responsibility and 
 ample experience, an authority for all statements 
 made by him? 
 
 (24) Have responsible bankers directed the 
 initial and all later steps taken in preparation of this 
 security, bringing an experienced, judicial, business 
 training to bear upon the fullest information, ob- 
 tained by the most capable experts available? 
 
CHAPTER IV 
 
 Collateral Loans 
 
 123. PLEDGE OR HYPOTHECATION. 
 
 "Collateral loans" are loans secured by pledge of 
 personal property. A pledge is a bailment of per- 
 sonal property as security for the payment of a 
 debt or the performance of an act, with an option 
 of sale in the pledgee upon the default of the 
 pledger in his engagement. The article pledged 
 may be any species of personal property, but of late 
 years a pledging of stocks, bonds, negotiable paper 
 and other representatives of intangible personal 
 property has come to be designated by the term 
 "hypothecation," or the giving of "collateral se- 
 curity," to distinguish such a pledge from a pledge 
 of material articles. A pledge gives greater rights 
 than a lien, for a pledgee has a power of sale which 
 the owner of a lien has not. It is less than a chattel 
 mortgage, for in a chattel mortgage the legal title 
 passes, subject to be divested upon the fulfillment 
 of the mortgage terms; in a pledge the title may or 
 may not pass ordinarily it does not, but it has 
 been held that it does in collateral securities. It 
 differs further from a chattel mortgage in that to 
 create a pledge no writing that it is a debt and a 
 surrender of possession of property is necessary, 
 and it is required merely that there be property as 
 security. Ordinarily, too, a chattel mortgage must 
 
 137 
 
138 LOANS AND INVESTMENTS 
 
 be recorded to be effective against third parties, 
 while a pledge need not be. 
 
 124. FORMATION BY CONTRACT. A 
 pledge is created by contract, either express or 
 implied. An assignment of securities by a debtor 
 to a creditor is presumed to be a pledge rather than 
 a payment, and where doubt exists whether the 
 transaction is a pledge or a chattel mortgage the 
 courts favor holding it a pledge. The aim is to 
 determine the real intention of the parties, and 
 classify the transaction according to the intention 
 shown. There must be a debt or engagement to 
 be secured in order to create a pledge, but this debt 
 may be some other person's than the pledger's, 
 and a pledge may be made to secure a present, 
 future or past debt, though to make a valid pledge 
 for a past debt some new consideration is ordin- 
 arily required. The pledge may be made to cover 
 new debts as they arise, but there must be an 
 agreement between the parties to effect this, for 
 the pledge will not be deemed to attach to the new 
 debt unless the new loan was made upon the se- 
 curity of the pledge. So the existence of a former 
 debt gives the pledgee no right to hold the pledge 
 when the debt to secure which it was given has 
 been paid. If the debt or contract to secure which 
 the pledge is given is illegal, the pledgee can- 
 not of course recover upon the contract, but he 
 may nevertheless retain the pledge until it is 
 redeemed. 
 
LOANS AND INVESTMENTS 139 
 
 125. WHAT MAY BE PLEDGED. Prac- 
 tically any personal property, tangible or intangi- 
 ble, may be pledged, as the right to shares of stock 
 in a corporation. Even property exempt from exe- 
 cution on a judgment, as a mechanic's tools, or 
 necessaries, may be pledged. Property not yet in 
 existence cannot be pledged, and the attempt to do 
 so merely creates a contract to make a pledge in 
 the future, like an agreement to sell. Pay of soldiers 
 and pensions cannot be pledged. By the National 
 Bank Act it is provided that "No association shall 
 make any loan or discount on the security of the 
 shares of its own capital stock, nor be the purchaser 
 or holder of any such shares, unless such security 
 or purchase shall be necessary to prevent loss upon 
 a debt previously contracted in good faith, and 
 stock so purchased or acquired, shall, within six 
 months from the time of its purchase, be sold or 
 disposed of at public or private sale." 
 
 126. PARTIES AND TITLE. A person who 
 transfers personal property in pledge as security 
 for a debt must own the property or at least have 
 apparent authority to pledge it. One who has been 
 voluntarily clothed by the owner with the indicia 
 of ownership, though this may have been induced 
 by fraudulent representation, may make a valid 
 pledge as against the owner. One who takes nego- 
 tiable instruments in pledge before maturity in good 
 faith for value and without notice of any defect 
 in the pledger's title, acquires a valid holding title. 
 
140 LOANS AND INVESTMENTS 
 
 Except in these two cases the pledgee acquires no 
 greater title than the pledgor had. Mere possession 
 of chattels, by whatever means acquired, if there 
 be no other evidence of property or authority to 
 sell from the true owner, will not enable the pos- 
 sessor to give good title. An agent may pledge 
 when and as his principal holds him out as having 
 authority; if an agent pledges goods of his prin- 
 cipal to secure his private debt, the principal is 
 entitled to recover them from the person to whom 
 they are pledged, unless the agent was invested with 
 the indicia of ownership, or the pledge was of ne- 
 gotiable securities. In most States, by statute en- 
 actment, factors (commission merchants) may 
 pledge goods entrusted to them to sell. One mem- 
 ber of a partnership may make a valid pledge of 
 firm property to secure a partnership debt, but not 
 to secure an individual debt. An executor, admin- 
 istrator, trustee or other person in a representative 
 capacity may not pledge his trust property for his 
 own benefit. One who has only a lien cannot make 
 a valid pledge, because to maintain a lien he must 
 retain possession, while a pledge requires a delivery. 
 Buying stocks on a margin creates the relation of 
 pledgee and pledgor between the broker and his 
 customer. 
 
 127. DELIVERY. An absolute essential to the 
 creation of a pledge is a delivery, actual or construc- 
 tive, of the property pledged. A constructive delivery 
 occurs when the evidence of recognized symbols of 
 
LOANS AND INVESTMENTS 141 
 
 the thing is delivered, as the delivery of a ware- 
 house receipt, or a bill of lading. But there must 
 be some delivery. Thus where a bank cashier, to 
 secure a creditor, sealed up a package of bank notes 
 with an endorsement of their purpose and placed 
 them in the bank vault, it was held that the creditor 
 had no pledge or lien. A delivery to a third party 
 for the pledger's benefit with his consent is suf- 
 ficient. A delivery with an intention to create a 
 pledge is sufficient to create the relation of pledgor 
 and pledgee without writing or other act, but not 
 in the case of certificates of stock, where a writing 
 is required unless the certificate has been endorsed 
 in blank. Even where a note is payable to a person's 
 order there may be a valid pledge of it without en- 
 dorsement, though the practice is not to be recom- 
 mended. But in the case of stock it is necessary 
 that there be a written transfer or power of attorney 
 of some kind. The pledge continues so long as 
 the pledgee retains possession, and the pledgee 
 has a right against all the world to the retention of 
 the article pledged until the payment of the debt 
 secured, except as against the holder of a right 
 which attached to the property before the making 
 of the pledge. But a pledge of collateral securities 
 may be temporarily redelivered to the pledgee for 
 the purpose of collection by the pledgor without 
 affecting the pledgee's lien, though this exception 
 is not favored and is strictly limited. 
 
 128, RIGHTS AND LIABILITIES OF 
 
142 LOANS AND INVESTMENTS 
 
 PLEDGOR. A pledger has a right to assign, by 
 sale or otherwise, his reversionary interest in the 
 pledge, and upon notice to the pledgee the latter 
 will be bound upon payment of the debt secured to 
 turn the pledge over to the assignee. He has also 
 a right to sue any one who injures the pledge, 
 though preference is given the pledgee in the matter 
 of suing because his interest is generally greater. 
 He has, of course, the right to recover the pledge 
 on payment of the debt for which it was given as 
 security, and he cannot be deprived of this right at 
 the time of making the contract. To allow this 
 would permit lenders to crush their customers. But 
 the pledger's right to redeem may be released by 
 a subsequent contract founded on a new considera- 
 tion. Statutes in many States allow a pawnbroker 
 to sell the pledge and foreclose the pledger's right 
 to redeem at the expiration of a fixed time, gen- 
 erally a year. As to the liabilities of a pledger, he 
 is, of course, liable for the original debt, default in 
 paying which may lead to a sale of the pledge and 
 and the application of the proceeds to the debt so 
 far as they will go. If not sufficient to extinguish 
 the debt he still'owes the balance. The pledger also 
 impliedly warrants his title as that of an absolute 
 owner. 
 
 129. RIGHTS AND LIABILITIES OF 
 PLEDGEE BEFORE DEFAULT. The pledgee 
 gets no better title than the pledgor had, except in 
 the case of negotiable instruments, and except 
 
LOANS AND INVESTMENTS 143 
 
 where the pledger has been clothed by the owner 
 with the indicia of ownership. The best example 
 of clothing one with the indicia of ownership occurs 
 in pledges of certificates of stock. These are not 
 regarded as negotiable instruments, but the owner, 
 by endorsing or signing the power of attorney to 
 transfer, thereby invests the holder with the ap- 
 parent ownership, and the latter may then pass a 
 good title to one who buys for value without notice, 
 in good faith. There are some limitations to this, 
 as where the pledgor is known to be an agent for 
 a trustee the pledgee cannot take the stock with 
 full protection unless he inquires into the authority 
 of the representative to make the pledge. Where 
 the owner himself never endorsed the certificate, 
 but some one else without authority did, that does 
 not avail against the true owner even in the hands 
 of a pledgee or transferee without notice for value. 
 The owner of an instrument negotiable or non- 
 negotiable cannot be precluded by a forgery. The 
 pledgee having the right of possession may sue any 
 person who causes injury to the pledge, because he 
 has generally a greater interest than the owner 
 himself in keeping the pledge intact. 
 
 130. RIGHT TO THE USE AND PROFITS 
 OF THE PLEDGE. The pledgee may use the 
 pledge so far as is reasonably necessary. Ordin- 
 arily this would be little or nothing, but the pledgee 
 of a horse would have to use the pledge in order 
 to keep it in condition, and in all cases the pledgee 
 
144 LOANS AND INVESTMENTS 
 
 may use the pledge as the pledger permits. The 
 pledgee may collect the profits or income of the 
 pledge, as dividends on stock or interest on bonds, 
 but he must apply them to the principal debt, and 
 if they exceed the amount needed, he holds the 
 excess in trust for the pledger. The pledgee may 
 have pledged stock transferred to his name on the 
 books of the company, and this is frequently done, 
 and may vote such stock, though in some States 
 the pledgee, upon the demand of the pledger, must 
 give the latter a proxy to vote the stock. The 
 pledgee is liable for assessments on the stock stand- 
 ing in his name, though by statute in some States 
 the pledger and not the pledgee is liable; but the 
 pledgee may charge against his pledger the amount 
 so paid. The pledgee is entitled to be reimbursed 
 for necessary expenses in keeping the pledge. The 
 pledgee may assign his interest, and this he does 
 by assigning both the debt secured and the pledge. 
 131. PLEDGEE'S RIGHT TO HYPOTHE- 
 CATE PLEDGED STOCK. Where a broker 
 purchases stock for a customer who deals with him 
 on margin (creating the relation of pledger and 
 pledgee), it seems that the broker has the right to 
 hypothecate the stock, at least to the extent that 
 the broker has advanced his own money in the pur- 
 chase. He is not bound to keep on hand the identi- 
 cal stock purchased, but still he must have on hand 
 or under his control at all times ready for delivery 
 to his customer shares of the same description, 
 
LOANS AND INVESTMENTS 145 
 
 and in amount sufficient to fill the customer's order. 
 He has no right to pledge his customer's stock 
 beyond this, and commits the wrong of conversion 
 if he does; but if he does, and there is nothing on 
 the certificate to warn the broker's pledgee that it 
 is already pledged, this second pledgee takes it 
 free from any claims of the customer, and need 
 not surrender it to the owner (purchaser) except 
 on payment of the debt of the broker for which it 
 was the second time pledged. This is owing to the 
 rule already discussed that one who clothes another 
 with apparent ownership cannot dispute the title 
 of a buyer or pledgee from such person in good 
 faith for value and without notice. The right to 
 use, sell, or rehypothecate the pledge may be given 
 by a pledge agreement, and is a common clause 
 in collateral notes. 
 
 132. REDELIVERY AND CONVERSION. 
 The pledgee must redeliver the identical thing 
 pledged, with the increase and profits, upon tender 
 of redemption by the pledger, except that he need 
 not deliver the identical certificates of stock. If 
 the pledgee does not redeliver he is guilty of con- 
 version, as he is at the time he makes an unwar- 
 ranted use or disposal of the pledge. The rule as 
 to measure of damage is generally the value at the 
 date of conversion, without reference to the nature 
 of the pledge. In New York State and in the 
 United States courts, in the case of conversion of 
 stocks, it is the highest value within a reasonable 
 
146 LOANS AND INVESTMENTS 
 
 time after the pledger becomes aware of the con- 
 version; in other States it is the value at date of 
 demand, or the highest intermediate value between 
 date of conversion and the date of trial, or the value 
 at date of conversion. 
 
 133. RIGHTS OF PLEDGEE AFTER DE- 
 FAULT. The pledgee upon default in redemption 
 at the agreed time by the pledger, may sue the 
 pledger upon the debt for which the pledge was 
 given as security, and may recover judgment with- 
 out affecting his lien on the property pledged; the 
 property pledged may then be applied on the 
 amount of the debt as represented by the judgment. 
 After default in redemption by the pledger, the 
 pledgee, on notice to the pledgor, and demand of 
 performance, and on reasonable notice of the time 
 and place of sale, may sell the property pledged at 
 public sale. Demand of performance is waived by 
 positive refusal to perform after performance is 
 due, but the pledger's right to notice of sale is not 
 thereby waived. This right to sell applies to all 
 property pledged except negotiable instruments; 
 these the pledgee must hold and collect as they 
 become due and apply the proceeds to the debt, in 
 the absence of a special power of sale. The reason 
 is that negotiable paper would never bring its true 
 value on a forced sale. The general power of the 
 pledgee to sell may be modified or enlarged by the 
 pledge agreement. Thus banks ordinarily require 
 of their borrowers a note waiving notice of time 
 
LOANS AND INVESTMENTS 147 
 
 and place of sale, and providing for private sale, 
 and many other provisions. A sale at a recognized 
 stock exchange has been held to be a sale at public 
 auction, but the point has not been clearly settled. 
 The pledgee, in the absence of agreement, has no 
 right to buy at the sale. If the subject matter of 
 the pledge can be divided the pledgee may sell only 
 such part as will discharge the debt; otherwise he 
 is liable for conversion of the part not necessary to 
 be sold. The notice should be served or given to 
 the pledger in person, or to an authorized agent 
 if the pledger have one. 
 
 134. TERMINATION OF PLEDGE. A 
 pledge is not terminated by the death or bank- 
 ruptcy of the pledger, but at the termination of 
 the pledge agreement the pledger's representatives 
 may make tender of the debt and demand the prop- 
 erty, and in default of such tender the pledgee may 
 sue the pledger's representatives or sell upon notice 
 to them. Payment terminates the pledge as does 
 redelivery, tender or sale, and if the pledgee does 
 not redeliver on a good and valid tender he converts 
 the pledge and may be sued for the value of the 
 property. 
 
 135. WAREHOUSEMEN AND WARE- 
 HOUSE RECEIPTS. The law relating to ware- 
 housemen and warehouse receipts is a branch of the 
 law of bailments. A warehouseman is one engaged 
 in the business of storing goods for others for com- 
 pensation. He is a bailee for hire and is required 
 
148 LOANS AND INVESTMENTS 
 
 by law to use reasonable skill and diligence, or 
 "ordinary" care as it is technically termed, in re- 
 spect to the property entrusted to him. Ordinary 
 care is that degree of care which men of common 
 prudence would exercise under similar circum- 
 stances with regard to their own property. A ware- 
 houseman is liable for ordinary negligence, or a 
 want of reasonable care. He is not an insurer 
 of the goods and is not responsible for their loss 
 where he has exercised ordinary care. A ware- 
 house receipt is a written acknowledgment by a 
 warehouseman that he holds certain described 
 goods in store for delivery to the person to whom 
 the receipt is issued or to his order where the 
 receipt is negotiable. The Uniform Warehouse 
 Receipts Act, which is now the law of thirty-three 
 States, codifies and makes uniform the law of ware- 
 house receipts. 
 
 136. COMMON AND STATUTORY LAW. 
 At common law, independent of statute, ware- 
 house receipts were assignable by delivery, or by 
 endorsement and delivery, and their transfer passed 
 to the assignee the title of the assignor to the prop- 
 erty. The transfer of the warehouse receipt had 
 the same effect as delivery of the goods themselves 
 and vested in the assignee the constructive posses- 
 sion, but he took no better right or title than that 
 possessed by the assignor. A valid transfer can be 
 made by a mere delivery of the receipt with intent 
 to pass title to the goods, without endorsement, 
 
LOANS AND INVESTMENTS 149 
 
 and statutes authorizing transfer of warehouse re- 
 ceipts by endorsement have been generally con- 
 strued not to invalidate a transfer of title by mere 
 delivery. But common law transfers, if they may 
 be so called, did not give to the assignee any greater 
 rights than the assignor possessed, and in a large 
 number of States, prior to the enactment of the 
 Warehouse Receipts Act, statutes were passed 
 declaring warehouse receipts negotiable. These 
 statutes, however, have been construed by the 
 courts as not conferring upon warehouse receipts 
 the full measure of negotiability which is possessed 
 by bills of exchange or promissory notes. They 
 gave to the holder to whom a receipt had been 
 regularly transferred by endorsement, the effect of 
 manual delivery of the goods represented; they 
 served to dispense with notice to the warehouse- 
 man that the receipt had been transferred, which 
 notice was generally otherwise necessary to protect 
 the holder from delivery of the goods to the original 
 bailor; and their effect was to transfer the title to 
 a bona fide purchaser free from any equities of 
 prior parties not apparent on the face of the in- 
 strument. They did not, however, confer upon the 
 transferee title to the goods as against one who 
 had a superior title to the transferor, nor confer 
 title where the receipt was innocently acquired 
 from a thief or finder, as against the true owner. 
 The Uniform Warehouse Receipts Act, which codi- 
 fies and makes uniform the common and statute 
 
150 LOANS AND INVESTMENTS 
 
 law, provides for two kinds of receipt, non-negotia- 
 ble and negotiable. The non-negotiable receipt is 
 one in which it is stated that the goods received 
 will be delivered to the depositor or to any other 
 specified person. The negotiable receipt is one in 
 which it is stated that the goods will be delivered 
 to the bearer or to the order of any person named 
 in such receipt. 
 
 137. NON-NEGOTIABLE WAREHOUSE 
 RECEIPTS. A non-negotiable receipt is not, gen- 
 erally speaking, a document upon which the banker 
 should advance value and receive in pledge. The 
 transferee acquires as against the transferor, the 
 title to the goods, subject to the terms of any agree- 
 ment with the transferor, and he acquires the direct 
 obligation of the warehouseman to hold possession 
 of the goods for him according to the terms of the 
 receipt. But prior to such notification, the title of 
 the transferee to the goods and the right to acquire 
 the obligation of the warehouseman may be de- 
 feated by the levy of an attachment or execution 
 upon the goods by a creditor of the transferee or 
 by a notification to the warehouseman by the trans- 
 feror or a subsequent purchaser from the transferee 
 of a subsequent sale of the goods by the transferor. 
 Furthermore, in case the goods are delivered by the 
 warehouseman to the transferor prior to notifica- 
 tion, the rights of the assignee or pledgee would 
 be endangered, if not defeated, as the warehouse- 
 man would not be responsible, although the receipt 
 
LOANS AND INVESTMENTS 151 
 
 was not produced and surrendered when the de- 
 livery was made. The banker, therefore, is not 
 particularly concerned with the non-negotiable 
 warehouse receipt except to let it alone and to have 
 an ability to know whether a receipt is non-nego- 
 tiable or negotiable. 
 
 138. NEGOTIABLE WAREHOUSE RE- 
 CEIPTS. Negotiable warehouse receipts are very 
 extensively pledged to bankers as collateral for 
 loans, but even under the Uniform Warehouse 
 Receipts Act they do not possess the full measure 
 of negotiability accorded by the law to bills of 
 exchange and promissory notes. They are nego- 
 tiable by endorsement and delivery, or by delivery 
 alone if in form so permitting, in the same way as 
 bills and notes, but although the receipt is, in form, 
 capable of being negotiated by delivery, as by en- 
 dorsement in blank, the bona fide transferee for 
 value from a thief or finder takes no title as against 
 the true owner. This is one risk which the banker, 
 as pledgee for value, incurs. If, however, a person 
 entrusted with a negotiable receipt by the owner 
 for a special purpose abuses his trust and makes a 
 wrongful negotiation, the bona fide transferee is 
 protected as against the owner. The transferee of 
 a negotiable receipt is also protected in his right 
 to the goods as against a delivery by the warehouse- 
 man without taking up the receipt. The Ware- 
 house Receipts Act requires, except in certain 
 special cases, such as sale to satisfy warehouse- 
 
152 LOANS AND INVESTMENTS 
 
 man's lien or in case of perishable or hazardous 
 goods, that where a warehouseman delivers goods 
 represented by a negotiable receipt he must take 
 up and cancel the receipt, or in case of partial de- 
 livery, make endorsement thereon, and failure to 
 do this makes him liable to the holder for value of 
 the outstanding receipt, whether the same was ac- 
 quired before or after such delivery, and such failure 
 is also made a criminal offense. This provision 
 applies only to negotiable receipts and without it 
 such receipts would frequently be valueless as se- 
 curity. Goods represented by an outstanding ne- 
 gotiable receipt are, by the Warehouse Receipts 
 Act, exempted from attachment or garnishment 
 by a creditor of the depositor while in the posses- 
 sion of the warehouseman, unless the receipt is first 
 surrendered or its negotiation enjoined. This is 
 an important provision for the protection of the 
 banker who takes the receipt as security for a loan. 
 139. WAREHOUSEMEN'S LIABILITY. 
 The Uniform Warehouse Receipts Act thus pro- 
 vides the rule of liability for contents of packages: 
 "A warehouseman shall be liable to the holder of 
 a receipt for damages caused by the non-existence 
 of the goods or by the failure of the goods to cor- 
 respond with the description thereof in the receipt 
 at the time of its issue. If, however, the goods are 
 described in a receipt merely by a statement of 
 marks or labels upon them, or upon packages con- 
 taining them, or by a statement that the goods are 
 
LOANS AND INVESTMENTS 153 
 
 said to be goods of a certain kind, or that the pack- 
 ages containing the goods are said to contain goods 
 of a certain kind, or by words of like purport, such 
 statements, if true, shall not make liable the ware- 
 houseman issuing the receipt, although the goods 
 are not of the kind which the marks or labels upon 
 them indicate, or of the kind they were said to be 
 by the depositor." 
 
 140. AGENTS OF WAREHOUSEMEN. 
 A further important question is whether a ware- 
 houseman, whose agent signs and issues a ware- 
 house receipt for goods which have not in fact been 
 received, is responsible to a transferee of the receipt 
 for the goods stated to have been received. The 
 rule of the common law, which has had a more 
 extensive application to cases of false bills of lading 
 issued by agents of carriers, was that the principal 
 was not bound, as the authority of the agent only 
 extended to the issue of receipts where goods had 
 been actually received and a receipt issued for goods 
 not in fact received was an act beyond the authority 
 of the agent and not binding on the principal even 
 in favor of a bona fide holder of the receipt. A few 
 States, among others New York and Pennsylvania, 
 hold the principal liable for the act of his agent in 
 such cases upon the theory of estoppel. The Uni- 
 form Warehouse Receipts Act in the provision last 
 above quoted changes the common law rule. It 
 provides that "a warehouseman shall be liable to 
 the holder of a receipt for damages caused by the 
 
154 LOANS AND INVESTMENTS 
 
 non-existence of the goods * * *" and this, 
 coupled with a further provision of the Act that 
 "the signature of the warehouseman may be made 
 by his authorized agent" makes him responsible to 
 a bona fide holder of a warehouse receipt which 
 acknowledges the receipt of goods not in fact re- 
 ceived. The banker, therefore, who loans money 
 upon a warehouse receipt falsely acknowledging 
 the receipt of 300 tubs of butter, or any other com- 
 modity, can compel the warehouseman to make it 
 good. 
 
 141. WARRANTIES OF GENUINENESS. 
 Where a receipt is negotiated or transferred for 
 value, the Warehouse Receipts Act provides a war- 
 ranty by the transferor of the receipt or of a claim 
 secured thereby, of the genuineness of the receipt, 
 that he has a legal right to negotiate or transfer it, 
 and that he has no knowledge of any fact which 
 would impair the validity or worth of the receipt. 
 Also that he has a right to transfer title to the 
 goods and that the goods are merchantable or fit 
 for a particular purpose whenever such warranties 
 would have been implied, if the contract of the 
 parties had been to transfer without a receipt the 
 goods represented thereby. This would enable a 
 banker, who took as pledge for a loan a forged re- 
 ceipt or a stolen receipt or a receipt for goods not 
 owned by the person who obtained the loan, to hold 
 the borrower responsible upon his warranty. But 
 the law exempts a pledgee of the receipt who re- 
 
LOANS AND INVESTMENTS 155 
 
 ceives payment of the debt for which the receipt 
 is given as security, either from the drawee of a 
 draft therefor or from any other person, from lia- 
 bility as warrantor of the genuineness of the receipt 
 or of the quantity or quality of the goods therein 
 described. 
 
 142. LIABILITY OF ENDORSERS. Al- 
 though a person who negotiates and sells a ware- 
 house receipt to another, for value, warrants the 
 genuineness of the receipt and the other matters 
 above specified, he does not, by endorsing the re- 
 ceipt, incur the ordinary liabilities which attach to 
 the endorser of a promissory note in case of default 
 of the maker. The Warehouse Receipts Act pro- 
 vides that "the endorsement of a receipt shall not 
 make the endorser liable for any failure on the part 
 of the warehouseman or previous endorsers of the 
 receipt to fulfill their respective obligations." This 
 is the law apart from the Warehouse Receipts Act 
 and has been so ruled, even where State statutes 
 have made warehouse receipts negotiable. The 
 liability is analogous to that of an endorser "with- 
 out recourse" of a promissory note. If the note is 
 not paid, the endorser cannot be held, but if the 
 note was a forgery or there was any defect of title, 
 he would be liable as warrantor. 
 
 143. WAREHOUSEMEN'S LIENS. The 
 warehouseman has a lien on the goods for his 
 charges, and statutes in many States have required 
 that his lien be stated in the receipt, otherwise he 
 
156 LOANS AND INVESTMENTS 
 
 cannot enforce such lien against the transferee for 
 value of the receipt. It is obvious that negotiable 
 receipts should show on their face what charges 
 are claimed against the goods. The Uniform 
 Warehouse Receipts Act requires that every re- 
 ceipt must embody "a statement of the amount of 
 advances made and of liabilities incurred for which 
 the warehouseman claims a lien. If the precise 
 amount of such advances made or of such liabilities 
 incurred is, at the time of the issue of the receipt, 
 unknown to the warehouseman or to his agent 
 who issues it, a statement of the fact that advances 
 have been made or liabilities incurred and the pur- 
 pose thereof is sufficient." 
 
 144. EXTENSIVE USE OF WAREHOUSE 
 RECEIPTS. A bona fide purchaser of a ware- 
 house receipt is one who has taken the receipt for 
 value without notice of defect in the title of the 
 transferor. A pledgee who takes a warehouse re- 
 ceipt as security for a loan is a purchaser for value, 
 and he acquires the pledger's title to the property, 
 so far as necessary to effect the object of the pledge. 
 By means of the Negotiable Warehouse receipt, 
 owners of millions of dollars of stored goods are 
 enabled, through pledge of the receipt, to obtain 
 needed loans and advances upon the security thereof, 
 and tide themselves over periods when the goods 
 are not readily salable. The warehouse receipt is 
 in many respects analogous to the bill of lading; 
 one represents goods in store, the other goods in 
 
LOANS AND INVESTMENTS 157 
 
 transit. Both are now used to an enormous extent 
 as instruments of credit, and loans and advances 
 which run into the billions of dollars are annually 
 made upon faith thereof. 
 
 145. COMMON CARRIERS. The transporta- 
 tion of merchandise by water and by land, f rom one 
 point to another at shorter or longer distances, is 
 a business of vast extent in our modern commerce. 
 The person or corporation who conducts this busi- 
 ness is termed a carrier. Carriers are of two classes, 
 private carriers and public or common carriers. A 
 private carrier is one who undertakes isolated cases 
 of transportation and whose usual vocation is dif- 
 ferent. He is a bailee of the goods entrusted to him 
 and, like other bailees, is bound to use ordinary 
 care where he carries for hire and a less degree of 
 care if the carriage is gratuitous. A common car- 
 rier is one whose regular calling is to transport, 
 for hire, goods and chattels for all who may choose 
 to employ and remunerate him. The common 
 carrier differs from an ordinary bailee in two im- 
 portant particulars (1) he is bound, according to 
 his facilities, to transport all goods which are 
 offered to him when coupled with proper remunera- 
 tion, (2) his common law liability is exceptional. 
 He is responsible for the goods, where lost or dam- 
 aged, as an insurer, except where the loss is caused 
 by act of God or public enemy. 
 
 146. BILLS OF LADING. A bill of lading 
 is a written acknowledgment by the carrier of the 
 
158 LOANS AND INVESTMENTS 
 
 receipt of the described goods, and an agreement, 
 for a consideration, to transport and deliver the 
 same at a specified place to the consignee or person 
 designated therein. The bill of lading must be 
 signed by the carrier, but it has been quite generally 
 held, with some few exceptions, that it need not 
 be signed by the shipper, and that the acceptance of 
 the bill by the shipper binds him to the terms of the 
 contract. The Uniform Bill of Lading Act provides 
 for the signature of the shipper, but the shipper does 
 not always sign and without his signature its ac- 
 ceptance by him completes the contract and binds 
 both parties to its terms. Bills of lading now in 
 common use are of two kinds, the Straight bill of 
 lading and the Order bill of lading. The Straight 
 bill of lading is an acknowledgment of the receipt 
 of goods and an agreement to carry and deliver to 
 a named consignee at destination. When this 
 agreement is fulfilled by the carrier its contract 
 is performed. The Straight bill contains no con- 
 tract of the carrier that he will require surrender 
 of the bill before delivery of the goods. The Order 
 bill of lading is a like receipt, but the contract is to 
 carry and deliver to the order of a specified person, 
 generally the shipper, and it contains an express 
 agreement that the surrender of the bill, properly 
 endorsed, shall be required by the carrier before 
 delivery of the property. In the forms approved 
 and recommended by the Interstate Commerce 
 Commission and generally used by carriers, the 
 
LOANS AND INVESTMENTS 159 
 
 Straight and Order forms of bill are identical, in- 
 cluding certain conditions on the back, except that 
 the Straight bill omits the following matters con- 
 tained in the Order bill: (1) the surrender clause, 
 .(2) the inspection clause, (3) the words "order of" 
 and (4) the word "notify," indicating the person to 
 be notified of the arrival of the goods. 
 
 147. NEGOTIATION OF ORDER BILLS. 
 The Uniform Bills of Lading Act, which has been 
 enacted in sixteen States and is a companion act to 
 the Warehouse Receipts Act, makes a distinction 
 between Straight or non-negotiable and Order or 
 negotiable bills of lading and provides that "a nego- 
 tiable bill may be negotiated by any person in 
 possession of the same, however such possession 
 may have been acquired, if by the terms of the bill 
 the carrier undertakes to deliver the goods to the 
 order of such person, or if at the time of negotiation 
 the bill is in such form that it may be negotiated 
 by delivery." The Uniform Bills of Lading Act, in 
 modified form, has also been passed by Congress 
 to take effect January 1, 1917. It applies to bills of 
 lading issued in interstate and foreign commerce. 
 Among its provisions is the one just quoted relat- 
 ing to negotiation of Order bills. This provision 
 gives a greater degree of negotiability than here- 
 tofore to Order bills of lading, because under it the 
 bona fide purchaser can acquire good title from a 
 thief or finder, if endorsed in blank so as to be 
 capable of negotiation by delivery. Order bills of 
 
160 LOANS AND INVESTMENTS 
 
 lading, however, are not in all respects on the same 
 footing as Straight bills of lading, for, as in the case 
 of warehouse receipts, there is no liability of the 
 carrier as insurer of the contents of packages where 
 he has described such contents merely by a state- 
 ment of the marks and labels upon them, and there 
 is no liability of an endorser, as in the case of prom- 
 issory notes, for default of the maker or prior en- 
 dorsers. The banker who loans money or makes 
 advances to one who assigns the bill of lading as 
 security is chiefly concerned with the Order bill 
 of lading. The Straight bill of lading affords him 
 no security, for there is no obligation of the carrier 
 to hold possession of the goods for the holder of 
 the bill, and their delivery to the consignee before 
 notice of the assignment of the bill of lading would 
 protect the carrier. The only bill of lading, there- 
 fore, which should be considered as security by the 
 banker is the Order bill, and even the taking of this 
 bill as collateral is sometimes attended with certain 
 risks. 
 
 148. FALSE BILLS. Heretofore a serious 
 risk to the purchaser or pledgee of an Order bill 
 of lading has arisen from the issue by the agent 
 of the carrier of a bill of lading acknowledg- 
 ing the receipt of goods not in fact received. 
 This might be done (1) mistakenly, (2) fraudu- 
 lently, as by collusion where there are no goods, 
 (3) as a matter of accommodation to the shipper, 
 to furnish him in advance with the means of ob- 
 
LOANS AND INVESTMENTS 161 
 
 taining credit and in the expectation that the goods 
 for which the bill has been prematurely issued will 
 be ultimately delivered to the carrier for transporta- 
 tion. By the rule of the common law which, before 
 the enactment by Congress of the modified Uniform 
 Bills of Lading Act, entitled "an act relating to 
 bills of lading in interstate and foreign commerce," 
 was recognized and applied by the Federal courts! 
 and by many State courts, the carrier was not liable 
 to a bona fide transferee or pledgee of the bill in 
 such case. The authority of the agent to sign and 
 issue bills of lading was held to exist only where 
 he had already received the goods and not to exist 
 in the absence of such receipt. Where he signed 
 and issued a bill, therefore, which acknowledged 
 the receipt of goods not in fact received, it was his 
 own act and not the act of the carrier, and the latter 
 was not bound to a transferee for value of the bill. 
 In some eight States the courts have refused to 
 apply this rule, and have held the carrier liable on 
 the ground that by holding his agent out to the 
 public as authorized to issue bills of lading he has 
 clothed him with an apparent authority in such 
 cases which the carrier is estopped to deny. In 
 some dozen or more States, special statutes have 
 also been enacted making the carrier liable, and 
 such liability is also provided by the Uniform Bills 
 of Lading Act, wherein the issue or negotiation 
 of bills without goods is also made a criminal 
 offense. The enactment by Congress of the Bills of 
 
162 LOANS AND INVESTMENTS 
 
 Lading Act above referred to, provides such lia- 
 bility in cases of interstate and foreign shipments, 
 and overturns the rule of non-liability applied by 
 the Federal courts. The operation of such rule is 
 now limited to intrastate shipments in a few States 
 only, where the Uniform Bills of Lading Act has 
 not been passed. The establishment of a liability 
 of the carrier for the truth of the statements in the 
 bill of lading is of vital importance, for otherwise, 
 wherever money is loaned upon a bill of lading 
 acknowledging the receipt of 100 bales of cotton, 
 or two carloads of shingles or 500 sacks of potatoes, 
 and no cotton, shingles or potatoes are behind the 
 bill, the money is lost, for in such cases the shipper 
 is generally irresponsible. The act of Congress 
 also makes it a criminal offense to negotiate or 
 transfer for value "a bill which contains a false 
 statement as to the receipt of the goods." 
 
 149. SPENT BILLS. Another but less seri- 
 ous risk, owing to its lesser frequency, grows out 
 of the rule applied by some State courts, though 
 not recognized in others, that where the goods 
 represented by an Order bill have been delivered 
 to a person holding the bill and rightfully entitled 
 thereto, but without requiring surrender of the bill, 
 the contract of the carrier has been performed, the 
 functions of the bill have ceased and it becomes a 
 spent or dead bill. Where this rule is applied, 
 should the holder of the unsurrendered bill, after 
 receiving the goods, fraudulently negotiate the bill, 
 
 - 
 
LOANS AND INVESTMENTS 163 
 
 the holder would acquire no enforceable rights, and 
 herein lies the risk. The Uniform Bills of Lading 
 Act provides a liability of the carrier to the holder 
 for value to whom a spent bill has been negotiated, 
 and a similar liability is provided by act of Con- 
 gress. The negotiation of spent bills is also made 
 criminal by the State Uniform Bills of Lading Act. 
 
 150. ALTERED BILLS. At common law, a 
 material alteration of a contract without consent 
 of the person obligated, destroyed it, and the holder 
 of such altered contract had no enforceable rights 
 therein. Both by one of the conditions of the 
 Uniform Bills of Lading and by provision of the 
 Uniform Act, an altered contract is now enforceable 
 for its original tenor and not destroyed completely. 
 The act of Congress also provides "that any alter- 
 ation, addition or erasure in a bill after its issue 
 without authority from the carrier issuing the same, 
 either in writing or noted on the bill, shall be void, 
 whatever be the nature and purpose of the change, 
 and the bill shall be enforceable according to its 
 original tenor." The risk from acquiring altered 
 bills has therefore been lessened, although there 
 is still danger of loss in the case of raised bills, as 
 where a bill acknowledging receipt of 10 boxes is 
 fraudulently raised to 100. 
 
 151. GOODS NOT OWNED BY SHIPPER. 
 Another, though infrequent, risk attendant upon 
 the giving of value upon the faith of an Order bill 
 of lading arises in the case where the shipper is 
 
164 LOANS AND INVESTMENTS 
 
 not owner of the goods shipped and is wrongfully 
 in possession of them. He delivers the goods to 
 the carrier and receives an Order bill of lading 
 therefor, upon which he obtains an advance. The 
 holder of the bill as security would, in this case, 
 have no right to the goods as against the true 
 owner. 
 
 152. GOODS LOST OR DAMAGED IN 
 TRANSIT. Where goods are lost or damaged 
 in transit through a cause for which the carrier is 
 exempted from responsibility by virtue of the con- 
 ditions in the bill of lading, of course there is an 
 impairment or loss of the security, as represented 
 by the bill of lading, unless there is coupled with 
 the bill of lading an insurance contract against such 
 loss. But in this particular case the risk is not as 
 great as might first appear, because the shipper or 
 owner of the goods to whom the advance has been 
 made upon security of the bill of lading, is generally 
 a responsible person who is liable for and will be 
 able to pay the money loaned, although the security 
 for such loan has been destroyed. It is only in 
 cases where insolvency or irresponsibility of the 
 shipper or debtor is concurrent with loss of the 
 goods from a cause for which the carrier is not 
 responsible that the holder of the security will 
 suffer. 
 
 153. ATTACHMENT OF GOODS REP- 
 RESENTED BY BILLS OF LADING. Numer- 
 ous cases have arisen in many of the State courts 
 
LOANS AND INVESTMENTS 165 
 
 where goods represented by an Order bill of lading 
 outstanding in the hands of a banker as pledgee 
 for value have been attached while in the possession 
 of the carrier by a creditor of the shipper. Lower 
 courts in many of these cases have failed to recog- 
 nize the rights of the banker holding the bill, and 
 have sustained the attachment; but almost in- 
 variably the higher courts of the different States 
 have upheld his rights, as pledgee for value of the 
 bill, as against the attaching creditor. In some 
 cases where the banker has been proved to be only 
 a collecting agent of the shipper, and not to have 
 advanced value for or given credit for the draft to 
 which the bill of lading is attached, the attach- 
 ments have been held valid; but wherever the 
 banker has taken title to the draft with the bill of 
 lading as security therefor, whether the full value 
 has been actually paid out to the shipper or only 
 credited to him in his bank account, the superior 
 rights of the banker as pledgee of the bill have been 
 upheld. The Uniform Bills of Lading Act pro- 
 vides an exemption from attachment of goods rep- 
 resented by an outstanding negotiable or Order, 
 bill of lading as follows: "If goods are delivered 
 to a carrier by the owner, or by a person whose act 
 in conveying the title to them to a purchaser for 
 value in good faith would bind the owner, and a ne- 
 gotiable bill is issued for them, they can not there- 
 after, while in the possession of the carrier, be 
 attached by garnishment or otherwise, or be levied 
 
166 LOANS AND INVESTMENTS 
 
 upon under an execution, unless the bill be first 
 surrendered to the carrier or its negotiation en- 
 joined. The carrier shall in no such case be com- 
 pelled to deliver the actual possession of the goods 
 until the bill is surrendered to him or impounded 
 by the court." The same language is contained in 
 the act of Congress except that the bill is termed 
 an "order" instead of a "negotiable" bill. 
 
 154. NON-LIABILITY OF PLEDGEE AS 
 WARRANTOR. In 1898 a court in Texas held 
 that a bank which had purchased a draft secured 
 by bill of lading for wheat and collected the amount 
 of the draft from the drawee, surrendering to him 
 the bill of lading, was liable to the drawee for the 
 amount collected where it turned out that the wheat 
 was musty and of an inferior quality than that 
 contracted for. The theory of the court was that 
 the bank was not only a purchaser of the draft, 
 but also a purchaser and seller of the wheat to 
 the drawee and an implied warrantor of the se- 
 curity. This doctrine was soon afterwards fol- 
 lowed by the Supreme Courts of North Carolina, 
 Alabama and Mississippi, but was subsequently 
 overturned in later cases in three of the four States 
 named, leaving the State of Mississippi as the only 
 one whose courts still adhere to this doctrine. The 
 contrary doctrine, that the bank purchasing a draft 
 and taking an assignment of the bill of lading in 
 pledge by way of security does not warrant the 
 genuineness of the bill or the quantity, quality or 
 
LOANS AND INVESTMENTS 167 
 
 condition of the goods, has been declared by the 
 Supreme Court of the United States and by a large 
 number of State courts, and is now expressly pro- 
 vided by the Uniform Bills of Lading Act, which, 
 however, provides the same warranties by seller to 
 purchaser as in case of transfer of warehouse re- 
 ceipts. Similar provisions are contained in the act 
 of Congress. 
 
 155. SHIPPER'S LOAD AND COUNT. 
 In cases where the goods represented by bills of 
 lading are loaded and counted by the shipper and 
 this is frequently the case where large factories are 
 located on spurs and sidings away from the main 
 track and away from the railroad freight depot 
 the practice is for the carrier to stamp on such 
 bills the words "shipper's load and count," which 
 indicate that the shipper has loaded and counted 
 the contents of a particular car or shipment, and 
 that the carrier is not responsible for the correct- 
 ness thereof. Obviously such bills, although they 
 may be Order bills, are not a safe basis of collateral, 
 for the integrity of the bill as to value of the ship- 
 ment rests entirely on the honesty of the shipper, 
 and the carrier is not responsible. The act of 
 Congress prohibits the insertion of words of this 
 character when goods are loaded by the carrier, 
 and also in certain cases where loaded by the ship- 
 per; that is to say, where the shipper of bulk 
 freight maintains adequate facilities for weighing 
 such freight, which are available to the carrier, and 
 
168 LOANS AND INVESTMENTS 
 
 makes written request of, and gives reasonable op- 
 portunity to, the carrier to ascertain the kind and 
 quantity of bulk freight, the carrier must do so 
 within reasonable time, and is prohibited from in- 
 serting in the bill "shipper's weight" or words of 
 like purport. 
 
 156. WORD "NOTIFY" ON ORDER BILLS. 
 It is sometimes assumed that the word "notify" 
 on an Order bill of lading carries notice that the 
 person to be notified has some right or equity in 
 the goods which might be asserted as against a 
 pledgee for value, and that it is therefore unsafe to 
 advance value upon such a bill. This is an er- 
 roneous assumption. The original form of bill of 
 lading was the Straight bill. But as under this bill 
 the carrier could deliver the goods to the con- 
 signee without taking up the bill, the shipper had 
 no means of retaining the goods as security until 
 he received payment of the purchase price. The 
 practice, therefore, became common of issuing bills 
 to order of the shipper, under which the carrier was 
 required to hold the goods and make delivery only 
 to the holder of and upon surrender of the Order 
 bill. The shipper would attach his bill to a draft 
 and forward it for collection and upon payment of 
 the draft by the purchaser of the goods, the bill 
 would be delivered to him and enable him to obtain 
 the goods from the carrier. The word "notify" 
 on such bills simply indicates a request to the 
 carrier that upon arrival of the goods he will notify 
 
LOANS AND INVESTMENTS 169 
 
 the person for whom they are intended that he 
 may, by paying the draft and obtaining possession 
 of and surrendering the bill of lading, receive de- 
 livery of the goods. In addition to sending the 
 draft and Order bill for collection, the practice is 
 now common for the shipper to obtain an advance 
 on the documents from his local banker, who, as 
 owner of the draft with the bill of lading attached 
 as security, has the collection made for his own 
 account. The Uniform Bills of Lading Act clears 
 up all doubt as to the effect of the word "notify" 
 in an Order bill by providing that "the insertion in 
 a negotiable bill of the name of a person to be noti- 
 fied of the arrival of the goods shall not limit the 
 negotiability of the bill or constitute notice to a 
 purchaser thereof of any rights or equities of such 
 person in the goods." The same provision is in the 
 act of Congress. 
 
 157. SURRENDER OF BILLS OF LADING 
 TO DRAWEES. Considerable doubt has arisen 
 in the past in the minds of bankers holding drafts 
 with bills of lading for collection, and some litiga- 
 tion has resulted, concerning the duty of the col- 
 lecting bank to surrender the bill of lading to the 
 drawee upon acceptance of the draft or his obliga- 
 tion to hold the security until the draft is actually 
 paid. The following provisions of the Uniform 
 Bills of Lading Act thus regulate the subject in 
 accordance with the weight of authority: Where 
 the seller of goods draws on the buyer for the price 
 
170 LOANS AND INVESTMENTS 
 
 of the goods and transmits the draft and a bill of 
 lading for the goods either directly to the buyer or 
 through a bank or other agency, unless a different 
 intention on the part of the seller appears, the 
 buyer and all other parties interested shall be justi- 
 fied in assuming: (a) If the draft is by its terms 
 or legal effect payable on demand or presentation 
 or at sight, or not more than three days thereafter 
 (whether such three days be termed days of grace 
 or not), that the seller intended to require pay- 
 ment of the draft before the buyer should be en- 
 titled to receive or retain the bill, (b) If the draft 
 is by its terms payable on time, extending beyond 
 three days after demand, presentation or sight 
 (whether such three days be termed days of grace 
 or not), that the seller intended to require accept- 
 ance, but not payment of the draft before the buyer 
 should be entitled to receive or retain the bill. The 
 provisions of this section are applicable whether 
 by the terms of the bill the goods are consigned to 
 the seller, or to his order, or to the buyer, or to his 
 order, or to a third person, or to his order. These 
 provisions, however, are not contained in the Act 
 of Congress. 
 
 158. COLLATERAL NOTES. Banks doing 
 an extensive collateral loan business usually have 
 a special form of collateral note. Such forms vary 
 in some particulars but the following is a typical 
 specimen: 
 
LOANS AND INVESTMENTS 171 
 
 New York ,191 
 
 $ 
 
 after date, FOR VALUE RECEIVED, the 
 
 undersigned jointly and severally promise to pay to the 
 order of THE INSTITUTE BANK OF NEW YORK 
 (hereinafter called the Bank), at its Banking Office in New 
 
 York City, DOLLARS, in United 
 
 States gold coin or its equivalent, having deposited with the 
 Bank, as collateral security for the payment of this note, or 
 any note given in extension or renewal thereof, as well as 
 for the payment of any other obligation or liability, direct 
 or contingent, of the undersigned, or any of them, to the 
 Bank, due or to become due, whether now existing or here- 
 after arising, the following property, viz. : 
 
 [Space for enumeration of collateral] 
 
 of a market value estimated by the undersigned at $ '; 
 
 and the undersigned agree to deliver to the Bank additional 
 securities, or to make payments on account to its satisfac- 
 tion, should the market value of the said securities, as a 
 whole, suffer any decline. The undersigned hereby give to the 
 Bank a lien for the amount of all such obligations and liabili- 
 ties upon all the property or securities now or at any time 
 hereafter given unto or left in the possession of the Bank by 
 the undersigned, whether for the express purpose of being 
 used by the Bank as collateral security, or for any other or 
 different purpose, and also upon any balance of the deposit 
 account of the undersigned, or any of them, with the Bank. 
 On the non-performance of this promise, or upon the non- 
 payment of any of the obligations or liabilities above men- 
 tioned, or upon the failure of the undersigned, forthwith, 
 with or without notice, to furnish satisfactory additional 
 securities, or to make payments on account, in case of de- 
 cline, as aforesaid, or in case of insolvency, bankruptcy, or 
 failure in business of the undersigned, or any of them, then 
 and in any such case, this note and all other obligations and 
 
172 LOANS AND INVESTMENTS 
 
 liabilities, direct or contingent, of the undersigned and each 
 of them, shall forthwith become due and payable, without 
 demand or notice; and full power and authority are hereby 
 given to the Bank to sell, assign, and deliver the whole of 
 the said securities, or any part thereof, or any substitutes 
 therefor, or any additions thereto, or any other securities 
 or property given unto or left in the possession of the Bank 
 by the undersigned, whether for the express purpose of be- 
 ing used by the Bank as collateral security, or for any other 
 or different purpose, or in transit to or from the Bank, by 
 mail or carrier, for any of the said purposes, at any broker's 
 board, or at public or private sale, at the option of the Bank, 
 without either demand, advertisement or notice of any kind, 
 all of which are hereby expressly waived. At any such sale, 
 the Bank may itself purchase the whole or any part of the 
 property sold, free from any right of redemption on the part 
 of the undersigned, which is hereby waived and released. 
 In case of any sale or other disposition of any of the prop- 
 erty aforesaid, after deducting all costs, or expenses of every 
 kind for collection, sale or delivery, the Bank may apply the 
 residue of the proceeds of the sale or sales so made, to pay 
 one or more or all of the said obligations or liabilities to it, 
 whether then due or not due, making proper rebate for inter- 
 est on obligations or liabilities not then due, and returning 
 the overplus, if any, to the undersigned, who agree to be 
 and remain liable, jointly and severally, to the Bank for any 
 deficiency arising upon such sale or sales. The undersigned 
 do hereby authorize and empower the Bank, at its option, 
 at any time, to appropriate and apply to the payment and 
 extinguishment of any of the obligations or liabilities, here- 
 inbefore referred to, whether now existing or hereafter con- 
 tracted and whether then due or not due, any and all moneys 
 now or hereafter in the hands of the Bank, on deposit or 
 otherwise, to the credit of or belonging to the undersigned, 
 or any of them. 
 
LOANS AND INVESTMENTS 173 
 
 The Bank may transfer this note and may deliver the said 
 collateral security or any part thereof to the transferee or 
 transferees, who shall thereupon become vested with all the 
 powers and rights above given to the Bank in respect there- 
 to; and the Bank shall thereafter be forever relieved and 
 fully discharged from any liability or responsibility in the 
 matter. No delay on the part of the holder hereof, in exer- 
 cising any rights hereunder, shall operate as a waiver of 
 such rights. 
 
 1 59. COLLATERAL LOAN AGREEMENTS. 
 Sometimes a special form of contract similar to 
 the following is made between banks and regular 
 loan customers : 
 
 WHEREAS, the undersigned expect, from time to time, to 
 borrow money from THE INSTITUTE BANK OF NEW 
 YORK (hereinafter called the Bank) and to pledge with the 
 Bank property of various kinds as collateral security for the 
 payment of such loan or loans to be hereafter made by the 
 Bank; Now, therefore, 
 
 IT IS AGREED by the undersigned with the Bank, that all 
 property thus pledged with it may be held by it as collateral 
 security for the payment of such loan or loans as well as for 
 the payment of any other obligation or liability, direct or 
 contingent, of the undersigned, or any of them, to the Bank, 
 due or to become due, whether now existing or hereafter 
 arising; and the undersigned agree to deliver to the Bank 
 additional securities, or to make payments on account to its 
 satisfaction, should the market value of the said securities, 
 as a whole, suffer any decline. The undersigned hereby 
 give to the Bank a lien for the amount of all such obligations 
 and liabilities upon all the property or securities now or at 
 any time hereafter given unto or left in the possession of the 
 Bank by the undersigned, whether for the express purpose 
 of being used by the Bank as collateral security, or for any 
 
174 LOANS AND INVESTMENTS 
 
 other or different purpose, and also upon any balance of 
 the deposit account of the undersigned, or any of them, 
 with the Bank. 
 
 On the non-performance of this promise, or upon the non- 
 payment of any of the obligations or liabilities above men- 
 tioned, or upon the failure of the undersigned, forthwith, 
 with or without notice, to furnish satisfactory additional 
 securities, or to make payments on account, in case of de- 
 cline, as aforesaid, or in case of insolvency, bankruptcy, or 
 failure in business of the undersigned, or any of them, then 
 and in any such case, all obligations and liabilities, direct 
 or contingent, of the undersigned and each of them, shall 
 forthwith become due and payable without demand or 
 notice ; and full power and authority are hereby given to the 
 Bank to sell, assign, and deliver the whole of the said se- 
 curities, or any part thereof, or any substitutes therefor, or 
 any additions thereto, or any other securities or property 
 given unto or left in the possession of the Bank by the 
 undersigned, whether for the express purpose of being used 
 by the Bank as collateral security, or for any other or differ- 
 ent purpose, or in transit to or from the Bank, by mail or 
 carrier, for any of the said purposes, at any broker's board, 
 or at public or private sale, at the option of the Bank, with- 
 out either demand, advertisement or notice of any kind, all 
 of which are hereby expressly waived. At any such sale, 
 the Bank may itself purchase the whole or any part of the 
 property sold, free from any right of redemption on the part 
 of the undersigned, which is hereby waived and released. 
 In case of any sale or other disposition of any of the prop- 
 erty aforesaid, after deducting all costs, or expenses of every 
 kind for collection, sale or delivery, the Bank may apply the 
 residue of the proceeds of the sale or sales so made, to pay 
 one or more or all of the said Obligations or liabilities to it, 
 whether then due or not due, making proper rebate for inter- 
 est on obligations or liabilities not then due, and returning 
 
LOANS AND INVESTMENTS 175 
 
 the overplus, if any, to the undersigned, who agree to be 
 and remain liable, jointly and severally, to the Bank for any 
 deficiency arising upon such sale or sales. The undersigned 
 do hereby authorize and empower the Bank, at its option, at 
 any time, to appropriate and apply to the payment and 
 extinguishment of any of the obligations or liabilities, here- 
 inbefore referred to, whether now existing or hereafter con- 
 tracted and whether then due or not due, any and all moneys 
 now or hereafter in the hands of the Bank, on deposit or 
 otherwise, to the credit of or belonging to the undersigned, 
 or any of them. 
 
 The Bank may assign or transfer this instrument and may 
 deliver the said collateral security or any part thereof to 
 the transferee or transferees, who shall thereupon become 
 vested with all the powers and rights above given to the 
 Bank in respect thereto; and the Bank shall thereafter be 
 forever relieved and fully discharged from any liability or 
 responsibility in the matter. No delay on the part of the 
 holder hereof, in exercising any rights hereunder, shall 
 operate as a waiver of such rights. 
 
 On the back of collateral notes and collateral loan 
 agreements some such provision as the following 
 may be printed: "In consideration of one dollar 
 paid to the undersigned, and of the making, at the 
 request of the undersigned, of the loan evidenced 
 by the within note, the undersigned hereby jointly 
 and severally guarantee to The Institute Bank of 
 New York, its successors, indorsees or assigns, the 
 punctual payment, at maturity, of the said loan, 
 and hereby assent to all the terms and conditions 
 of the said note, and consent that the securities for 
 the said loan may be exchanged or surrendered 
 from time to time, or the time of payment of the 
 
176 LOANS AND INVESTMENTS 
 
 said loan extended, without notice to or further 
 assent from the undersigned, who will remain bound 
 upon this guaranty, notwithstanding such changes, 
 surrender or extension." 
 
CHAPTER V 
 
 Seasonal Demands for Money 
 
 160. SEASONAL MOVEMENTS IN MONEY 
 MARKETS. The demand for money in the United 
 States is seasonal in character. This fact is largely 
 due to conditions pertaining to the marketing of 
 agricultural crops. Seasonal demands for money 
 vary to some extent in different sections of the 
 country in accordance with local conditions, but 
 the seasonal swings manifested in New England, 
 the Middle States, and the district tributary to 
 Chicago, are essentially the same. Since this terri- 
 tory includes New York City, the country's domi- 
 nant money market, it may be taken as typical. 
 This territory shows five important seasonal periods 
 which may be briefly described as follows: 
 
 (1) Throughout January and during the early 
 part of February there is normally a pronounced 
 "easing up" of the money market. By the fore 
 part of January the crop-moving demand for money 
 in the West and South is over and the return flow 
 of cash is at its height. There is a natural reaction 
 in part psychological which results from the 
 relaxing of the heavy strain on the money market 
 incident to January 1 settlements and to the pass- 
 ing of the holiday season. At this time freight 
 traffic, both on the railroads and the inland water- 
 ways, is relatively small. 
 
 177 
 
178 LOANS AND INVESTMENTS 
 
 (2) The next seasonal movement is the "spring 
 trade revival/' beginning about the middle of Feb- 
 ruary and extending until the latter part of March 
 or the fore part of April (in some years a week or 
 so later). This recovery is stimulated by the cheap 
 money prevailing during the preceding period, rail- 
 road traffic is released from the incubus of cold 
 weather and snow, and the inland waterways are 
 opened up; on April 1 comes the demand for large 
 interest and dividend settlements, and in this period 
 comes the spring demand of agriculturists for the 
 planting of the crops. 
 
 (3) The third important seasonal movement is 
 the weakening money market of the late spring, 
 followed by the summer depression. This period 
 extends from the fore part or middle of April to 
 the fore part of August. It is interrupted by a 
 temporary reaction about July 1, the time of semi- 
 annual settlements. This period shows the natural 
 reaction from the high rates of the preceding 
 period, the anticipation and later the realization 
 of the hot months of summer comprising the vaca- 
 tion period, the lessened demand for funds in the 
 middle West after the planting of the crops, and 
 the resulting return of cash to New York. The 
 declining and cheap money market at this time, 
 which finds expression in such phenomena as large 
 bank reserves, low percentage of loans to deposits, 
 low interest rates, gold exportations, and high 
 security prices, is to some extent self -corrective. 
 
LOANS AND INVESTMENTS 179 
 
 (4) The crop-moving period is the fourth 
 period. This period, the discounted beginning of 
 which is evidenced by the upward turn of inter- 
 est rates on sixty to ninety day commercial paper 
 and four months' time paper as early as the first 
 week in July, may perhaps best be dated from the 
 first week in August, when call rates begin their 
 upward movement and when bank reserves begin 
 their decline. Under the pressure of the crop- 
 moving demand for cash in the West and South, 
 bank reserves are depleted and the money market 
 tightens rapidly until about October 1. 
 
 (5) The fifth and last seasonal period in the 
 New York money market extends from about the 
 first week in October to the opening of the new 
 year. It is a period of considerable uncertainty 
 and of many minor fluctuations, but the demand 
 for moneyed capital continues large until after the 
 holiday season and January settlements. The 
 westward movement of cash falls off rapidly in 
 November and December, and by the latter month 
 the return flow has set in. The southward move- 
 ment declines in November, but shows some signs 
 of increasing temporarily in December. Gold im- 
 ports reach a low point in December. 
 
 Doubtless the Federal Reserve System will exer- 
 cise a large influence in the direction of lessening 
 the extent of these seasonal fluctuations, and pos- 
 sibly also some influence upon the delimitations of 
 the periods themselves. Seasonal demands for 
 
180 LOANS AND INVESTMENTS 
 
 money, however, are organic, and while new bank- 
 ing conditions may diminish their acuteness, the 
 problem of periodical variations promises to con- 
 tinue to complicate the banking business. 
 
 161. SEASONAL VARIATIONS IN NEW 
 ENGLAND. A comprehensive study of the causes 
 and effects of seasonal demands for money was 
 made a few years ago by Professor E. W. Kem- 
 merer of Princeton University, and published by 
 the Monetary Commission. According to Professor 
 Kemmerer, currency movements to and from New 
 England are principally to and from the Eastern 
 States (almost entirely New York City). In Janu- 
 ary there is a strong movement of cash from New 
 England to New York City, in part the result of 
 large purchases of cotton by manufacturers in 
 Massachusetts and vicinity, and in part probably 
 the result of the return flow of cash to the banks 
 after the holiday demand and of the call for New 
 York remittances in settlement of holiday pur- 
 chases. February shows a comparatively small 
 movement of cash in both directions. March and 
 April are characterized by heavy shipments of cash 
 from New York City to New England, caused in 
 part by the heavy demand for remittances to Massa- 
 chusetts manufacturers by western and southern 
 jobbers and in part probably by the spring needs 
 of New England farmers. May, June and July 
 appear to be moderately inactive months, so far 
 as currency movements between New England and 
 
LOANS AND INVESTMENTS 181 
 
 the Eastern States are concerned, with some flow 
 of cash in both directions, but no great preponder- 
 ance in one direction over the other. For August, 
 September and October the movement is toward 
 New England. The August movement is at least 
 in part due to the preparation on the part of New 
 England bankers for an anticipated difficulty in 
 getting funds from New York in the autumn, when 
 New York banks are subject to such large calls 
 from the West and South. The September and 
 October movement is largely due to remittances 
 made at that time by jobbers in the West and South 
 in settlement of accounts for the purchase of shoes, 
 dry goods, and other articles of New England 
 manufacture. For November and December cash 
 tends to flow from New England to New York City, 
 in response to the large purchases of cotton by New 
 England manufacturers during these months, the 
 drafts upon the mills for cotton coming mainly 
 through New York. 
 
 162. SEASONAL VARIATIONS IN THE 
 MIDDLE WEST. New York exchange in Chi- 
 cago is normally high throughout January, and 
 there is a strong movement of cash from Chicago 
 to New York at that time. The crop moving and 
 holiday demand being over, money tends to be rela- 
 tively cheap in Chicago, and flows to New York 
 City, where it is absorbed somewhat in speculative 
 activity and in the higher security prices which 
 normally rule the latter part of January and the 
 
182 LOANS AND INVESTMENTS 
 
 fore part of February. From the last of January 
 to the fore part of March, New York exchange 
 tends to fall, and shipments of cash from Chicago 
 to the Eastern States are very small. During this 
 period the demand for money in Chicago is in- 
 creased by the anticipated opening of navigation 
 on the Great Lakes, the demand on the part of 
 western bankers for currency to meet the spring 
 needs of farmers, and by the fact that the first of 
 March in many sections of the Middle West is 
 the commonest time for making settlements of 
 interest and principal on farm mortgages. New 
 York exchange reaches its minimum (for this part 
 of the year) early in March, and then advances 
 rapidly until it reaches its maximum for the year 
 the latter part of May. It then continues at a 
 high level until early in July, when the crop mov- 
 ing demands begin to make themselves felt. About 
 the first of July New York exchange begins to fall 
 in response to the crop moving demand, declining 
 rapidly, with minor interruptions, until early in 
 September, and then maintaining a low level until 
 the fore part of November. There is a strong 
 movement of currency from the Eastern States to 
 Chicago in August, September and October, reach- 
 ing its maximum for the year in October. During 
 the last seven or eight weeks of the year, the crop 
 moving demand having subsided, New York ex- 
 change tends to rise, and the return movement of 
 cash to the East begins. The seasonal movements 
 
a LOANS AND INVESTMENTS 183 
 
 in New York exchange in St. Louis are similar to 
 those in Chicago. The seasonal currency move- 
 ments between Chicago and the Eastern States are 
 fairly representative of those between the Middle 
 Western States as a whole and the Eastern States. 
 163. MIDDLE WEST AND SOUTHERN 
 STATES. Currency movements between the Mid- 
 dle Western States and the Southern States are 
 large, and afford valuable evidence as to the sea- 
 sonal variations in the demand for money in the 
 two sections compared with each other. January 
 is clearly the month of largest receipts by the 
 Middle Western States from the Southern States. 
 This January movement is apparently the return 
 movement of cash after the crop moving demand 
 in the South has subsided, and it is largely to St. 
 Louis and Chicago principally the former. While 
 there is a pronounced falling off in February in 
 this flow of cash to the Middle Western States, 
 it continues, nevertheless, in substantial amounts 
 for several months, with May as the second highest 
 month of the year. Beginning about the first of 
 May, the banks in the winter wheat section are 
 called upon to finance the winter wheat crop, and 
 this fact may explain in part the strong movement 
 of cash from the South in May. Receipts of the 
 Middle Western States from the Southern States 
 decline rapidly from June to November, and, con- 
 temporaneously, there is an increasing movement 
 of cash in the opposite direction, culminating in 
 
184 LOANS AND INVESTMENTS 
 
 October, and apparently showing that, despite the 
 great needs of the Middle West for cash in the 
 crop moving season, the needs of the South are 
 sufficiently greater to make the flow of cash 
 strongly southward from the Middle West. Sep- 
 tember and October have been found to be clearly 
 the months of largest movements of cash from the 
 Middle Western States to the Southern States, 
 while January has been found to be the month of 
 largest movement of cash in the opposite direction. 
 November and December show considerable move- 
 ments of cash in both directions, and may perhaps 
 best be classed as transitional months. 
 
 164. SEASONAL VARIATIONS IN THE 
 SOUTH. New York exchange in New Orleans 
 shows the usual advance during the fore part of 
 January, in response to the demands for New York 
 funds for investment during the slack season in 
 the South. As the funds are transferred, there is 
 naturally a decline (extending from about the third 
 to the eighth week), after which exchange exhibits 
 no important seasonal movements until about the 
 middle of May. From then until about the middle 
 of June exchange tends to advance. During the 
 next three weeks there is a reaction, followed by 
 a temporary advance, extending from about the 
 middle of July to the middle of August. The 
 southern crop moving demand begins in earnest 
 about the middle of August, when bills against 
 crop shipments are offered in large quantities, and 
 
LOANS AND INVESTMENTS 185 
 
 exchange is forced down rapidly and almost con- 
 tinuously until the minimum rates of the year are 
 reached in the fore part of November. The crop 
 moving demand having reached its high point about 
 the forty-fifth week, the return flow of cash from 
 nearby agricultural communities to New Orleans 
 sets in, money becomes more plentiful, and ex- 
 change rates advance, the upward movement being 
 expedited by the holiday demand for New York 
 exchange and by the demand incident to January 
 settlements. January is the month of strongest 
 movements of cash from the South toward the 
 Eastern States. The five months, February to 
 June, inclusive, are months of moderate move- 
 ments of cash toward the Eastern States. Begin- 
 ning with July, there is an increasing movement 
 in the opposite direction, culminating in September 
 and October, when the crop moving demand is at 
 its height. In November and December there is 
 considerable movement in both directions, and 
 those months may best be classed as transitional 
 months between the southward crop moving flow 
 of September and October and the northward 
 return flow of January. 
 
 165. SEASONAL VARIATIONS ON THE 
 PACIFIC COAST. From the beginning of Janu- 
 ary until about the first of March, New York 
 exchange in San Francisco rises rapidly. January 
 and February are months of relatively large ship- 
 ments of cash from San Francisco to the Eastern 
 
186 LOANS AND INVESTMENTS 
 
 Vt.- 
 
 States. Among the principal causes may be men- 
 tioned the fact that advances which have been made 
 for the movement of general crops are being repaid 
 rapidly, the demand for eastern remittances to pay 
 bills incurred for holiday purchases, and the desire 
 of local taxpayers to get movable funds out of the 
 State the latter part of February before the tax 
 returns of the first Monday in March are made to 
 the assessors. From the fore part of March to the 
 fore part of June, the general tendency of New 
 York exchange is upward, although there are minor 
 interruptions. March, April and May are months 
 of comparatively small shipments of cash by San 
 Francisco to the Eastern States, and the shipments 
 in the opposite direction are of little importance. 
 During the latter part of June, New York exchange 
 temporarily advances, probably in response to 
 demands for remittances east to meet July settle- 
 ments. Exchange rates decline from about the 
 first week in July to the fore part of September. 
 This decline is not sufficient to bring about the 
 shipment of cash to San Francisco from the Eastern 
 States. It is, however, sufficient to reduce the east- 
 ward flow of cash. The decline is probably due to 
 the large amount of eastern credits available locally 
 at this time from the shipments of California 
 products, especially green fruits, to eastern points. 
 From about the middle of September to the latter 
 part of October, New York exchange tends to rule 
 at near par. During this period the outward move- 
 
LOANS AND INVESTMENTS 187 
 
 ments of grain, green fruit, and fish, tend to force 
 exchange down, while the facts that this is the 
 quarter of large receipts of gold from Alaska, mak- 
 ing it a period of large receipts of gold bullion at 
 the mint, and that the San Francisco mint makes 
 returns for this gold in gold coin or New York 
 exchange at the option of the owner of the bullion, 
 tend to keep New York exchange at par. Exchange 
 falls rapidly from the latter part of October to 
 about the first of December, when it reaches the 
 lowest point of the year. Shipments of cash be- 
 tween San Francisco and the Eastern States are 
 unimportant during this period. November and 
 December, however, are the months of largest 
 transfers of cash to San Francisco. The fall in 
 exchange at this time appears to be due primarily 
 to the outward movement of dried fruits and to the 
 fact that this is the active part of the northern grain 
 season. The low point of the year is reached about 
 the last week in November, when the tax collector 
 for the city and the county of San Francisco has 
 been accustomed to withdraw large sums of actual 
 coin from circulation, and to lock much of it up 
 in the vaults of the city hall. 
 
 166. SEASONAL VARIATIONS IN FOR- 
 EIGN EXCHANGE. Sterling exchange rates 
 normally rise throughout January and the fore part 
 of February. Gold movements to and from the 
 United States at this time are generally not large, 
 but the tendency is toward exportation. In Lon- 
 
188 LOANS AND INVESTMENTS 
 
 don the money market tends to be reasonably 
 strong in January, weakening, however, in Febru- 
 ary. From the latter part of February until the 
 latter part of March, the tendency of sterling ex- 
 change rates is slightly downward. March is a 
 moderately weak month in the London money 
 market. Sterling exchange in New York advances 
 rapidly from the latter part of March until the 
 middle of June, reaching its highest point of the 
 year in June. For April, May and June the move- 
 ment of gold is outward, the average net exporta- 
 tions reaching their highest figures for the year in 
 May and June. The London market appears to 
 "ease up" considerably at this time. Sterling rates 
 continue high through July, though declining 
 slighty, and then decline rapidly under the influence 
 of cereal and cotton bills and of the crop moving 
 demand for money, until they reach their lowest 
 point of the year about the first week of October. 
 The months of October, September and November 
 (in the order named) are the months of largest 
 net gold importations. In the London money mar- 
 ket the fall months are commonly spoken of as the 
 period of the "autumnal pressure" or the "autumnal 
 drain." From the fore part of October until the 
 latter part of November, sterling exchange tends 
 to move upward, and from the latter date until the 
 end of the year it is very uncertain. Gold importa- 
 tions are usually much smaller in December than 
 in November. Recent important developments in 
 
LOANS AND INVESTMENTS 189 
 
 the use of finance bills, by which funds are bor- 
 rowed by American bankers in Europe, especially 
 in London, on collateral security, usually in the 
 form of stocks and bonds, have had an important 
 influence upon the sterling exchange market, tend- 
 ing to level somewhat the seasonal fluctuations. It 
 has, however, by no means destroyed the normal 
 seasonal swing of the exchange market. 
 
 167. SEASONAL VARIATIONS IN PRICES 
 OF BONDS. On theoretical grounds it would be 
 expected that periods of greatly increasing demand 
 for money, like the crop moving period, would tend 
 to cause lower prices for bonds, and that a period 
 of greatly decreasing demand, like that of mid- 
 summer, would tend to cause higher prices. In the 
 fall months a greater burden of work is imposed 
 upon the money in circulation, and unless its rate 
 of turnover increases the same amount will not do 
 the work except at a lower level of prices. The 
 extra burden of exchange work is carried in part 
 by the expansive power of deposit currency, but 
 even deposit currency must be supported by cash 
 reserves, and the need of cash for crop moving 
 purposes, which results in the westward and south- 
 ward movement of reserve money, limits the ex- 
 pansive power of deposit currency. For the pur- 
 pose of testing the truth of such reasoning, "and 
 interest" quotations were compiled and index num- 
 bers computed by Professor Kemmerer for the 
 prices of twenty-seven railroad bonds for periods 
 
190 LOANS AND INVESTMENTS 
 
 ranging from nine to nineteen years. These figures 
 were then combined into a composite for all bonds 
 for all years, each point in the composite represent- 
 ing three hundred and ninety-three or three hun- 
 dred and ninety-four bond years. The evidence 
 afforded by these figures shows the following 
 seasonal tendencies: 
 
 (1) There is a strong tendency for bond prices 
 to rise from the beginning of the year until about 
 the first week in February, a period during which 
 the money market has been found to be almost 
 invariably declining and weak. From the first to 
 the fifth week of the year the average price of all 
 twenty-seven bonds rose from 98.99 to 99.79, the 
 average index number of prices rising from 48.1 
 to 60.9. For twenty-six of the twenty-seven bonds 
 the average price was higher for the fifth week than 
 for the first, and for two hundred and sixty-eight 
 of the three hundred and ninety-four bond years 
 the price for the fifth week was higher. In addition 
 to the influence of the weak money market at this 
 period, it should be noted that after January (and 
 also July) disbursements of interest and dividends, 
 there are considerable amounts of funds seeking 
 reinvestment. 
 
 (2) The second seasonal period extends from 
 the fore part of February to the latter part of 
 March. It is a period during which the tendency 
 of prices is downward, and a period of increasing 
 demand for loanable capital. The average price 
 
LOANS AND INVESTMENTS 191 
 
 of the twenty-seven bonds fell from 99.79 for the 
 fifth week to 99.02 for the eleventh week, the 
 average index number falling from 60.9 to 51.1. 
 For twenty-five of the twenty-seven bonds the 
 average price was lower for the eleventh week than 
 for the fifth, and the price was lower for the eleventh 
 week in two hundred and ninety of the three hun- 
 dred and ninety-four bond years. 
 
 (3) The third seasonal tendency is for bond 
 prices to rise from the latter part of March until 
 the fore part of May, and to be comparatively high 
 from then until about the middle of June a ten- 
 dency in substantial harmony with the money mar- 
 ket movements of this season of the year. The 
 average price of the twenty-seven bonds rose from 
 99.02 for the eleventh week to 99.56 for the 
 twenty-fourth week, the average index number 
 rising from 51.1 to 56.7. For twenty-two of the 
 twenty-seven bonds the average price was higher 
 for the twenty-fourth week than for the eleventh, 
 and of the three hundred and ninety-three bond 
 years, two hundred and nine showed higher prices 
 for the twenty-fourth week than for the eleventh. 
 
 (4) For the period from the middle of June 
 until early September the evidence is contra- 
 dictory, but on the whole seems to point to a ten- 
 dency for prices to be moderately high. 
 
 (5) Beginning near the middle of September, 
 bond prices tend downward until about the middle 
 of October. The average price of all twenty-seven 
 
192 LOANS AND INVESTMENTS 
 
 bonds fell from 99.49 for the thirty-sixth week to 
 99.11 for the forty-first, and the average index 
 number fell from 54.9 to 50. For twenty-one of 
 the twenty-seven bonds the average price was lower 
 for the forty-first week than for the thirty-sixth, 
 and the price was lower for the forty-first week 
 in two hundred and thirty-six of the three hundred 
 and ninety-four bond years. 
 
 (6) From about the middle of October, after 
 the heaviest part of the crop moving demand for 
 money is over, until early December, bond prices 
 show an upward tendency. The average price of 
 all bonds rose from 99.11 for the forty-first week 
 to 99.75 for the forty-ninth week, the average index 
 number rising from 50 to 56.3. Twenty-five of the 
 twenty-seven bonds showed higher average prices 
 for the forty-ninth week than for the forty-first, 
 and of the three hundred and ninety-four bond 
 years, two hundred and forty-three showed a higher 
 price for the forty-ninth week. In addition to the 
 relaxation of the crop moving demand for money 
 at this time, another factor is the tendency of 
 dealers to accumulate bonds in anticipation of an 
 increasing demand rising from the dividend and 
 interest disbursements of January 1. The latter 
 part of December is a transitional period for bond 
 prices, as it has been found to be for many other 
 money market phenomena, the tendency being 
 downward from the forty-ninth to the fifty-first 
 week, and then upward for the fifty-second week. 
 
LOANS AND INVESTMENTS 193 
 
 The average price of all twenty-seven bonds fell 
 from 99.75 for the forty-ninth week to 99.39 for 
 the fifty-first week, and then rose to 99.58 for the 
 fifty-second. The corresponding average index 
 numbers were, respectively, 56.3, 52.2 and 55. For 
 twenty- three of the twenty-seven bonds the average 
 price was lower for the fifty-first week than for the 
 forty-ninth. The price was lower also for the fifty- 
 first week than for the forty-ninth in two hundred 
 and thirty-nine of the three hundred and ninety- 
 four bond years. The tendency toward instability 
 in December is shown by the fact that December 
 had both more maximum annual prices and more 
 minimum annual prices than any other month of 
 the year. 
 
 It may be concluded that the extent of the sea- 
 sonal variations in bond prices is usually not great, 
 but that the percentage is large enough in the abso- 
 lute to amount to many million of dollars annually. 
 The seasonal movements are for the most part not 
 very pronounced in their regularity, but on the 
 whole tend to conform to the normal seasonal 
 swing of the money market. 
 
 168. SEASONAL STRAINS ON BANK RE- 
 SERVES. Seasonal demands for money have a 
 direct influence on bank reserves. The enormous 
 sum of twenty billion dollars, more or less, is the 
 sum of individual deposits in American banks, 
 exclusive of savings banks. Of this large sum 
 approximately one-half consists of individual de- 
 
194 LOANS AND INVESTMENTS 
 
 posits subject to check without notice. Most of 
 the remainder consists of various kinds of savings 
 deposits, a considerable part of which are legally 
 payable on demand, and most of which are actually 
 so payable as a matter of banking policy and prac- 
 tice. Such total individual deposits represent over 
 five times the total money in circulation, while that 
 part of them which is subject to withdrawal 
 without notice represents probably at least three 
 times the country's total monetary circulation. 
 The obligation of banks to pay their demand 
 deposits on demand is so exacting that a failure to 
 do so is an act of insolvency, and may be made the 
 occasion of forcing the guilty bank to close its 
 doors. As regards a large proportion of their sav- 
 ings deposits, commercial banks may legally exer- 
 cise the privilege of requiring thirty or sixty days' 
 notice for withdrawal. They seldom do so, how- 
 ever, since refusal to pay savings deposits on 
 demand impairs public confidence in any bank, and 
 is likely to cause a run on its demand deposits. 
 
 169. ADEQUACY OF RESERVES. The 27,- 
 000 commercial banks, holding approximately ten 
 billion dollars of demand deposits, according to re- 
 cent statistics, have in their vaults less than one and 
 a half billions in cash, less than one-third of which is 
 "legal tender money." Their total cash reserves 
 therefore average less than 16 per cent, of their in- 
 dividual deposits subject to check without notice, 
 and but 7.6 per cent, of their total individual de- 
 
LOANS AND INVESTMENTS 195 
 
 posits. Subject to the requirements of law, which in 
 the United States usually compels banks to keep a 
 certain minimum reserve against deposits, and 
 subject also in some cases to minimum reserve 
 rules of the local Clearing House Association, each 
 bank must decide, according to the nature of its 
 own business, the characteristics of its own cus- 
 tomers their habits and prejudices and accord- 
 ing to the varying states of the money market, how 
 large a cash reserve it will keep. Most foreign 
 countries do not impose by law minimum reserve 
 requirements against bank deposits. It is the 
 almost universal practice, however, in the United 
 States. Such requirements have been imposed by 
 the national government since the passage of the 
 National Banking Act in 1863, and are also imposed 
 by the banking laws of nearly all the States. Inas- 
 much as reserve money in vaults yields no direct 
 profit to the bank, the desire for profits continually 
 exercises pressure to reduce the cash reserves to 
 a minimum. On the other hand, profits in the long 
 run require that the bank shall enjoy the confidence 
 of the public; and a reputation for strength and 
 conservatism is to a bank a great asset. The main- 
 tenance of a reserve at all times fully adequate to 
 meet demands is a large factor in building up a 
 bank's reputation, and, as many American bankers 
 can testify after a period of money stringency, such 
 a reserve is an important factor in the peace of 
 mind of bank officials. A reserve, however, that 
 
196 LOANS AND INVESTMENTS 
 
 would be adequate for one bank may be grossly 
 inadequate for another; while a reserve that is 
 adequate for a bank at one season of the year may 
 be far from adequate for the same bank at another 
 season. 
 
 170. LEGAL TENDER AND OTHER RE- 
 SERVE CREDITS. Bank deposits are payable 
 in legal tender money, and legal tender money 
 alone if the depositor insists. Therefore, narrowly 
 speaking, the term bank reserve might be limited 
 to legal tender money in the possession and owner- 
 ship of the bank. Inasmuch, however, as certain 
 other kinds of money, e. g., gold certificates, silver 
 certificates, National bank notes and Federal Re- 
 serve notes, are everywhere accepted by the public 
 in final payment of debts, and are redeemable in 
 legal tender money on demand, by an institution 
 of unquestioned financial stability, the United 
 States Government, it is reasonable from the eco- 
 nomic point of view not always the legal point 
 of view to extend the term to cover such kinds 
 of money. Furthermore, in countries where there 
 is a central bank, as in France and Germany, or 
 a group of central banks as in the Federal Reserve 
 System of the United States, with liberal powers 
 of bank note issue, and with public responsibilities 
 in the line of rediscounting, and of otherwise con- 
 serving the national money market, it seems 
 reasonable, from the economic point of view, to 
 extend the term reserve so as to cover not only 
 
LOANS AND INVESTMENTS 197 
 
 the bank notes of the central banks, but also 
 bankers' non-interest-bearing demand deposits in 
 these central banks. In France, Germany and 
 England bank notes of the central bank are legal 
 tender; and bank reserves, or "cash balances," as 
 they are commonly called, always mean "cash on 
 hand and in the central bank." When a legal mini- 
 mum reserve exists, as in the United States, it is 
 a debatable question whether it is sound public 
 policy to permit bank notes and bankers' deposits 
 in the central bank to be included to an unlimited 
 extent in the funds constituting the legal minimum. 
 171. SECONDARY RESERVES AND 
 THEIR CHARACTER. Having decided upon the 
 size of its normal reserves, i. e., a fair working 
 balance plus a reasonable "factor of safety," the 
 bank seeks to invest the remainder of its funds 
 where they will bring the largest returns consist- 
 ent with safety, and with the future development 
 of the bank's business. Since the great bulk of 
 a commercial bank's liabilities to its customers are 
 demand liabilities, and since those which are not 
 demand are usually payable on very short notice, 
 i. e., thirty to sixty days, the bank in making its 
 investments is constrained to put a substantial part 
 of its funds in quick assets, investments which can 
 be turned into cash promptly and without much 
 loss in time of need. This type of investment is 
 called a "secondary reserve," because, following 
 the cash on hand, it is a "second line of defense" 
 
198 LOANS AND INVESTMENTS 
 
 in case of exceptional demands. Strictly speaking 
 it is not a "reserve" at all, but a form of interest- 
 yielding investment. These secondary reserves 
 may consist of innumerable forms of investments ; 
 they may be interest-bearing demand deposits in 
 other banks, self-liquidating commercial paper ar- 
 ranged so that the maturities come along at short 
 intervals, commodity paper secured by cotton, grain 
 or other staple commodities, call or time loans on 
 stock exchange collateral; securities purchased, 
 especially listed railroad and municipal bonds, and 
 many other kinds of evidence of indebtedness. 
 Whatever form these investments take, the banker 
 in selecting them submits them to a three-fold test: 
 (1) Marketability in times of emergency, (2) Safety, 
 and (3) Income yield. 
 
 172. MARKETABILITY IN EMERGEN- 
 CIES. The first requirement of a secondary re- 
 serve is exchangeability in times of emergency 
 for money, which is itself the ultimate means 
 of payment and the most highly exchangeable 
 of economic goods. The emergencies to be met 
 may be runs on the bank, flurries in the local 
 money market; the fairly regularly recurring 
 periods of seasonal strain, like the crop moving 
 period in the fall or the period of the "spring re- 
 vival;" or it may be one of the great financial crises 
 that strike us occasionally. Whatever may be the 
 cause of the emergency, the secondary reserve is 
 the bank's insurance fund to protect it against em- 
 
LOANS AND INVESTMENTS 199 
 
 barrassment and insolvency. When the demand 
 comes, if the secondary reserve can be turned 
 quickly into cash, i. e., into a primary reserve, the 
 bank keeps open its doors and conserves its reputa- 
 tion; if it cannot be transmuted quickly into cash, 
 the bank suspends cash payments and usually closes 
 its doors either temporarily or permanently. Even 
 if later it meets its obligations and resumes busi- 
 ness, it will have suffered a serious impairment in 
 that great banking asset, reputation for financial 
 stability. The secondary reserve, like the second 
 line of defense in time of battle, when it is called 
 upon to be the first line, is first of all expected to 
 meet the attack, and meet it effectively. If it can 
 do so without serious loss, so much the better, but 
 loss or no loss, it should meet it. To this end it 
 must above all else be "emergency-marketable." 
 
 173. SAFETY OF INVESTMENT. It is 
 self evident that a bank's secondary reserves should 
 be safely invested. Banks want interest, but they 
 do not wish to lose the principal. This requirement 
 of safety is important in itself, and is a corollary 
 of the preceding requirement of marketability in 
 times of emergency. For, while unsafe and specu- 
 lative securities may have active markets in pros- 
 perous times, they have little market in times of 
 crisis; and it is then that the concerns that issue 
 them go to the wall in large numbers. Not all 
 intrinsically safe securities are marketable in 
 stringent times, but intrinsically safe securities 
 
200 LOANS AND INVESTMENTS 
 
 alone are highly marketable. Only assets that rest 
 upon "bed rock" values can be depended upon as 
 secondary reserves. 
 
 174. INCOME YIELD OF INVESTMENT. 
 In order of importance the third criterion of a 
 good secondary reserve is income yielding capacity. 
 Although the banking business is in a large measure 
 "affected with a public interest," and bankers are 
 in a high degree "public trustees," it is still true 
 that the chief motive power that drives the modern 
 banking machinery is the desire for financial profit. 
 A secondary reserve is primarily an emergency in- 
 vestment, but it is none the less an investment, and 
 the threatened emergencies which influence its 
 character are of infrequent occurrence and usually 
 of brief duration. The rate of "fair weather" profit, 
 therefore, is an important consideration even in the 
 formation of a secondary reserve. The profits, 
 however, should not be viewed with a near-sighted 
 vision. It is as true of secondary reserve invest- 
 ments as of other investments of bank funds, that 
 the successful banker is the man with foresight 
 the banker "with a telescope in his head" who 
 often passes by opportunities for good immediate 
 profits in order to seize opportunities to strengthen 
 and broaden his clientele for future business. 
 
 175. COMMERCIAL PAPER IN EUROPE. 
 For many years the chief secondary reserve in the 
 banks of Europe has been commercial paper, princi- 
 pally the commercial acceptance, in which the seller 
 
LOANS AND INVESTMENTS 201 
 
 of merchandise draws a bill of exchange on the 
 buyer at, say, sixty or ninety days' sight, the buyer 
 of the merchandise accepting the bill, and later pay- 
 ing it at maturity out of the proceeds of the sale of 
 the merchandise. The seller of the merchandise ordi- 
 narily discounts this paper at his bank. Such com- 
 mercial bills bearing the names of large and reliable 
 business houses become ideal secondary reserves 
 in the portfolios of banks. They bear at least two 
 names, i. e., that of the drawer and that of the 
 drawee, and often in addition the name of one or 
 more endorsers. They normally carry on their 
 face, or on documents attached, evidence of a com- 
 mercial transaction which is closed; the drawee, 
 i. e., the buyer of the goods, having accepted them 
 and obligated himself to pay for them a definite sum 
 of money at a specified date. These bills are ordin- 
 arily drawn for current merchandising transactions 
 and bear evidence that they are not for capital 
 investments. They are self liquidating in that the 
 sale of the goods by the drawee provides the funds 
 with which to pay the bill, and in that the goods 
 are ordinarily turned over rapidly. In view of the 
 fact that it is the drawers of the bills (i. e., the 
 sellers of the merchandise) who discount them at 
 the bank, not the drawees (i. e., the buyers of the 
 merchandise and the ones who are to pay the bills), 
 and of the further fact that the bills often pass 
 through several hands in the open market before 
 their maturity, these bills usually are paid promptly. 
 
202 LOANS AND INVESTMENTS 
 
 High grade paper of this kind is always acceptable 
 for rediscount at the great central banks of Europe, 
 and the proceeds of the rediscounting operation, 
 when left on deposit or taken in the form of bank 
 notes, serve as primary reserves. The great central 
 banks feel a public moral responsibility to rediscount 
 at their official discount rates such paper in practi- 
 cally unlimited quantities when the public interest 
 seems to demand it. The fact that this paper is re- 
 discountable at the central bank makes it also sal- 
 able in the open market, with the result that good 
 grade commercial bills in many parts of Europe are 
 in time of peace almost as dependable in emergencies 
 as is cash in vault. A bank with a reasonable amount 
 of such bills in its portfolio has an ideal secondary 
 reserve. 
 
 176. SITUATION IN FRANCE. Upon this 
 subject a brief reference to the testimony given 
 to members of the National Monetary Commission 
 by bankers in France will be useful. Officers of 
 the Credit Lyonnais, one of the leading banks of 
 France, testified as follows : 
 
 Question "Does the Bank of France rediscount 
 bills for the other banks in France?" 
 
 Answer "The Bank of France rediscounts all 
 bills when the person presenting the bill is admitted 
 to discount and when the bills have the necessary 
 three signatures, have less than three months to 
 run, and are payable in cities where the bank has 
 a branch. It is not legally obliged to discount all 
 
LOANS AND INVESTMENTS 203 
 
 bills presented, but, as a matter of fact, nobody has 
 ever complained of its way of proceeding." 
 
 Question "You regard that item of bills dis- 
 counted as your practical reserve because of your 
 ability to rediscount the bills at the Bank of 
 France? 
 
 Answer "Yes; bills discounted and cash are, 
 for an establishment such as ours, the most essen- 
 tial part of our liquid assets." 
 
 The founder of the Credit Lyonnais declared 
 that if the Bank of France did not exist he would 
 close the Credit Lyonnais in times of crisis. Ac- 
 cording to the estimate of the Governor of the 
 Bank of France, about 70 per cent, of the paper 
 held by the bank bore the signature of some bank 
 as one of the endorsers. 
 
 177. SITUATION IN OTHER EUROPEAN 
 COUNTRIES. A similar situation exists in 
 Germany and most other continental European 
 countries as regards the dependence of the com- 
 mercial banks upon the central bank for obtaining 
 emergency funds by rediscounting commercial 
 paper. In England the situation is somewhat 
 different in that the joint-stock banks rarely re- 
 discount at the Bank of England. However, these 
 banks loan funds extensively to discount and brok- 
 erage houses, and, when pressure comes for funds, 
 they call these loans, with the result that the dis- 
 count and brokerage houses resort to the Bank of 
 England for funds. Indirectly, therefore, the result 
 
204 LOANS AND INVESTMENTS 
 
 is much the same as on the continent. Reserve 
 money in England is "cash on hand and in the Bank 
 of England," and the statements of most banks 
 do not differentiate the two items. The Bank of 
 England always stands ready to rediscount prime 
 commercial paper and transmute it into reserves. 
 In Europe generally, therefore, prime commercial 
 paper is the chief dependence for a secondary re- 
 serve, and it meets in a high degree the three re- 
 quirements of a good secondary reserve, viz., 
 "emergency marketability," safety, and good in- 
 come yield. 
 
 178. SITUATION IN THE UNITED 
 STATES. The situation in the United States is 
 very different, although recent developments under 
 the Federal Reserve System are slowly changing 
 the American situation in the direction of that of 
 Europe. In the United States, commercial paper, 
 which consists chiefly of one name promissory 
 notes, has not until recently been very satisfactory 
 as a secondary reserve. The absence of any central 
 bank in this country for a couple of generations prior 
 to 1914, denied to American banks the privilege of 
 a practically unlimited market for the rediscount 
 of this commercial paper, a privilege which has so 
 long been enjoyed by European banks. Further- 
 more, the provisions of our National Banking Law 
 denying to National banks the privilege of estab- 
 lishing branches, and provisions in the banking 
 laws of many of our States either prohibiting en* 
 
LOANS AND INVESTMENTS 205 
 
 tirely the establishment of branches by State banks, 
 or imposing heavy restrictions upon their establish- 
 ment, has prevented the growth in this country 
 of many large banks. Our bond-secured bank note 
 system has been another inhibiting influence. 
 America is unique among the advanced countries 
 of the world in its great number of small and inde- 
 pendent banks, the chief business of most of which 
 is limited to a small community. There accord- 
 ingly developed no large commercial banks which 
 could be depended upon to provide a wide market 
 for the discount of commercial paper. The Na- 
 tional Bank Act as interpreted by the courts pre- 
 vented National banks from accepting time bills 
 drawn upon them, and bank acceptances were not 
 permitted under the banking laws of most of the 
 States. Accordingly, prior to the inauguration of 
 the Federal Reserve System, the bank acceptance, 
 which is such a highly marketable type of paper 
 in Europe, was almost unknown in this country. 
 Aside from the paper of a few large business 
 houses, which in recent years has been widely 
 marketed throughout the country by note brokers, 
 American commercial paper was essentially local 
 paper. 
 
 179. LACK OF COMMERCIAL PAPER 
 MARKET. Nothing that could be called prop- 
 erly a commercial paper market existed in the 
 United States. A petty amount of rediscounting, 
 it is true, was done for country banks by a few 
 
206 LOANS AND INVESTMENTS 
 
 large banks; also a considerable amount of direct 
 loaning to small banks on their customers' paper 
 as collateral. But there was no broad and depend- 
 able market in which banks could always secure 
 funds on their unmatured commercial paper in 
 times of emergency. Furthermore, one name 
 promissory notes, unlike the commercial accept- 
 ances so common in Europe, are not self liquidat- 
 ing paper. The notes are usually discounted at 
 the payer's own bank, i. e., the bank where the 
 purchaser of the goods keeps his account; not, as 
 so commonly in Europe, at the payee's bank, i. e., 
 the bank in which the seller of the goods keeps his 
 account. They are accordingly often renewed and 
 the borrowers are naturally averse to having their 
 notes pass out of the hands of their friendly local 
 bank, and into the hands of strangers. American 
 business men in the past have strenuously objected 
 to having their paper "hawked about from bank 
 to bank," and the practice of rediscounting with 
 another bank, when known, was looked upon as 
 a sign of weakness. For these and other reasons 
 American commercial paper was essentially non- 
 liquid paper. It could not be realized upon until 
 maturity, and often not then. It lacked the most 
 fundamental requirement of a secondary reserve 
 "emergency marketability" American bankers were 
 accordingly compelled to turn to bonds for their 
 secondary reserves. 
 
 180. BONDS AS SECONDARY RESERVES. 
 
LOANS AND INVESTMENTS 207 
 
 Although State banks in a number of States 
 are permitted to invest in stocks, the National 
 Banking Law as interpreted by the courts does 
 not permit National Banks to own stocks, except 
 to protect themselves from loss in the case of 
 loans previously made. The authority to invest 
 in bonds is enjoyed throughout the country by 
 State banks, and although not expressly granted 
 by the National Banking Act, has been held by the 
 courts to be implied in the power to carry on busi- 
 ness by discounting and negotiating promissory 
 notes, drafts, bills of exchange, and other evidences 
 of debt. As a matter of fact, National banks have 
 invested in bonds other than United States Govern- 
 ment bonds from the beginning of the National 
 banking system in 1863. There has been an in- 
 crease in the National banks' investment holdings 
 of such securities since the inauguration of the 
 Federal Reserve System. This increase, prob- 
 ably of little permanent significance, because of 
 the confused conditions of business during the 
 early part of the war period, and because the 
 release of hundreds of millions of reserve money 
 through the reduction in the legal reserve require- 
 ments of National banks, and the offering of lib- 
 eral facilities for rediscount through the opening 
 of the Federal Reserve banks, released large 
 amounts of bank funds at a time when the bond 
 market was particularly favorable because of the 
 offering at attractive rates of big blocks of Ameri- 
 
208 LOANS AND INVESTMENTS 
 
 can securities by the people of belligerent Europe. 
 According to the latest figures available the 
 security holdings of loan and trust companies are 
 slightly larger than those of National banks, while 
 those of State banks are about one-third as large 
 as those of National banks. 
 
 181. SECONDARY RESERVES UNDER 
 THE FEDERAL RESERVE SYSTEM. What- 
 ever may have been the utility of bonds in the past 
 as secondary reserves for commercial banks, a new 
 situation has been created by the Federal Reserve 
 System. The twelve Federal Reserve banks provide 
 liberal facilities for rediscount throughout the coun- 
 try, A broad interpretation of those provisions of 
 the Federal Reserve Act which describe the kinds 
 of paper that can be rediscounted, has been made by 
 the Federal Reserve Board. The Board has also 
 made a liberal interpretation of the open market 
 provisions of the act, bank acceptances and trade 
 acceptances are being given preferential discount 
 rates by the Federal Reserve banks, and their use 
 is being slowly extended. An open discount market 
 is developing. American commercial paper is losing 
 its rigidity as a bank asset, and also its provincial- 
 ism; it is becoming liquid and national. The Fed- 
 eral Reserve authorities, leading bankers, mer- 
 chants, and economists are doing much to level up 
 the character of our commercial paper. Banks with 
 a good grade of such paper in their portfolios can 
 now, for the first time in our history, be absolutely 
 
LOANS AND INVESTMENTS 209 
 
 certain of their ability to turn such paper into cash 
 either by sale in the open market or by rediscount 
 with a Federal Reserve bank. These privileges, to- 
 gether with the provision of the Federal Reserve 
 Act that after three years from the opening of the 
 Federal Reserve banks, only cash in vault and on 
 deposit with the Federal Reserve bank can be 
 counted by a member bank as legal reserve, appear 
 destined to induce commercial banks to place an 
 increasing part of their demand deposits in com- 
 mercial paper. 
 
 182. BUSINESS CYCLES. In addition to 
 seasonal variations, business is affected by longer 
 periods of alternating depression and activity. 
 Such alternations follow one another at irregular 
 intervals, and have become known as "business 
 cycles." Nobody can predict exactly the length 
 of any period of activity or the length of any 
 period of depression. Such periods in the past 
 have been of varying duration, and have been 
 characterized by similar phenomena, as follows: 
 
 (1) Beginning with a period of depression, there is a 
 gradual recovery, and business reaches a stage of what may 
 be called normal activity. From the normal stage business 
 may develop into a condition of abnormal activity, culminat- 
 ing in a crisis. The crisis itself may be accompanied by a 
 panic or not, but invariably a period of depression follows 
 any crisis. Banks are not mainly responsible for these 
 changes, for banking operations rather reflect than create 
 business conditions ; but the banking business is deeply con- 
 cerned with alternations between depression and activity. 
 
210 LOANS AND INVESTMENTS 
 
 When business is inactive the trend of commodity prices is 
 downward, and profits are small, if there are any profits at 
 all. The demand for capital is relatively small, including 
 the demand for bank loans. Banks at such times commonly 
 find that they could lend a good deal more than solvent 
 borrowers want. At such a period there is a good deal of 
 business house cleaning. Weak concerns are weeded out, 
 and those that stand the strain are forced to put into use 
 every device that will lessen the cost of production. A per- 
 iod of depression, therefore, may be regarded from many 
 points of view as creating the conditions necessary for more 
 prosperous times. 
 
 (2) What brings about a revival in business activity? 
 It is a little difficult to say, but usually it would seem to be 
 something which stimulates particular branches of business. 
 It may, for example, be the active demand in foreign coun- 
 tries for American agricultural products. If such a demand 
 comes, and there happen to be good harvests in this country, 
 obviously at least one class in the community gets a large 
 and satisfactory return for its endeavors. The demand for 
 other commodities from the agricultural sections of the 
 country would in such circumstances unquestionably in- 
 crease. Improved conditions in agriculture would have an 
 effect which would be felt to a greater or lesser extent 
 throughout the whole range of industry. This demand would 
 be greater in some branches than it would be in others.. 
 It might be particularly great for agricultural implements. 
 This increased demand for agricultural implements would in 
 turn create an increased demand for iron and steel products ; 
 and, again, the increased prosperity in agricultural sections 
 of the country would presumably extend to the railroads and 
 increase their demand for products. The increased demand 
 thus spread to these other lines of business would in turn 
 from them react back once more over the entire industrial 
 field, and thus by a process of induction, so to speak, each 
 
LOANS AND INVESTMENTS 211 
 
 kind of business would act and react upon all kinds of busi- 
 (niess in a favorable way. People would in such circum- 
 stances begin to feel a bit more optimistic about the future. 
 Wholesalers, jobbers and retailers would begin to stock up 
 more largely with all kinds of commodities in which they 
 deal. Financial conditions would be favorable to the advance, 
 because in a period of financial depression the demand for 
 capital is relatively small, including the demand for short- 
 time loans. All conditions, then, are favorable to the expan- 
 sion of business in case a profitable demand arises for addi- 
 tional products of industry. A period of recovery has then 
 been reached. 
 
 (3) With the advent of business activity an increased 
 number of people are willing to invest additional capital for 
 an expected future demand. A willingness manifests itself 
 to extend railroads, to enlarge factories or build new fac- 
 tories, to construct additional office buildings, etc., and for 
 the time being no difficulty is encountered in securing capital 
 for such enterprises. This construction work necessarily 
 creates an increased demand for the production of industries 
 which supply material for construction purposes, notably 
 the iron and steel industry. Prices now begin to advance 
 and perhaps advance rather rapidly. This further increases 
 business activity for the time being, for when prices advance 
 profits immediately increase, and for a very natural, simple 
 reason. Wages and salaries do not move up very rapidly, 
 not nearly so rapidly as prices of most commodities may 
 move. Naturally, therefore, the advantages from advance 
 in prices goes to those persons who own the current prod- 
 ucts of industry. The persons who own the current products 
 of industry are the active business men and the sharehold- 
 ers in corporations. Increased profits naturally stimulate 
 further enterprises, further construction and further invest- 
 ments designed to supply additional commodities of all 
 sorts. Now the demand for capital may begin to outstrip 
 
212 LOANS AND INVESTMENTS 
 
 current savings. Rates, not only for short-time loans but 
 for capital which is to be invested for long periods, begin to 
 advance, but the business man is perfectly ready to pay 
 these higher rates, because his profits, owing to higher 
 prices, are unusually large. 
 
 (4) This is the situation of affairs during a period of 
 activity which becomes a period of normal business activity. 
 When prices are moving upward profits are large, and errors 
 of judgment are particularly likely to be made in the invest- 
 ment of additional capital. The assumption is made that 
 profits will remain at their existing high level or perhaps 
 reach a still higher point. Less care is exercised in such 
 circumstances in making investments, and the willingness 
 to pay fancy prices for the capital which is secured is 
 marked. Moreover, after a time, wages do begin to advance, 
 and even salaries may move up a little, though they are the 
 last to be affected. The upward movement of wages may 
 be more rapid after a while than the further upward move- 
 ment of prices, although on the whole that does not seem 
 to be the case. From the study of price statistics and wage 
 statistics it does not appear that in the year or two of abnor- 
 mal activity preceding a crisis wages in general have been 
 moving up more rapidly than prices. The serious cause for 
 trouble in the labor situation is to be found elsewhere. The 
 increased activity of business necessarily means full employ- 
 ment for everybody and competition for workmen and a 
 larger amount of overtime. The results are higher costs of 
 production. Men are taken on rapidly, and the average 
 efficiency of the men is lowered, partly because men are 
 naturally not so efficient when they know they can with 
 perfect ease get another equally good and perhaps better 
 position, partly because of inadequate training, since busi- 
 ness is so active that there is not time to train the newer 
 men taken on, and partly because of overstrain. Men can 
 work overtime for a short period without affecting their effi- 
 
LOANS AND INVESTMENTS 213 
 
 ciency, but a good deal of overtime is bound to lessen the 
 average output per hour of the workman. All of these 
 elements tend to increase the labor cost of production 
 toward the close of active business, and all of these are fac- 
 tors quite independent of the amount of wages paid. 
 
 (5) In a period of very active business, also, there is less 
 time to devise and put into operation further arrangements 
 for lessening cost. The thing which seems important is to 
 get out product and get it out as rapidly as possible. Just 
 because profits have been large, business men are prepared 
 to take more risks. They are prepared to extend their opera- 
 tions unduly on the capital which they themselves have 
 invested in their business. They trust that everything will 
 come out all right, even though they allow a good many 
 bills payable to accumulate ; and even though they are grant- 
 ing more and more credit to their customers. Balance sheets 
 show an increased amount of receivables, and an increased 
 amount is borrowed on short time. When the supply of 
 capital available for long-time investment becomes a scarc- 
 ity, when it becomes difficult to float issues of bonds, or to 
 secure money through additional preferred or common 
 stock, a business which is expanding its operations is likely 
 to attempt to do so on the basis of an increased amount of 
 short-time credit. Now a concern which has borrowed a 
 large amount on short time is in a very vulnerable position. 
 If anything happens which delays collections very much, or 
 if anything happens to banks which makes them desire to 
 contract loans, such an overextended business gets into diffi- 
 culties. Moreover, if anything happens which tends to check 
 the upward movement of prices, which causes profits to de- 
 cline, it will have a serious effect upon such a business, for 
 after all one of the considerations taken into account in 
 granting short time credit is the high earning power of the 
 borrowing concern. If it is evident that the earning power 
 is lessened, banks may be inclined to curtail loans. 
 
214 LOANS AND INVESTMENTS 
 
 (6) All the conditions, therefore, tend to become unfav- 
 orable in a period of general business activity. The situation 
 becomes one in which comparatively slight disturbing 
 influences may cause a collapse. It is, however, impossible 
 to predict just when a collapse will come. Sometimes the 
 business situation changes slowly from one of business 
 activity to one of depression, without any striking or dra- 
 matic circumstances. That is, however, not the rule. As a 
 rule, a crisis marks the transition between business activity 
 and business depression. At the end of a period of very 
 active business, an exceptionally large number of concerns 
 are in a position where anything which lowers their earning 
 power, or which delays the payment to them for what they 
 have sold, will put them into difficulties. These difficulties 
 may be only temporary, if the earning power is good, but 
 whether they are temporary or permanent the immediate 
 effect is pretty much the same it weakens the banks, it 
 destroys confidence in the immediate future of business, and 
 brings home to people generally that it is highly probable 
 that over all the field of industry there are presumably many 
 weak and overextended concerns. When people begin to 
 feel this way about the situation, they naturally cancel all 
 plans for future investment which they can by any means 
 cancel. Plans for construction work of all sorts are given 
 up, and the demand for the various materials which go into 
 construction work falls off. Prices drop, and with the fall 
 of prices profits drop, and many concerns which were based 
 upon the assumption that profits would continue at the rate 
 at which they were when those enterprises were started go 
 to the wall. Then is seen the beginning of a period of depres- 
 sion once more, which after a time will be used for another 
 business house cleaning. Crises may degenerate into panics 
 or they may not, and it does not depend so much upon the 
 severity of the crisis as it does upon the character of the 
 banking system. When a crisis comes on, people engaged in 
 
LOANS AND INVESTMENTS 215 
 
 business attempt to strengthen themselves against a storm. 
 They do it in two ways by deferring payments to others 
 and by seeking to get paid by others and seeking to borrow 
 from banks. The demand for accommodation from the 
 banks is invariably increased when a crisis comes along. 
 The proceeds of such loans are commonly not used, but are 
 wanted as a sort of insurance or backlog. 
 
 (7) Under such circumstances, the contraction of loans 
 by banks not only makes the general business situation for 
 the moment more unsatisfactory, but it also lessens public 
 confidence in the banks and leads people to withdraw money 
 from the banks, thus still further strengthening the tendency 
 of the banks to force contraction. In our various crises this 
 course has been followed until panic conditions have been 
 created, and until the banks have realized that it was impos- 
 sible to insist upon further contraction because it would 
 involve general ruin. The banks have then, when forced by 
 panic conditions, continued loans and have also sometimes 
 suspended cash payments. In other countries, and it is 
 hoped in this country under the Federal Reserve System, the 
 contraction of loans in crises is not insisted upon simply for 
 the purpose of strengthening the banks. It is hoped that 
 there will be sufficient cash and credit available so that loans 
 will not be contracted at such times, but that a sufficient 
 increase in loans will be made to meet the needs of the busi- 
 ness community. If we get such conditions crises will not in 
 the future in this country degenerate into panics. 
 
CHAPTER VI 
 
 International Exchange 
 
 183. FOREIGN EXCHANGE. Foreign ex- 
 change is the business which is concerned with the 
 buying and selling in one country of rights to 
 money in other countries, available either immedi- 
 ately or in the future, for the purpose of settling 
 debts incurred in the broad transactions of inter- 
 national commerce. The business seems commonly 
 to be regarded as a very mysterious subject, one 
 beset with innumerable complications. The gen- 
 eral principles of the subject are, however, by no 
 means abstruse. The conduct of a foreign ex- 
 change department requires special training and 
 a certain natural ability; but any intelligent per- 
 son can readily obtain an understanding of the 
 subject, and such an understanding is of much 
 value to those engaged in other branches of 
 banking. 
 
 184. DOMESTIC EXCHANGE. Much for- 
 eign exchange business is closely akin to certain 
 kinds of domestic business carried on by all banks, 
 such as making payments and collections between 
 different parts of the country. In this particular 
 domestic exchanges are closely analogous to for- 
 eign exchanges. Domestic exchange rates rise and 
 fall within limits which are set by the plentif ulness 
 or scarcity of drawable funds in financial centers 
 
 216 
 
LOANS AND INVESTMENTS 217 
 
 or by the cost of shipping currency between any 
 two places. The quotations are usually expressed 
 in a premium or discount on a purchase or sale of 
 $1,000. If it costs, for example, 50 cents to ship 
 $1,000 between two places, the rate of exchange 
 may be up to 50 cents above or below par, depend- 
 ing upon the effect of supply and demand upon 
 the funds utilized. 
 
 185. DEMAND RATES OF EXCHANGE. 
 Foreign exchange demand rates fluctuate in es- 
 sentially the same way. They move above and 
 below par to the gold export or gold import point, 
 and these export and import points are determined 
 by the cost of shipping, not currency, but gold. 
 Quotations are, however, expressed in a different 
 manner, because of the differences in the monetary 
 units of different countries. It would be incon- 
 venient to express foreign exchange rates in the 
 terms used for domestic exchange, although it 
 would be possible. 
 
 186. MINT PAR OF EXCHANGE. The 
 basis of exchange between two systems of coinage 
 is known as the mint par of exchange, and is de- 
 scribed as the rate at which the standard coin of 
 one country is convertible into the standard coin 
 of another in accordance with mint laws. This 
 basis of exchange can only be effective between 
 countries having the same standard of value. As 
 an example, the English sovereign is by law made 
 to weigh 123.27447 grains troy or 7.98805 grammes 
 
218 LOANS AND INVESTMENTS 
 
 of gold eleven-twelfths fine. The United States 
 ten dollar gold piece, the golden eagle, is by law 
 made to weigh 258 grains of gold, nine-tenths fine. 
 To find the mint par between the two coins, the 
 following method is used: 
 
 Question How many dollars equal one pound? 
 
 If the weight of one pound equals 123.274 grains 
 standard gold 
 
 If standard gold of 12 grains equals 11 grains 
 of fine gold 
 
 If fine gold of 232.2 grains equals 10 dollars 
 1 X 123.274 X 11 X 10 
 
 = $4.8665 
 
 1 X 12 X 232. 2 
 
 Mint par is One pound equals 4.8665 dollars. 
 
 187. STERLING EXCHANGE. If it costs, 
 for example, in normal times, $2.50 to ship $1,000 
 in gold to England, then $2.50 sets the limit to 
 the possible fluctuation in sight exchange. The 
 par of exchange between the United States and 
 England is $4.8665 and the exchange rates fluctu- 
 ate above and below this figure by the cost of ship- 
 ping gold to England. Such cost is usually at 5 
 per mille, or .024 cents. This added to the mint 
 par of exchange is dollars 4.89, which we may 
 assume to be the limit beyond which the American 
 debtor will not go in buying exchange on London 
 for gold will then be shipped to settle debts. This 
 limit is known as a gold or specie point. 
 
 188. FRENCH EXCHANGE. In the case of 
 
LOANS AND INVESTMENTS 219 
 
 France the quotation is expressed in a different 
 manner. Instead of being expressed in United 
 States money it is expressed in francs in the 
 number of francs which the gold in the dollar will 
 make. The gold in a dollar will make five francs 
 eighteen and one-eighth centimes (francs 5.18J4). 
 Exchange on Paris therefore fluctuates above and 
 below this point by the cost of shipping gold to 
 Paris. 
 
 189. GERMAN EXCHANGE. Exchange on 
 Berlin, like that on London, is expressed in United 
 States money, but instead of using the mark, four 
 marks are made the basis of the quotation. The 
 gold in four marks coined into dollars makes ninety- 
 five and three-sixteenths cents (cents 95 3/16). 
 Consequently German exchange may rise above 
 and fall below this point by the amount that it 
 costs to send gold to Berlin. Changes in Paris and 
 Berlin rates are usually quoted in fractions, 1/8, 
 1/16, and 1/32, while sterling exchange is quoted 
 to four points of decimals. 
 
 190. SIGNIFICANCE OF CHANGES IN 
 EXCHANGE QUOTATIONS. When exchange 
 is expressed in United States currency, a rising 
 quotation indicates an approach towards the export 
 point. It also indicates a demand for remittances 
 which is in excess of the supply. When, however, 
 quotations are expressed in the currency of a for- 
 eign country, the opposite is true. A fall in the 
 quotations then indicates an approach to the export 
 
220 LOANS AND INVESTMENTS 
 
 point. For example, a payment of one thousand 
 pounds is to be made in London. If exchange is 
 near the export point more will be paid than if it 
 is near the import point, for at the export point 
 the gold value of the sovereign plus the cost of 
 shipping will be paid. If the rate were $4.88, more 
 would be paid to send one thousand pounds to 
 London than if the rate were $4.86. But suppose 
 it is desired to pay one thousand francs in Paris. 
 Clearly more will be paid if only 5 francs 16 cen- 
 times are obtainable for a dollar than if 5 francs 
 18 centimes for a dollar were obtainable. 
 
 191. EXPORT AND IMPORT POINTS. 
 The expenses incurred in shipping gold determine 
 the export and import points, or gold or specie 
 points as they are known. The obvious expenses 
 are freight, insurance, commission and the cost 
 of packing the gold. All these elements of expense 
 are somewhat variable. Freight charges may not 
 be uniform, and it makes a difference as to the 
 kind of gold available for shipment. The most 
 inexpensive form for the purpose is gold in bars. 
 Bars can be packed more handily, are of full weight, 
 and there is less loss from abrasion than in the 
 case of shipments of coin. Gold bars are secured 
 from the United States Treasury at a constant 
 charge of 4 cents per $100. In the past it has not 
 always been possible to get an adequate supply of 
 bars, but in the future this difficulty will probably 
 not present itself, because the Government has 
 
LOANS AND INVESTMENTS 221 
 
 been empowered to hold gold in the form of bars 
 against gold certificates. Formerly all the gold 
 thus held was coined. The export point will at 
 times in the future be a little lower than in the 
 past, because of this possibility of securing gold 
 bars. 
 
 192. VARIABLE PRICES OF GOLD. The 
 great European central banks have a sliding scale 
 of rates for gold, buying bars and foreign coin at 
 coinage value as a maximum price and at that 
 price less the loss of interest during the period 
 required for coinage as a minimum price. In sell- 
 ing gold they impose rates which offset in varying 
 degree the advantage of shipping bars or foreign 
 coin rather than more or less worn domestic coin. 
 By these means the importation of gold is at times 
 stimulated, or its exportation obstructed, but the 
 influence is slight and temporary. In the long run 
 they have no appreciable influence upon the dis- 
 tribution of the precious metal throughout the 
 world. 
 
 193. TIME FACTOR IN GOLD SHIP- 
 MENTS. A very important element of expense 
 in gold shipments is time. If a fast express steamer 
 is sailing the import point is nearer par than during 
 a week when only the slower boats are available. 
 This is a factor, however, only influencing imports. 
 When $1,000,000 of gold is exported sight exchange 
 can at once be sold to an equivalent amount. The 
 exporter has his money at once. Suppose, how- 
 
222 LOANS AND INVESTMENTS 
 
 ever, it is a case of imported gold. The importer 
 loses the interest the money would have earned in 
 London while the gold is in transit, consequently 
 the gold import point is somewhat further away 
 from par than the gold export point. If we assume, 
 for example, that at a given moment the gold ex- 
 port point to London is about iy 2 cents above par, 
 then we would probably find that the gold import 
 point was something like 2 cents below par, the dif- 
 ference being increased or diminished as foreign 
 interest rates rose or fell. It should also be noted 
 that foreign central banks frequently allow immedi- 
 ate credit for gold while in transit. This, of course, 
 brings the export point still nearer the par of 
 exchange. There has been a slow but steady re- 
 duction in the possible range of demand exchange 
 fluctuation. Twenty or thirty years ago the export 
 point to London was above $4.89. It is now 
 normally in the neighbourhood of $4.88. The im- 
 port point was then in the vicinity of $4.83. It is 
 now normally above $4.84. But from what has been 
 said it will be seen that the exact point at which it 
 is possible to export or import gold at a profit is 
 subject to much variation even within short periods 
 of time. 
 
 194. CABLE TRANSFERS. The cable trans- 
 fer rate is always above the demand rate. It gives 
 the purchaser the amount of his purchase immedi- 
 ately, whereas in the case of demand exchange the 
 proceeds will not be placed to his credit until the 
 
LOANS AND INVESTMENTS 223 
 
 steamer arrives on the other side six to ten days 
 later. The seller of cable transfers loses interest 
 on the amount of his sales at once, since his bal- 
 ances in the foreign banks, which uniformly draw 
 interest are at once reduced. The interest rate on 
 these balances is not, however, constant. There 
 is a varying spread between the cable transfer rate 
 and the demand rate. If, for instance, a foreign 
 exchange dealer is getting iy 2 % upon his balance 
 in London at one time, and at another time is get- 
 ting 2%, he will naturally charge more for a cable 
 transfer in the second case than he would in the 
 first. There are also special causes for fluctua- 
 ton in cable transfers. It sometimes happens that 
 many persons defer making necessary remittances 
 in expectation that rates will go down at the last 
 moment. They must meet their engagements on 
 the other side, and the demand at such times for 
 cable transfers may cause the rate to move ab- 
 normally far from the demand rate. 
 
 195. RATES ON TIME BILLS. A glance at a 
 newspaper will show that in addition to cable trans- 
 fer and demand rates there are a variety of other 
 rates generally quoted bankers' bills and various 
 kinds of commercial bills drawn for varying periods 
 of time. Rates for these bills are always lower 
 than demand rates. If it was found that the de- 
 mand rate on London was $4.86 it might also be 
 found that the rate on bankers' 60-day bills was 
 $4.83, and it might be found that the rate on a 
 
224 LOANS AND INVESTMENTS 
 
 certain class of commercial bills was $4.82*4 and 
 on another kind $4.82. The quotations on time 
 bills are less than those for demand exchange by 
 the amount of the varying costs of discounting 
 them in the foreign country on which they are 
 drawn, and by the stable costs of commissions and 
 stamp taxes. If the rate of discount on a 60-day 
 banker's bill is 3% in London, then the quotation 
 for a bill of similar kind in New York will be the 
 sight rate of exchange less the discount and other 
 charges on the bill in London. Should the discount 
 rate in London advance on that particular kind of 
 bill, then the quotation will move somewhat farther 
 away from the sight rate. The reason for the 
 different prices or quotations for the various kinds 
 of time bills is that there is a scale of discount 
 rates in the London market dependent upon the 
 character of the bill. The lowest rate prevails on 
 bills drawn for acceptance on a London bank or 
 acceptance house. There are usually various other 
 rates increasing up to the "bank rate," which is 
 the rate of discount of the Bank of England. 
 
 196. CLASSIFICATION OF TIME BILLS. 
 Bills without clocuments, known as clean bills, 
 are usually marketed by drawers of well known 
 and established credit. Most foreign trade gives 
 rise to documentary bills of exchange. The seller 
 draws a bill of exchange upon the purchaser, or 
 upon the bank of the purchaser, attaching to the 
 bill various documents, the most important being 
 
LOANS AND INVESTMENTS 225 
 
 the bill of lading, without which it is impossible to 
 secure possession of the goods. Documentary bills 
 are of two kinds, documentary for payment and 
 documentary acceptance bills. In documentary 
 payment bills the purchaser of the goods can not 
 get possession of them until he has paid the bill 
 of exchange. These payment bills, again, may be 
 classified as those drawn against sales of perish- 
 able goods and such other goods as the purchaser 
 is fairly certain to want immediately upon arrival, 
 and those drawn in connection with goods which 
 the purchaser may not want until the bill matures. 
 If the purchaser desires the goods immediately 
 and makes payment, he is allowed a rebate, which, 
 in the case of English bills, is 1% below the cur- 
 rent Bank of England rate. Therefore the maxi- 
 mum price of such bills is the sight rate of exchange, 
 less the rebate and the ordinary commission and 
 stamp tax. If the goods are of a kind which are 
 not likely to be wanted by the purchaser until 
 maturity of the bill of exchange, then the dealer" 
 purchasing the bill may be obliged to hold it until 
 maturity. If he does not care to finance the trans- 
 action during the life of the bill it cannot be dis- 
 counted, because the purchaser of the goods may 
 at any time exercise his right of taking up the 
 bill. The exchange dealer may, however, use such 
 bills as collateral, drawing his own bill upon his 
 foreign correspondent. 
 197. DOCUMENTARY ACCEPTANCE 
 
226 LOANS AND INVESTMENTS 
 
 BILLS. Documentary acceptance bills are of two 
 kinds those which are drawn for acceptance on a 
 merchant, and those which are similarly drawn on 
 a bank or acceptance house. Naturally the latter 
 command the better rate, because the acceptors 
 are universally known. Documentary acceptance 
 bills on merchants are regularly discounted at a 
 slightly higher rate in London, and consequently 
 the price of such a bill in this country will be 
 slightly lower than documentary bills on London. 
 For this reason, to an increasing extent the bank 
 acceptance is displacing the commercial bill in 
 foreign trade throughout the world. The importer, 
 for example, secures an acceptance credit for some 
 definite amount with a well known bank in his own 
 or some other country. He then instructs his agent, 
 or those from whom he purchases goods, to draw 
 bills accompanied by shipping documents upon the 
 accepting bank. Similarly the exporter may draw 
 bills on banks in his own or in some other country 
 with which his customers have established ac- 
 ceptance credits. 
 
 198. ARBITRAGE. Arbitrage is the utiliza- 
 tion of all the principal financial centers of the 
 world for the purpose of purchasing in the cheapest 
 markets exchange to cover the obligations of 
 definite transactions. A New York banker sells 
 a 60-day bill on London. To meet this bill at 
 maturity he may cause Dutch, French or Russian 
 bills on London to be remitted to that city for his 
 
LOANS AND INVESTMENTS 227 
 
 account, always using in largest volume those bills 
 which are procured most cheaply. Such transac- 
 tions maintain the equilibrium of the world's prin- 
 cipal exchanges. The dealer in arbitrage is very 
 similar to the stock broker who specializes in cer- 
 tain stocks and uses all the bourses of the world 
 to make his deliveries as cheaply as possible to the 
 advantage of his profit account. Arbitrage re- 
 quires specialization and is a distinctive field. 
 
 199. FINANCE BILLS. The finance bill is 
 an instrument of foreign exchange connected in 
 largest measure with speculative transactions. It 
 is a bill drawn by a banker on a correspondent 
 banker. A stock exchange firm is desirous of mak- 
 ing a loan to complete a speculative transaction in 
 which it is engaged. Under the ordinary method 
 of procedure it places with its banker acceptable 
 collateral, with a margin of 20%, and gives a note 
 for the amount desired. v The banker negotiating 
 the loan, in order to make the amount of the loan 
 again available for his use, draws a 60 or 90-day 
 bill upon his foreign correspondent, usually one 
 in London, which he sells in the New York market. 
 When this bill arrives in London it is accepted by 
 the banker upon whom it is drawn and funds are 
 provided at maturity for its cancellation. Often- 
 times another bill of similar kind is drawn to pro- 
 vide for the payment of the one maturing. A free 
 use of this instrument would cause American ex- 
 change on London to cheapen. 
 
228 LOANS AND INVESTMENTS 
 
 200. REVOLVING CREDIT. Most credits 
 opened for the purpose of enabling exporters to 
 obtain payment for goods when ready for shipment 
 can be made into revolving credits. There are 
 three forms of revolving credit: (a) The exporter 
 is accorded the privilege of drawing drafts in an 
 amount outstanding at any one time of $10,000, 
 for example, which drafts are drawn as the goods 
 are ready for shipment. When the full amount of 
 the established credit is exhausted no drafts can 
 then be drawn until any or all of the outstanding 
 drafts are paid, at which time the amount of the 
 paid drafts again becomes available to be drawn 
 against, provided, always, that the amount of the 
 credit as originally established is not exceeded; 
 (b) A credit, for example, is established for $10,000. 
 It is to be drawn against in one draft. When the 
 draft so drawn has been paid the full amount of the 
 credit is again available; (c) A credit, for ex- 
 ample, is established for $10,000. It is to be drawn 
 against in one amount. When such a draft has 
 been drawn, the full amount is again available to 
 be drawn against. This is practically a credit for 
 an unlimited amount. 
 
 201. TRAVELERS' LETTERS OF CREDIT. 
 Travelers' letters of credit are widely used and 
 very generally known. They are at once a letter 
 of introduction, and also a request from one banker 
 to other bankers in business relationship with him 
 to accord courtesies to and to pay to the holders 
 
LOANS AND INVESTMENTS 229 
 
 thereof a sum of money in amount not to exceed 
 the amount provided for in the letter. The issuing 
 banker obligates to hold himself liable for drafts 
 drawn under the terms of the letter, and for this 
 he usually charges a commission on the amount 
 of the letter of credit. If the letter is to be used 
 throughout the world an authenticated book con- 
 taining a list of correspondents who will cash 
 drafts thereunder is given the holder of the letter 
 of credit. A letter so issued is termed a circular 
 letter of credit. When a letter is available in cer- 
 tain centers only, the issuance of such letter is 
 especially advised to the banker upon whom it is 
 made available and signatures of the holder are 
 forwarded at the same time. 
 
 202. EUROPEAN FINANCING OF AMERI- 
 CAN FOREIGN TRADE. The United States, 
 like other rapidly developing countries, has not in 
 the past financed any appreciable amount of its 
 foreign trade, either of exports or of imports. De- 
 mands for capital within the country have been so 
 great that rates for loans have regularly been above 
 those in European money centres, and especially in ( 
 London. London, and to the same extent other 
 European money markets, have, therefore, financed 
 not only the trade between Europe and the rest of 
 the world, but also trade between non-European 
 countries. 
 
 203. FINANCING OF IMPORTS. Let us 
 take, for example, the case of an importation of 
 
230 LOANS AND INVESTMENTS 
 
 wool to the United States from Australia. The 
 most common way of arranging payment has been 
 through the commercial letter of credit on a Lon- 
 don bank. Let us suppose that a Boston wool 
 house is about to purchase a cargo of wool. It will 
 secure through some foreign exchange banker in 
 this country an acceptance credit with some Lon- 
 don bank. Under the terms of this credit, the 
 agent in Australia of the Boston wool house will 
 be empowered to draw documentary acceptance 
 bills up to a certain amount on the London bank. 
 Upon the purchase of the wool a bill on the Lon- 
 don bank is drawn, and with shipping documents 
 attached it is sold to some Australian bank. Thus 
 the funds are provided with which to pay for the 
 wool. The Australian bank sends the bill with 
 documents to its London correspondent, and at the 
 same time ordinarily will sell an equivalent amount 
 of sight exchange against the credit which it will 
 secure in London through the discount of the docu- 
 mentary bill. No one in Australia has any further 
 connection with this transaction. The correspond- 
 ent of the Australian bank in London takes the bill 
 with its documents to the London bank on which 
 it is drawn for acceptance. Having been accepted 
 by the London bank, which takes the shipping 
 documents, the bill is discounted in the open market 
 by the London agent of the Australian bank. This 
 provides funds to meet the sight exchange which 
 the Australian bank had sold. The London bank 
 
LOANS AND INVESTMENTS 231 
 
 which accepted the bill then sends the documents 
 to this country to the foreign exchange banker 
 through whom the arrangement was made or per- 
 haps to a shipping broker. The wool house can not 
 get possession of the wool until it can get the bill, 
 and the exchange banker need not give up this 
 document until he is provided with funds sufficient 
 to purchase the sight exchange on London neces- 
 sary to meet the payment of the bill accepted by the 
 London bank. Thus everyone is secured at each 
 stage in the transaction, in so far as the bill itself 
 may be regarded as security. 
 
 204. FINANCING OF EXPORTS. Here 
 let us take the case of a shipment of goods from 
 United States to South America. The financing 
 is handled in a number of different ways, but 
 one of them will serve for illustrative purposes. 
 A commission house exporting goods to South 
 America will commonly be paid in 90-day drafts 
 on some London bank, drawn by the South Ameri- 
 can purchaser of the goods. If the commission 
 house waits until these bills mature, it will be a 
 long time out of its money the time that the 
 goods are in transit to South America, the time 
 that is required in sending the bill of exchange to 
 London, and 90 days thereafter. Something like 
 six months will elapse before the maturity of the 
 bill. But the commission house in New York wants 
 its money at once. It may itself, therefore, draw a 
 90-day bill upon a London^ bank and get the cash 
 
232 LOANS AND INVESTMENTS 
 
 by selling this bill in the New York market. This 
 90-day bill will be sent to London and discountedi 
 in the London market. Thus it will be seen that 
 London really finances the shipment of goods from 
 New York to South America. When the 90-day 
 bill falls due the New York house must provide 
 payment, since the South American bill is not yet 
 due. This it can manage by discounting the South 
 American bill in the London market. Finally, 
 when this bill matures, means of payment will have 
 been provided by the South American purchaser 
 of the goods. Thus during the period of six months 
 London has financed the transaction; first, by dis- 
 counting the bill of the New York commission 
 house, and then by discounting the bill drawn by 
 the South American purchaser. 
 
 205. FOREIGN EXCHANGE DEPART- 
 MENTS. A considerable number of banks 
 throughout the country have established foreign 
 exchange departments in recent years. They have 
 entered into the necessary arrangements with 
 foreign banks, establishing balances with them, and 
 are thus able to provide their customers directly 
 with cable transfers, sight drafts, and also letters 
 of credit, both travellers' and commercial. A for- 
 eign exchange department of this kind does not 
 require any considerable amount of capital. It can 
 be conducted on a small margin. Indeed, so far as 
 the ordinary bank is concerned, it is quite feasible 
 for the foreign exchange department to clean up 
 
LOANS AND INVESTMENTS 233 
 
 every day. It will purchase time bills of exchange 
 drawn against merchandise shipments, which it can 
 secure either from New York or direct at the rate 
 at which these bills on receipt will be discounted in 
 London or elsewhere. It therefore incurs no risk 
 from fluctuations in foreign rates of discount 
 fluctuations which the American banker would 
 hardly be in position to forecast. Having pur- 
 chased time bills at a rate which is less than the 
 demand rate of exchange by the amount of the 
 discount on arrival, stamp tax and commission, 
 the bills may be at once sent on for discount, andi 
 at the same time the foreign exchange department 
 may sell an equivalent amount of demand ex- 
 change. Of course, if the foreign exchange man- 
 ager cares to take a risk, he need not sell demand 
 exchange equivalent to his purchases of time bills; 
 but if he has not very much capital to work with, 
 and wishes to avoid practically all risk from fluctua- 
 tions in exchange rates, it is ordinarily possible 
 to do so. 
 
 206. HOW THE DEMAND RATE OF EX- 
 CHANGE IS DETERMINED. The many banks 
 scattered all over the country which have foreign 
 exchange departments do not directly have any- 
 thing to do with the determination of the sight 
 rate of exchange. That rate is determined by the 
 operations of a comparatively small number of 
 dealers in exchange in New York City. Some of 
 them are private banking firms, and others are the 
 
234 LOANS AND INVESTMENTS 
 
 managers of foreign exchange departments of 
 banks and trust companies. These institutions and 
 firms necessarily incur a certain amount of risk 
 in connection with foreign exchange dealings. 
 They buy and sell a more or less indefinitely large 
 amount of sight exchange. If it is believed by one 
 of them, taking into consideration all of the various 
 inferences, that rates are going down, he will be 
 likely to offer a good sized block of sight exchange, 
 and if another takes the opposite view he will be 
 prepared to buy. Dealings between the large for- 
 eign exchange houses are reflected in constant vari- 
 ations in the demand rate of exchange. Sometimes 
 the exchange market is quiet, but at times it is in 
 a feverish condition. Those who are engaged in 
 the foreign exchange business in New York must 
 takeiaccount of every influence which may increase 
 or diminish the amount of foreign exchange ma- 
 terial. What may be called the foreign exchange 
 material consists in the first place of all sorts of 
 time bills drawn against or resulting from exports 
 and imports of merchandise. All of the com- 
 mercial bills drawn against cotton shipments, 
 grain, petroleum shipments, etc., build up balances 
 on the other side against which exchange may be 
 sold. Interest payments, shipping charges, tourist 
 expenses, dealings in securities, issues of American 
 securities marketed abroad or resold to this 
 country, all provide foreign exchange material. 
 207. INTERNATIONAL BORROWING. 
 
LOANS AND INVESTMENTS 235 
 
 In addition to all these exchange creating factors, 
 there are temporary loans made by one foreign 
 market in another foreign market. These may be 
 made in a variety of different ways. The foreign 
 exchange house in New York enjoying good credit 
 may for example draw bills upon a London cor- 
 respondent payable in three months. These bills, 
 on acceptance by the London correspondent, may 
 be readily discounted, thus giving the American 
 exchange house a balance to the amount of the 
 bills, and enabling it to sell an equivalent amount 
 of sight exchange in New York. This is what 
 ordinarily happens in the case of foreign borrow- 
 ing. No actual money commonly moves between 
 the two markets. Similarly, borrowing may be 
 arranged by an exchange dealer for one of his 
 clients who may deposit collateral as security. 
 Sometimes the initiative may be taken by a for- 
 eign banker who desires to lend in this market. 
 Profit on these foreign loans is largely determined 
 by the course of the sight exchange rate. Suppose, 
 for example, that the sight rate of exchange is $4.86, 
 and that a long bill is drawn and sold at $4.82, a 
 difference reflecting the discount rate on London. 
 When the long bill matures, the borrower must 
 purchase sight exchange with which to take it up. 
 If the sight exchange rate is then still at $4.86 he 
 will have paid only four cents on each pound for 
 the use of the money during the period. But in the 
 event that the sight rate has gone up to $4.87 his 
 
236 LOANS AND INVESTMENTS 
 
 loan is more costly, as he will be paying five cents 
 for each pound. These foreign short time loans do 
 not ordinarily occasion movements of money into 
 the borrowing country, but they frequently check 
 gold exports. They are seldom made except when 
 the rate of exchange is high toward the export 
 point. Let us suppose that the rate in New York 
 for three months' collateral loans is 5%, and that 
 the discount rate in London is 3%. It may then be 
 advantageous to borrow in London if the sight rate 
 is at least as high as $4.87. It can not go much 
 above $4.88, and it may be at a much lower point 
 three months hence, when it becomes necessary to 
 purchase demand exchange. If the rate does go 
 down, it reduces the cost of the loan to the bor- 
 rower. If, however, he should enter upon this 
 transaction when the sight exchange rate was $4.85, 
 he would incur the risk of a possible advance to 
 $4.88, making the loan an extremely costly affair. 
 208. LOANS BY FOREIGN BANKS. The 
 foreign lender may be willing to take the risk of 
 fluctuations in the sight exchange rate. If so he 
 lends in currency. Suppose, for example, that the 
 quotation on banker's time bills is $4.83, and that 
 some one in New York wishes to borrow $500,000. 
 The bill is drawn for say 100,000 on London by 
 the New York agent of the London bank, acting 
 on instructions. The bill is sold for $4.83, and the 
 proceeds are turned over to the borrower in New 
 York; that is, he gets $483,000. When the bill ma- 
 
LOANS AND INVESTMENTS 237 
 
 tures, the borrower must return $483,000, plus what- 
 ever rate of interest has been agreed upon, let us 
 say 5%. The borrower is not affected by fluctua- 
 tions in sight exchange. But now the foreign lender 
 may desire to get back his money in London. He 
 instructs his correspondent to buy sight exchange 
 on London. If the demand rate has gone down, 
 then the London bank gains from having assumed 
 the risk. If the sight rate is down to $4.85, for in- 
 stance, it can buy sight drafts on London for 
 100,000 for $485,000. It gets the benefit of the 
 higher return. If the sight rate were $4.87, it 
 would be obliged to pay $487,000 in order to get its 
 money back in London. When the foreign banker 
 is inclined to think that the rate on sight exchange 
 is going down, he will be willing to lend in currency 
 in this market; if his opinion is the other way, then 
 the risk will have to be assumed by the borrower. 
 He will receive the proceeds of the bill just as in 
 the other case, but at the maturity of the bill he; 
 must provide the means for its liquidation in Lon- 
 don, paying for the exchange at current rates. 
 
 209. RELATION OF INTEREST RATES 
 TO EXCHANGE RATES. It will thus be seen 
 that interest rates have an important influence upon 
 fluctuations in exchange rates over short periods of 
 time. Whenever there is a large balance of pay- 
 ments against a country, temporary borrowing can 
 not prevent exchange rates in the long run from 
 moving to the export point. But within limits it is 
 
238 LOANS AND INVESTMENTS 
 
 possible to postpone gold movements if interest 
 rates go to a much higher level than those prevail- 
 ing in the foreign countries to which heavy pay-* 
 ments are due. In such circumstances, so long as 
 the credit of the debtor market remains good in 
 foreign countries, very considerable temporary 
 loans may be made, thus providing sight exchange. 
 But if a large number of three month bills are 
 drawn now, at the end of the three months' period 
 it is necessary to make payments or secure renewals 
 and renewals can not be continued indefinitely. 
 
 210. UTILITY OF BANKERS' TIME 
 BILLS. Within moderate limits, borrowing by 
 means of bankers' time bills serves a useful purpose, 
 tending to steady the sight rate of exchange. In 
 the absence of these bills a comparatively slight 
 excess in the demand for or supply of exchange 
 would cause rates to move violently between the 
 export and the import points. When drawn for the 
 purpose of steadying the exchanges they are some- 
 times spoken of as anticipatory bills. Bankers' 
 bills, for example, are regularly drawn by New 
 York in the early summer months, because it is 
 known that in the autumn a great quantity of com- 
 mercial exchange will come into the market in con- 
 nection with exports of cotton and grain. Antici- 
 patory bills are in no sense different from other 
 bankers' bills. It is simply that within limits and 
 at certain times they really are anticipatory. The 
 term finance bills is sometimes used in a derogatory 
 
LOANS AND INVESTMENTS 239 
 
 sense, as if commercial bills were the only perfectly 
 reputable variety of bills of exchange. Bankers' 
 bills are, however, essential for the smooth working 
 of the exchanges. Both commercial bills and bank- 
 ers' are serviceable in various transactions. 
 
 211. BORROWING AND LENDING EX- 
 CHANGE MARKETS. From the foregoing dis- 
 cussion it may have been inferred that there are 
 two more or less distinct groups of foreign ex- 
 change markets borrowing markets and lending 
 markets. The borrowing markets are numerous, 
 while the lending markets are few, with a strong 
 tendency for a single market to acquire nearly the 
 entire business. In many ways it is advantageous 
 to have one city in the world which serves as a 
 centre for payments between all parts of the world. 
 London became the central money market of the 
 world, reaping all the advantages of that position, 
 because it has been able to absorb whatever amount 
 of foreign bills might be sent thither for discount. 
 This is an essential condition for the normal work- 
 ing of the exchanges under a system of settlements 
 largely concentrated in a single market. The mar- 
 ket on which bills of exchange are drawn, as we 
 have seen, must be prepared to discount them. In 
 order to avoid the risk of loss from fluctuations in 
 exchange, bankers purchasing time bills drawn on 
 another country, must be able to discount them 
 at once in that market, so that they may be able 
 to sell demand exchange against the proceeds. 
 
240 LOANS AND INVESTMENTS 
 
 212. ARRIVAL RATES. Exchange bankers 
 in New York and in all other exchange markets 
 each day, and oftener if rates change, receive spot 
 and forward delivery quotations from London cor- 
 respondents. Spot quotations, as the name implies, 
 are discount rates on bills already in London. For- 
 ward delivery quotations are the rates at which 
 London bankers and discount houses agree to take 
 bills arriving in the next mail from the market to 
 which they are quoted. These arrival rates enable 
 exchange bankers in New York and elsewhere to 
 purchase time bills without running any risk from 
 changes in London discount rates while the bills 
 are in transit. When downward tendencies in Lon- 
 don discount rates seem probable, the banker may 
 not take advantage of the arrival rate; just as in 
 the belief that exchange rates are to advance he may 
 decide to hold the bills to maturity. In fact the ad- 
 vantages and uses of forward delivery quotations 
 are in every way analagous to those arising from 
 discounting bills which have already been delivered. 
 In one case the arrangement eliminates risk during 
 the transit period, in the other during the entire life 
 of the bill after it reaches the country on which it 
 is drawn. 
 
 213. POSITION OF LONDON. It is evident 
 therefore that if time bills of exchange are to be 
 handled with a minimum of risk it must always be 
 possible to discount them in the country on which 
 they are drawn. This has always been possible in 
 
LOANS AND INVESTMENTS 241 
 
 London, and at rates which have averaged some- 
 what below those prevailing in other money mar- 
 kets. For this reason and because it facilitates set- 
 tlements and makes possible a broad exchange mar- 
 ket on all countries, foreign bills of exchange 
 throughout the world for many years preceding 
 the European War had been principally drawn on 
 London. Persistent efforts to give bills on other 
 money centres, notably Berlin, the standing of the 
 sterling bill, have not succeeded. In addition to its 
 readiness to absorb the indefinitely large volume of 
 foreign bills, London also has exercised most effec- 
 tively another essential function that of accepting 
 bills for banks and traders in all parts of the world. 
 Until recently the acceptance business in London 
 was conducted almost entirely by private banking 
 firms known as accepting houses; but of late years 
 the joint stock banks have entered this field. The 
 value of the London acceptance was due not so 
 much to the financial strength of the acceptors as 
 to the knowledge of the financial standing of banks 
 and traders throughout the world which they had 
 acquired, and the skill and restraint which they had 
 manifested in the conduct of this important branch 
 of the banking business. 
 
 214. EUROPEAN WAR AND THE EX- 
 CHANGES. These various interdependent for- 
 eign exchange functions have been developed dur- 
 ing a long period in which peace had become the 
 normal condition of the world. It is, therefore, no 
 
242 LOANS AND INVESTMENTS 
 
 more than was to have been expected that with the 
 approach of the European war the entire mechan- 
 ism of foreign exchanges should be so seriously 
 dislocated as to come almost to a standstill. Onj 
 Saturday, July 25th, 1914, foreign exchange opera- 
 tions were still being conducted in normal fashion 
 throughout the world. Demand exchange in New 
 York was quoted at $4.8830. Gold exports in con- 
 siderable quantities seemed imminent, but nothing 
 more serious seems to have been expected. Over 
 Sunday the outbreak of a general European War, 
 which had been commonly regarded as a vague pos- 
 sibility, became alarmingly probable. On Monday 
 demand exchange opened at $4.92 and the foreign 
 exchange market was completely disorganized. 
 This condition was in no way peculiar to New York. 
 Foreign exchange dealings between all of the 
 money markets of the world were in a similar ab- 
 normal state. In no other business was the effect 
 of the approach of the war felt so immediately, 
 generally and severely. The complicated and deli- 
 cately balanced mechanism of foreign exchanges, 
 developed during long years of peaceful intercourse, 
 collapsed like a house of cards. 
 
 215. THE WAR AND THE LONDON AC- 
 CEPTANCE. Two operations essential for the 
 working of the foreign exchanges had been instantly 
 interrupted, and, indeed, practically discontinued 
 the business of accepting and that of discounting 
 foreign bills of exchange in London. When Lon- 
 
LOANS AND INVESTMENTS 243 
 
 don ceased to perform these two functions, the 
 mechanism of the foreign exchanges throughout 
 the world inevitably and at once became completely 
 disorganized. Acceptors on London were under 
 heavy obligations on bills of exchange drawn by 
 banks and merchants throughout the world, who 
 in turn were under obligation to remit funds to 
 them before the maturity of the bills. Among these 
 bills accepted in the ordinary course of business 
 were a large number, amounting in the aggregate 
 doubtless to many millions of pounds, for banks and 
 merchants in the countries which were rapidly drift- 
 ing toward war. Remittances could not be expected 
 from parties in hostile countries until after the res- 
 toration of peace. It was also certain that remit- 
 tances would be delayed in many instances in the 
 case of bills accepted for clients in allied and also 
 in neutral countries, owing to the disturbances oc- 
 casioned by the outbreak of the war. In these cir- 
 cumstances acceptors in London were in no position 
 to make new acceptances, and the value of the ac- 
 ceptance itself was impaired. It should further be 
 noted that exchange banks in New York and in all 
 other markets were under heavy contingent liabili- 
 ties on account of endorsements of bills drawn on 
 London acceptors. In the event of the failure of 
 London accepting houses, these bankers would have 
 to supply funds to take up the bills, and in the dis- 
 turbed conditions prevailing might incur serious 
 loss through the failure of drawers, to whom of 
 
244 LOANS AND INVESTMENTS 
 
 course they would have recourse. Uncertainty re- 
 garding the value of the London acceptance com- 
 pletely transformed the character of the business 
 of buying commercial bills of exchange. A busi- 
 ness which normally is highly secure and even rou- 
 tine in character was in a moment changed to one 
 surrounded with uncertainties of a most unfamiliar 
 and incalculable nature. At the same time shipping 
 hazards, and uncertainty as to market conditions 
 in foreign countries, were taking away much of the 
 value of the security which the bill of lading ordi- 
 narily gives in the case of bills drawn against ex- 
 ports. Both exporters and those who might pur- 
 chase their bills would therefore be embarking upon 
 venturesome transactions, utterly lacking the 
 highly developed safeguards which normally pro- 
 tect international dealings, both in commodities 
 and in bills of exchange. 
 
 216. THE WAR AND THE LONDON DIS- 
 COUNT MARKET. The consequences of the un- 
 certain position in which London acceptors were 
 placed by the approach of the war do not seem to 
 have been at once fully realized even in foreign ex- 
 change circles. They were perhaps overshadowed 
 by the presence of another disorganizing influence, 
 the full force of which was immediate and obvious. 
 From Monday, July 27, to the middle of August, 
 the business of discounting foreign bills in London 
 was almost entirely suspended. With the approach 
 of the war it might well have been presumed that 
 
LOANS AND INVESTMENTS 245 
 
 London would decline to quote forward delivery 
 rates before the discounting of bills already in Lon- 
 don was discontinued. As it happened, both spot 
 and forward delivery quotations were discontinued 
 at the same time, on Monday, July 27, striking evi- 
 dence of the great change for the worse which af- 
 fairs had taken over Sunday. 
 
 217. THE WAR AND THE NEW YORK 
 EXCHANGE MARKET. This discontinuance of 
 discount quotations by London was the most im- 
 portant single factor in the exchange market in 
 New York and elsewhere throughout the world on 
 Monday, July 27. It involved a complete transfor- 
 mation, not only of the business of buying commer- 
 cial bills, but also of conditions in the demand ex- 
 change market as well. On Saturday the exchange 
 banker purchasing commercial bills could arrange 
 discount terms at once in London and sell demand 
 exchange against the proceeds. On Monday the 
 purchase of such bills involved the investment of 
 capital until the date of maturity in a far from satis- 
 factory security, owing to the position of London 
 acceptors. On Saturday every commercial bill of- 
 fered in the market provided the means for an im- 
 mediate sale of demand exchange. On Monday the 
 immediate supply of demand exchange could no 
 longer be enlarged to the slightest extent by this 
 means. The principal source of an immediate sup- 
 ply of a demand exchange was entirely cut off. 
 Demand exchange could still be sold against for- 
 
246 LOANS AND INVESTMENTS 
 
 eign balances, but these were not large. The ex- 
 portation of gold was a further source of supply of 
 demand exchange, but could not go on indefinitely 
 without endangering the foundation of the domes- 
 tic credit structure. In these circumstances, al- 
 though exchange transactions were not entirely 
 suspended, there was a complete cessation of cer- 
 tain exchange operations, in the absence of which 
 there can be no broad exchange market. Each 
 dealer made every effort to provide the exchange 
 urgently needed by regular customers, but trans- 
 actions between dealers were almost altogether dis- 
 continued. In normal times, by offering to buy 
 exchange at higher prices, a dealer can secure what- 
 ever amount he may require. At such times changes 
 in rates serve to adjust supply and demand in the 
 exchange market. Beginning with Monday, July 
 27, rates merely reflected the urgent and even fran- 
 tic efforts of particular purchasers to secure ex- 
 change. Rates fluctuated widely, but as each trans- 
 action stood by itself they had no general market 
 significance. 
 
 218. THE WAR AND THE LONDON 
 SIGHT RATE. Through the assistance of the 
 British Government, London was able to resume, 
 toward the end of August, 1914, both the accepting 
 and discounting of bills. But a few months later a 
 new cause of difficulty presented itself. Sterling 
 exchange, which throughout the world had ruled 
 far above par for some time after the outbreak of 
 
LOANS AND INVESTMENTS 247 
 
 the war, gradually began to decline, at first slowly, 
 then more rapidly, until it was far below the gold 
 export point from London. By August, 1915, ster- 
 ling exchange in New York had dropped to $4.50, 
 and fluctuated widely over short periods of time. 
 In other words, the base rate from which rates on 
 all time bills are calculated no longer fluctuated 
 within narrow and definite limits between the ex- 
 port and import points. It consequently became an 
 unsatisfactory medium in which to enter into con- 
 tracts for payment at a future date. This unsatis- 
 factory position of the sterling rate was due to the 
 enormous importations of supplies to Great Britain 
 on account of the war. Toward the end of 1915 ar- 
 rangements were finally made for financing these 
 purchases largely through the negotiation of loans 
 in the United States; and thereafter the sterling 
 rate was pegged at about $4.76. The establish- 
 ment of a stationary base in this artificial manner 
 could not, however, give that confidence in sterling 
 which it enjoyed when subject only to slight 
 changes due to normal trade and credit influences. 
 219. DEVELOPMENT OF DOLLAR EX- 
 CHANGE. The European war, it will thus be 
 seen, created conditions favorable to the develop- 
 ment of the business of drawing bills of exchange 
 on other markets than London, and in particular on 
 New York, the most important financial centre in 
 neutral countries. Fortunately the power to accept 
 bills of exchange, had been granted to the national 
 
248 LOANS AND INVESTMENTS 
 
 banks by the Federal Reserve Act of 1913, and also 
 to State banks and trust companies in a number of the 
 States, Moreover, after the disturbance occasioned 
 by the outbreak of the war had been overcome, dis- 
 count rates in New York fell to a level distinctly 
 below that in London. Under these favorable cir- 
 cumstances American bankers entered the foreign 
 exchange field as acceptors and lenders. Commer- 
 cial letters of credit providing for the acceptance of 
 bills payable in dollars have proved satisfactory 
 both to American and foreign traders. As a factor 
 in creating the existing demand for Dollar Credits, 
 the establishment of American branch banks abroad 
 cannot be emphasized too strongly. Through these 
 branch banks, a new and adequate medium for the 
 liquidation of transactions as between the United 
 States and certain foreign countries has been placed 
 at the disposal of American merchants. A direct 
 channel is now open to the ebb and flow of credit 
 transfer between the United States and the coun- 
 tries mentioned, and, as a natural sequence, the 
 former disparity existing against the Dollar, as 
 compared with Pound Sterling and the principal 
 Continental exchanges, has disappeared. The re- 
 sulting equalization in the rates of exchange 
 benefits the American merchant to the extent of 
 relieving him of the charges formerly paid to the 
 indirect channels of liquidation, or, in other words, 
 to the foreign banker. The Dollar Credit is of 
 capital importance to every American merchant 
 
LOANS AND INVESTMENTS 249 
 
 who is interested either directly or indirectly in 
 the importation of commodities of any character. 
 A study of the advantages accruing from this form 
 of credit will demonstrate the desirability of its 
 general employment as the vehicle for financing 
 not only our own imports but also those of other 
 countries. Primarily, it is more economical than 
 the Sterling or Continental Credit, for the initial 
 commission cost of issuance is lower. Secondly, 
 it is based on a known quantity, the Dollar, a fac- 
 tor of supreme importance in these days of extreme 
 and violent fluctuations in the exchange rates, and 
 therefore all exchange risk is eliminated from the 
 operation as far as the importer is concerned. 
 Maturities drawn under Dollar Credits are due and 
 payable in Dollars on a given date, and no question 
 arises as to what the exchange rate on London 
 may be 90 days after acceptance of the bill. 
 
 220. FOREIGN EXCHANGE AFTER THE 
 WAR. It is advantageous, both to importers and 
 exporters, to have bills drawn on a single central 
 world market, rather than on cities in each of the 
 countries with which they are trading. There has 
 been a broad market everywhere for sterling bills, 
 because not only trade with England but with all 
 countries has been handled by means of bills drawn 
 on London. If a prolonged period of peace is to 
 be anticipated at the close of the present war, the 
 supremacy of London foreign exchange market will 
 probably continue. On the other hand if national 
 
250 LOANS AND INVESTMENTS 
 
 enmities are to be continued and strife is merely 
 transferred from the battle field to the market place, 
 the convenience of a central money market will pre- 
 sumably not be sufficient to warrant the risk in the 
 event of further outbreaks. Moreover, if interna- 
 tional trade is to be developed by national organiza- 
 tions, primarily for national objects, rather than for 
 individual profit, it will be necessary for each im- 
 portant country to organize the financial machinery 
 needed for handling its own trade. 
 
 221. NATIONAL FOREIGN TRADE POL- 
 ICY. Foreign trade is to be an ever increasingly 
 important factor in the future development of 
 America. The banker's interest in this develop- 
 ment is vital not only to himself, but to the citizen- 
 ship of his country. The close relationship of 
 banking and foreign trade and national welfare is 
 clearly set forth by F. A. Vanderlip, President of 
 the National City Bank of New York, in the follow- 
 ing words: 
 
 (1) "There is a disposition sometimes to compare do- 
 mestic trade with our foreign business and to say that, after 
 all, foreign trade is a small matter, and we have field enough 
 at home. I want to try to show the dangerous narrowness 
 of that view by drawing some illustrations from the bank- 
 ing situation. A bank's reserve is the cash which the banker 
 has in his vault. That, in the main, must be gold, and is, in 
 fact, all gold, or its representative, the gold certificate, ex- 
 cept a moderate amount of United States notes and silver. 
 The foundation of all banking credit is the gold reserve. 
 The structure of banking credit must stand on that founda- 
 
LOANS AND INVESTMENTS 251 
 
 tion, and its size is directly governed by the amount of re- 
 serve the banks hold. 
 
 (2) "I could visually illustrate the relation, which you 
 all already understand, if I had a flat disc of gold and some 
 sand. I could pile sand on that flat disc of gold to a perfectly 
 definite amount, governed by two factors, the size of the disc 
 and the angle at which the sand would lie undisturbed. 
 Suppose we let that angle be the measure of our legal re- 
 serve requirement. In the passage of the Federal Reserve 
 Act that angle was increased when we lowered the ratio of 
 reserve that banks must hold. We are now able to base a 
 taller structure of banking credit upon a given gold basis, 
 and to do so safely, than we were before the Federal Re- 
 serve banks were created. 
 
 (3) "Now, the tendency in every bank management is 
 to loan money so long as sound borrowers can be found and 
 the bank has in its vault idle funds above its legal reserve 
 requirements. That is to say, on our gold disc will be piled 
 all the grains of sand, letting them represent loans, that can 
 be placed there. If our gold disc is enlarged, the amount of 
 sand we can pile on it is increased eight or ten times as much 
 as the amount of fresh gold added to the gold base, for the 
 structure of bank credit normally bears a relation, taking 
 the country as a whole, of eight or ten times the size of the 
 gold reserve. Now, conversely, if through any banking 
 operation the gold reserve is reduced the same thing will 
 happen to the structure of bank credit as must happen to my 
 pile of sand if I decrease the diameter of my gold disc. 
 Credits must be reduced approximately ten times the 
 amount that the gold base is reduced. It was a recognition 
 of this principle and an appreciation of the havoc which it 
 plays when reserves are rudely disturbed which led to de- 
 vising the Federal Reserve Law and the mobilization of all 
 reserves, so that we cannot again have just the sort of dis- 
 turbance, and even panics, that used to follow the normal 
 
252 LOANS AND INVESTMENTS 
 
 seasonal shipment of reserve money out of the financial 
 centers for crop moving operations. We have safeguarded 
 that danger, but we have not altered the principle, and if 
 the country faces a situation where, through any other 
 process, the gold reserve may at one time be greatly aug- 
 mented and the credit structure built full-sized upon it, and 
 then through the operation of trade balances, if gold is drawn 
 out from under that credit structure, the credits must be 
 reduced in corresponding ratio as surely as the pile of sand 
 upon the gold disc would decrease if we began to clip from 
 the edge of the disc the foundation upon which the sand 
 stood. 
 
 (4) "So much for 'the illustration! Now, what is it that 
 we have seen happen since the outbreak of the war in our 
 domestic banking situation? There have been two factors 
 that worked toward an increased credit structure. The 
 Federal Reserve Law, reducing reserve requirements, went 
 into effect, that is to say, the angle at which the sand lay on 
 the gold disc was increased, and we have had an enormous 
 influx of gold ; in other words the gold disc was greatly en- 
 larged. The result was easy to foresee. Bankers always 
 loan an idle surplus if they can, and it is not surprising then, 
 if we turn to statistics, to see that the loans and discounts of 
 National banks alone have gone up more than a billion 
 dollars and for all the banks the total would not fall far 
 short of two billion dollars. Our heap of sand on the gold 
 disc is about one-sixth larger than it was when the war 
 broke out. 
 
 (5) "What is going to happen to that gold disc when 
 the war is over? What defense have we for our gold re- 
 serve? What program of preparedness are we working out 
 to meet the international attack that is threatened to be 
 made upon the gold foundation of our credit system? Do 
 you recognize why that question is of vital interest to every 
 citizen, to every man with a bank account? The interior 
 
LOANS AND INVESTMENTS 253 
 
 farmer, merchant or manufacturer, wholly local in his inter- 
 ests, may think he has but the remotest interest in foreign 
 trade; he is, however, interested in bank reserves, and the 
 course of foreign trade as it reacts on those reserves will 
 affect his business future to an extent that may some day 
 amaze him. 
 
 (6) "So long as the war goes on the world will be so 
 tipped askew, in all probability, that the gold holdings of 
 other countries will continue to fall into our lap As the 
 gold falls it will be added to our reserves. As those reserves 
 grow, so will grow our credit structure based upon them. 
 When the war is ended, we will find all Europe depleted of 
 its gold, staggering under a weight of inflated bank and 
 government paper, and under the direst stress to rebuild 
 its stock of gold. The point of attack will be our gold re- 
 serves. The methods will be every means known to trade 
 and commerce by which merchandise, securities and credits 
 can be exchanged for gold. The laws of political economy 
 will be on the side of the attack. A plethora of gold, such as 
 we will have always means rising prices. We will establish 
 a price basis here which will make us a good market to sell 
 in and a bad market to buy in. We are now advancing our 
 labor costs, and that and every other element that enters 
 into production will, under the influence of this giyat in- 
 crease in our gold reserves, tend toward high market values. 
 
 (7) "If we find ourselves, when conditions start again 
 toward the normal, to be the market where prices are the 
 highest, where the cost of production is the greatest, and 
 where the interest rate is the lowest, the road will be open 
 for attack upon our gold reserves. If that attack is suc- 
 cessful, then the whole credit structure that will have been 
 reared upon it must be rudely reduced, for the reduction in 
 credits must be manyfold greater than the loss of gold. What 
 defense can we put up? How can we safeguard ourselves? 
 We have recognized the principle and safeguarded ourselves 
 
254 LOANS AND INVESTMENTS 
 
 in a domestic way by the enaction of the Federal Reserve 
 Law, but there can be no safeguarding by law from an inter- 
 national attack upon our gold stock. Other means must be 
 found than any that could be provided by legislation. Nor, 
 do the means lie in the hands of the bankers. They may rec- 
 ognize the danger, and, instead of loaning to the limit per- 
 mitted by law, run with strong reserves; but any surplus 
 that we could expect the bankers to hold would suffice for 
 but a short time if the drain were severe. We may invest 
 in short term foreign loans that can be converted into credits 
 to check a gold demand. We have already done some of 
 that and will probably do a good deal more. There have 
 been bankers so short-sighted as to object to our making any 
 loans abroad, but I believe the day will come when you will 
 find that those loans, convertible into credits, as they will 
 be, will form a check to gold withdrawals, and be one of 
 the most important safeguards of our gold stock. But efforts 
 in the way of defense, such as excessive reserves or short 
 term foreign investments, must be as nothing when com- 
 pared to what is possible in the form of credits created by 
 exports of produce and merchandise. There is the strength 
 of our defense. Its effective measure will be the size of our 
 exports compared to our imports. The size of that favorable 
 balance must form the true defense of our gold stock. That 
 is why every citizen, whether he knows it or not, is inter- 
 ested in the subject of National trade policy." 
 
CHAPTER VII 
 
 Bonds and Circulating Notes 
 
 222. BANK NOTES AND DEPOSITS. 
 There has been a general failure in popular discus- 
 sion of banking to recognize the identity of the note 
 and the deposit so far as they relate to the bank 
 itself. There may be a difference of opinion about 
 the comparative effects of notes and deposits upon 
 the level of prices and the general business of the 
 community, but none about their relationship to 
 the bank. If the borrower presents himself at a 
 bank for accommodation, has his security accepted, 
 and his loan granted, there is no theoretical differ- 
 ence so far as the bank is concerned whether it 
 credits him with $1,000 on its books and allows 
 him to draw it out at pleasure, or to transfer it 
 to others, or whether it hands him a package of 
 one thousand one dollar demand notes, which he 
 may present at sight for payment, or which he may 
 hand to one thousand other persons, who may pre- 
 sent them if they choose. Whether the bank has 
 credited the borrower with $1,000, or has given 
 him one thousand one dollar demand notes (or 
 "bank notes"), it is in exactly the same position 
 so far as the outside world is concerned that is to 
 say, it has accepted the borrower's note for $1,000 
 and in return has given him a sight claim for $1,000 
 upon itself, the consideration being a rate of interest 
 
 255 
 
256 LOANS AND INVESTMENTS 
 
 of specified amount. The bank note must, there- 
 fore, be looked upon from the standpoint of bank- 
 ing just as is the bank deposit as a sight liability. 
 223. RELATION OF NOTES TO CUR- 
 RENCY. The note, when once issued, differs 
 from the deposit in its practical effect upon the 
 bank only in respect to the time it remains in cir- 
 culation. It is plain that $1,000 in notes paid out 
 by a bank over its counter may be almost immedi- 
 ately placed on deposit with it, in which case all 
 that has happened has been that the bank has ex- 
 changed one form of liability for another form. 
 But such an issue of notes may remain in the hands 
 of individuals for a great while. If there is absolute 
 confidence on the part of such individuals that the 
 bank is solvent and able to pay its obligations, and 
 if there is a shortage of currency in the community 
 so that the bank notes fill a convenient place, the 
 life of the notes may be very long. In case of the 
 deposit, the existence of the credit upon which that 
 deposit is based may be equally long. Thus, if a 
 single bank does the business of a given community, 
 and grants a credit of $1,000 to a borrower, who 
 secures a renewal of his credit from time to time, 
 it is possible that this credit may be indefinitely 
 continued, while the claim on the bank may be 
 passed from hand to hand in the form of checks. 
 As a matter of fact, a check does not pass many 
 times before it is presented for redemption, while 
 the practice of commercial banks is not to grant too 
 
LOANS AND INVESTMENTS 257 
 
 frequent or too long renewals of credits. This 
 means that any given draft upon a deposit is not 
 likely to remain long in existence, while the credit 
 which brought it into existence is itself likely to 
 be terminated at a comparatively early day. 
 
 224. BANK NOTES AND CHECKS. The 
 same thing is true of the loan on the strength of 
 which bank notes are issued, but the bank note 
 itself* may pass from hand to hand a great many 
 more times than would a check for an equal amount. 
 In other words, the circulation activity of the bank 
 note is likely to be much greater than that of the 
 deposit of equal face value. This means that the 
 bank note has a somewhat different status as cur- 
 rency from that which is occupied by the deposit 
 subject to check. How far the currency activity 
 of the note affects prices in a way different from 
 the influence exerted by the deposit need not be 
 discussed at this point, it being a problem of money 
 rather than of banking. The fact remains that the 
 bank note performs a "currency function" which 
 has generally been considered more important than 
 that of the deposit. If a given volume of bank 
 notes is, on the average, maintained in circulation 
 in any given country, such volume evidently dis- 
 places an equal amount of some other form or 
 forms of currency or coin. This may be a desirable 
 feature of the bank note system, inasmuch as it 
 substitutes a credit instrument of comparatively 
 low cost for a costly circulating medium like gold. 
 
258 LOANS AND INVESTMENTS 
 
 225. PROTECTION OF NOTES. Because 
 of this "currency function," it has been felt by 
 legislators in most countries that the issue of bank 
 notes ought to be controlled with great care, and 
 as a result numerous methods for restricting note 
 issues have been attempted. This protection may 
 take, and does in practice take, several different 
 forms. One of the most familiar forms is the 
 limiting of the total amount of bank notes to be 
 issued by a given institution. A second mode of 
 protecting the note-holder is that of setting aside 
 a special security for the protection of notes. Thus 
 banks may be directed to invest in a given kind 
 of bonds a sum equal to the amount of the notes 
 they issue. This type of control is seen in the 
 National banking system. Coupled with this (as 
 seen in the National banking system) may be a 
 provision that the notes shall be a first lien upon 
 the assets of the bank which issues them. A third 
 method of protecting a note issue may be the flat 
 guarantee of the government which has chartered 
 the issuing bank that in the event of the failure of 
 such bank it will assume a responsibility for its 
 notes. A fourth mode of protection may be found 
 in regulations designed to control the classes of 
 security which shall be held by banks behind their 
 notes. Thus banks may be directed not to issue 
 more notes than are protected by given classes of 
 commercial security. This has the effect of limit- 
 ing note issues beyond a certain point to those 
 
LOANS AND INVESTMENTS 259 
 
 classes of loans in which the specified kind of 
 security can be obtained. A fifth mode of protec- 
 tion is seen in the establishment of peculiar 
 facilities for redemption of notes and for assuring 
 their prompt return to the bank which put them out. 
 
 226. WHY NOTES ARE ISSUED. The 
 issue of bank notes is taken as so much a matter 
 of course that the reason for their issue is not 
 usually considered in much detail. In fundamental 
 analysis, of course, the notes come out for exactly 
 the same reasons which govern the creation of 
 deposits someone secures a loan from the bank, 
 and the credit corresponding thereto is granted in 
 the form of a note issue. But this does not explain 
 the selection of the note as compared with the 
 deposit. There must be some reason determining 
 whether a note will be handed to a borrower or 
 whether a credit of like amount will be written in 
 a pass book. This is usually a question of business 
 convenience merely, and as such is to be settled by 
 the borrower (always supposing that the bank is 
 able to issue the note if it chooses, under the exist- 
 ing law). The borrower may prefer notes because 
 of their greater acceptability to the person or per- 
 sons to whom they are to be paid. 
 
 227. THEORY OF NOTE ISSUE. From 
 what has been said it is clear that the theory of 
 note issues in their relation to the bank is identical 
 with that of deposits and their relation to the bank. 
 There is in fact no distinction to be drawn in this 
 
260 LOANS AND INVESTMENTS 
 
 respect between the note and the deposit. The 
 putting out of an issue of notes will be considered 
 by the bank under exactly the same terms and con- 
 ditions as those which have controlled it in regard 
 to the creation or grant of a line of credit based 
 on deposits. The classes of security accepted by 
 the bank when it is asked to make an issue of notes 
 are the same as those which it will accept when 
 granting a loan in the form of a credit on its books. 
 The protection of the bank against loss depends 
 entirely upon the security which it receives, and 
 the standing of the borrower who gets the loan. 
 There is no special profit in the issue of notes that 
 does not inhere in the creation of deposits. 
 
 228. SECURITY FOR BANK NOTES. The 
 question whether note issues should be given any 
 ultimate security different from that possessed by 
 the other liabilities of the bank has been consid- 
 erably discussed and opinions vary widely with 
 reference to it. Probably the best opinion of the 
 day is that no such special security is desirable, 
 but that the safety of the note-holder is to be pro- 
 vided for by means of prompt and active redemp- 
 tion and by confining the issue of notes to banks 
 whose capital is large enough and whose methods 
 are sound enough to assure the note-holder and 
 the government that there will be a high degree 
 of responsibility on the part of the institution. This 
 idea is carried a step further when provision is 
 made (as in the Canadian banking system) for 
 
LOANS AND INVESTMENTS 261 
 
 making the banks jointly liable for the notes of 
 all insolvent banks. In the case of the Canadian 
 banks, the result is accomplished by compelling 
 banks which desire to issue notes to put up a jointly 
 contributed fund called a "guaranty fund" on which 
 the notes of any insolvent bank may, under certain 
 circumstances, be made to draw. The result of 
 such a provision is to make banks exercise an over- 
 sight over one another's issues and to create a 
 probably higher degree of watchfulness than would 
 exist were the banks severally, but not jointly, 
 liable for the outstanding notes. 
 
 229. BONDS AND BANK NOTES. Such a 
 system, however, is entirely different from one in 
 which a bank is compelled, before issuing any notes, 
 to lay aside a part of its assets in a segregated fund 
 for the purpose of protecting the note issue based 
 thereon. This is the system employed under the 
 National Bank Act of the present day and has 
 proved to be unsatisfactory. Every National bank 
 upon being organized was originally required to 
 buy an amount of bonds dependent upon the amount 
 of its capitalization, and to deposit these bonds 
 in trust with the Treasurer of the United States. 
 Upon so doing, the bank was permitted to receive 
 bank notes to an equal amount, and could then dis- 
 pose of these as it pleased, using them in loans to 
 borrowers. Should the bank fail, the notes could 
 be provided for by selling the bonds and thus 
 establishing a fund for their cancellation. The 
 
262 LOANS AND INVESTMENTS 
 
 Federal Reserve Act repealed the provision re- 
 quiring such purchases of bonds by banks. Inas- 
 much as United States bonds have always been of 
 high standing in the market since the system of 
 note issue referred to was first established, there 
 has never been a time when anyone felt the slight- 
 est question about the ultimate goodness of the 
 National bank note. This very secure character 
 has, however, been obtained at considerable cost, 
 since the use of United States bonds has rendered 
 it very difficult to get the notes into circulation 
 when they were wanted and conversely has made 
 it hard to retire them when they were not wanted. 
 230. STATUS OF AMERICAN NOTE CUR- 
 RENCY. It has been a principal cause of com- 
 plaint of the existing currency situation in the 
 United States for many years past that our medium 
 contained no element corresponding to what is 
 known as the "elastic" bank note issues of other 
 countries. There have been many kinds of cur- 
 rency in circulation, the principal being as follows : 
 
 (1) United States notes or greenbacks, legal 
 tender in payment of debts. 
 
 (2) Gold certificates representing actual gold 
 coin held as a trust fund in the Treasury. 
 
 (3) Silver certificates representing silver coin 
 held as a trust fund against them in Washington. 
 
 (4) Currency certificates representing United 
 States notes held as a trust fund in Washington or 
 at sub-treasuries to facilitate bank exchange. 
 
LOANS AND INVESTMENTS 263 
 
 (5) Gold coin, legal tender in payment of debts. 
 
 (6) Silver dollars, legal tender in payment of 
 debts. 
 
 (7) Silver subsidiary coin, legal tender in pay- 
 ment of debts up to $5. 
 
 (8) Minor coins of limited legal tender quality. 
 
 (9) National bank notes issued by the banks 
 and protected by Government bonds deposited with 
 the Treasury Department. 
 
 231. INELASTICITY OF CURRENCY. It 
 is easily seen that of all these classes of currency 
 and money which have been in circulation none 
 could be increased save by the actual bringing of 
 metal to the mint for coin, with the exception of 
 National bank notes. The latter could be enlarged 
 in volume by the deposit of Government bonds and 
 the placing of a 5 per cent, redemption fund with 
 the Treasury Department. Even in the latter case, 
 however, it is clear that the amount of National 
 bank notes which could be issued was limited in 
 the aggregate amount by the total volume of United 
 States bonds in existence, and was still further 
 limited by the fact that many such -bonds were held 
 and used to protect public deposits, while still 
 others were held by investors, and so were not 1 
 available for circulation purposes. As the National 
 bank currency had increased in amount until it 
 absorbed practically all of the available volume of 
 bonds, it has been apparent at certain times in the 
 past that a great demand for notes could not be 
 
264 LOANS AND INVESTMENTS 
 
 satisfied by the taking out of bank currency. In 
 order to overcome the "inelasticity" of practically 
 every element in the currency system various plans 
 have been proposed. 
 
 232. SUFFICIENCY OF PROTECTION. 
 The experience of other countries and the theory 
 of banking both combined to indicate that there is 
 no sound reason for differentiating between the 
 protection accorded to notes and that accorded to 
 deposits; but that which is sufficient in one case 
 should be sufficient in all others, and that this (as 
 the experience of our nation indicates) should be 
 the best constituent of the assets of the banks 
 namely, sound, short time commercial paper. The 
 difficulty in applying this standard has been two- 
 fold. 
 
 (1) It has been contended that there was not 
 sufficient sound paper of the kind required in the 
 United States. 
 
 (2) It has been urged that existing bank notes 
 could not be displaced on account of the injustice 
 to the banks which had bought bonds to deposit 
 as security for the notes, and for other reasons. 
 The problem, therefore, of those who wished to in- 
 troduce a more satisfactory method of issuing new 
 currency has been that of protecting the owners 
 of existing bonds and at the same time of furnishing 
 an adequate basis for new note issues in the shape 
 of undoubtedly sound commercial paper. To attain 
 these objects there have been many complicated 
 
LOANS AND INVESTMENTS 265 
 
 plans in the past, and an additional element of com- 
 plexity has been added by reason of the attempt 
 usually made to introduce special means of insuring 
 the safety and goodness of the notes. 
 
 233. NOTES UNDER THE FEDERAL RE- 
 SERVE ACT. When the Federal Reserve Act 
 was in process of drafting, all these considerations 
 were taken under advisement, and it was thought 
 best to provide for the proper treatment of existing 
 note currency as well as for the issue of new notes. 
 Originally the Federal Reserve Act provided for 
 the refunding of existing bonds that is to say, 
 the exchange of the bonds now outstanding for 
 new bonds to bear three per cent, interest, 
 and the gradual retirement of National bank 
 currency as this refunding proceeded. Provision 
 was also made for the issue of bank notes by 
 the several Reserve banks based upon the deposit 
 of commercial paper of the kind made eligible for 
 rediscount under the terms of the laws; and the 
 general purpose contemplated by the measure was 
 that in the course of twenty years existing National 
 bank notes should be retired, and new Federal Re- 
 serve notes should take their place. 
 
 234. CLASSES OF NOTES. While the Act 
 was under consideration in Congress alterations 
 were introduced into it, and the machinery by which 
 the purposes of the Act were to be fulfilled was 
 altered, although it may be broadly said there was 
 no change in the objects ultimately aimed at. Prob- 
 
266 LOANS AND INVESTMENTS 
 
 ably the most important alteration thus made in 
 the terms of the law was that which designated 
 the new Federal Reserve notes as obligations of 
 the United States, thus making them, in the techni- 
 cal sense at least, a Government currency. Another 
 important innovation was a provision whereby 
 Federal Reserve banks might be required by the 
 Federal Reserve Board to buy National bonds held 
 by member banks at a rate not to exceed $25,000,000 
 per annum, while they were to be permitted to issue 
 a new kind of currency to be known as Federal 
 Reserve bank notes on the strength of the bonds 
 which they thus acquired. It will be seen that the 
 Act, therefore, provides for two new classes of 
 currency: 
 
 (1) Federal Reserve notes. 
 
 (2) Federal Reserve bank notes. 
 
 The former are protected by commercial paper of 
 the kind rendered eligible for rediscount under the 
 terms of the law; the latter are protected by Na- 
 tional bonds purchased from the member banks 
 of the System, or any other Government bonds 
 having circulation privileges. The ultimate form 
 of the Federal Reserve Act, however, provides for 
 the conversion of two per cent, bonds into three 
 par cent, bonds by Federal Reserve banks; such 
 three per cent, bonds, moreover, to lose their privi- 
 lege of deposit with the Government to protect 
 circulation. 
 
 235. PROCESS OF CONVERSION. It will 
 
LOANS AND INVESTMENTS 267 
 
 thus be seen that, under the terms of the Federal 
 Reserve Act, the natural development would be 
 conversion in a period of years of most of the 
 National bank notes into Federal Reserve bank 
 notes, with accompanying retirement of these 
 notes, through the conversion of the two per cent, 
 bonds protecting them, into three per cent, bonds; 
 while, in the meantime, Federal Reserve notes based 
 on commercial paper would be issued from time to 
 time as demanded, in quantities sufficient to supply 
 the elastic element in currency, and to fill up such 
 gaps in existing National bank notes as might be 
 caused through the retirement of note issues due 
 to the conversion of two per cent, into three per 
 cent, bonds not bearing the circulation privilege. 
 
 236. DEMAND FOR NOTES. It is now 
 time to see how this technical proceeding works 
 in practice, and what will be the effect of it upon 
 the average man the country over. Let us first 
 observe with some care exactly what gives rise to 
 a demand for currency and to consequent issues of 
 Federal Reserve notes. When A trades with B 
 to the extent of $100,000 worth of goods he thereby 
 creates a demand for some means of transferring 
 the value of $100,000. This exchange may be made 
 by the actual use of money, or by the drawing of 
 a check. Where the buyer of the goods does not 
 have the means to pay for them he usually applies 
 to his bank for accommodation, and such bank may 
 meet his requirements^ by^giving him a credit on 
 
268 LOANS AND INVESTMENTS 
 
 its books, technically known as a "deposit," or by 
 issuing to him its own notes or the equivalent there- 
 of. There is no reason why the bank which is thus 
 applied to, if it desires to grant the credit at all, 
 should not give the accommodation in either form 
 that may be desired by the customer. The cus- 
 tomer is likely to be governed entirely by the 
 demand of the people with whom he is dealing as 
 to the form of payment required. In the case of the 
 bill of goods for $100,000 already spoken of, it is 
 probable that a check on the bank would be exactly 
 what he wanted, in which case no question of note 
 issue is raised. But it may also be that the funds 
 are not wanted for a single payment of this kind, 
 but that accommodation is sought for some purpose 
 which necessitates a number of small payments to 
 persons who do not or cannot employ bank checks. 
 In this instance notes would be needed. Or it may 
 happen that a bank discounts some paper for the 
 purpose of obtaining currency with which to supply 
 actual calls for currency made by its customers who 
 are not necessarily borrowers but who want notes 
 to carry in their pockets for the purpose of meeting 
 demands from day to day. 
 
 237. NOTES AS NEEDED. What the Fed- 
 eral Reserve Act does is to permit a bank to take 
 the promises of individuals to pay at the end of a 
 designated period, indorse these promises with its 
 own signature, and, by the deposit of them with 
 the Federal Reserve bank, obtain in exchange 
 
LOANS AND INVESTMENTS 269 
 
 Federal Reserve notes issued to that bank by a 
 Government officer known as a Federal Reserve 
 Agent. The fact that these notes are technically 
 obligations of the Government confuses the situa- 
 tion to some extent, because it makes the transac- 
 tion appear as if it were one which involved the 
 Government in some way. As a matter of fact, 
 it is the member bank's demand which gives the 
 signal for the issue of the notes and determines how 
 many of them shall come out; while it is the 
 demand of the customer of the member bank which 
 influences the action of that bank in applying for 
 them. Ultimately and in broadest terms, then, the 
 provision of the Federal Reserve Act simply allows 
 individuals to make their own obligations based on 
 commercial, industrial or agricultural transactions, 
 and then, by putting these through a local bank, to 
 get note currency corresponding thereto. As long 
 as their credit is good they can get the notes, pro- 
 vided that the Federal Reserve bank is in a position 
 to protect these notes amply with gold. Under the 
 terms of the Federal Reserve Act this protection 
 must amount to at least 40 per cent, of the face of 
 the note issue; and of this 40 per cent, five per 
 cent, is deposited with the Treasury Department 
 for current redemption, the other 35 per cent, being 
 held in the vaults of the Federal Reserve bank 
 which issues the notes. The currency is thus elastic, 
 inasmuch as it can be increased to the extent of 
 two and one-half times the supply of gold available 
 
270 LOANS AND INVESTMENTS 
 
 100 per cent, being two and one-half times 40 
 per cent. while it is safe, inasmuch as the protec- 
 tion is adequate for all ordinary requirements. 
 Nothing limits the amount of notes that can be 
 issued, therefore, except the needs of the business 
 community and the adjustment of the country's 
 gold supply to that of other nations. 
 
 238. FEDERAL RESERVE BANK NOTES. 
 The Federal Reserve bank note differs from the 
 Federal Reserve note in that it is based upon 
 Government bonds which are deposited with the 
 Treasury Department to safeguard it, just as is 
 the case with National bank notes. The Federal 
 Reserve bank, under the provisions of the Federal 
 Reserve Act, is. permitted to buy Government bonds 
 as a form of investment if it chooses to do so. In 
 addition to this, Federal Reserve banks in the ag- 
 gregate may be assigned by the Board Govern- 
 ment bonds to an amount not to exceed $25,000,000 
 per annum, and may be required to purchase them 
 and pay for them at par. Such assignment takes 
 place only in the event that member banks desiring 
 to sell their bonds file application with the Treasury 
 Department for the disposal of these bonds and the 
 retirement of circulation based thereon. If the 
 aggregate of such applications should be more than 
 $25,000,000 per annum, the Federal Reserve Board 
 apportions the purchases among the banks by a 
 method prescribed in the law, which amounts to a 
 distribution according to capital and surplus. In- 
 
LOANS AND INVESTMENTS 271 
 
 asmuch as the banks which thus seek to exchange 
 their bonds are, of course, unable to get back the 
 notes that were issued on these bonds (the latter 
 being in circulation throughout the country), this 
 provision of the law amounts to permitting the 
 member banks to transfer to the Federal Reserve 
 banks up to the amount of $25,000,000 a year, such 
 Government bonds with the circulation privilege 
 as they may have in their possession pledged to 
 secure National bank notes, the Federal Reserve 
 banks becoming thereupon obligated for all out- 
 standing National bank notes previously issued 
 against them. Of course, the transaction would 
 not occur in precisely this way, as the Federal 
 Reserve bank would pay for the bonds, and the 
 money would go into the Treasury, there to be held 
 against the outstanding bank notes which had been 
 issued on the strength of these bonds. The Federal 
 Reserve bank would then be able to issue its own 
 notes against the bonds so taken over if it saw fit, 
 as it doubtless would; but the result would be 
 the same. 
 
 239. TIME OF RETIREMENT. It is easy 
 to see that if this process went on for about thirty 
 years at the rate of $25,000,000 per annum, all of 
 the National bonds would have been taken over by 
 the Federal Reserve banks, the National bank notes 
 based thereon retired, and an equal amount of 
 Federal Reserve notes issued in their place. We 
 should then have this underlying sub-structure of 
 
272 LOANS AND INVESTMENTS 
 
 Federal Reserve bank notes (or, in the interim, of 
 Federal Reserve bank notes and National bank 
 notes combined) ; while above would be a super- 
 structure of Federal Reserve notes based on re- 
 discounted commercial paper, and varying in 
 amount according to the needs of the country. How 
 great are such needs? They are, of course, only 
 temporary and exceptional, inasmuch as the regu- 
 lar, steady, permanent demands are met by the 
 underlying structure of bond-secured notes. These 
 varying demands are in part the result of so-called 
 "seasonal" calls, for the moving of crops and the 
 like, and in part the result (at special times) of 
 so-called "panic" demands. There is no positive 
 information as to the actual amount of the seasonal 
 demands for crop moving. They vary greatly ; and 
 as long as there is in existence a large underlying 
 body of notes, there will always be more or less 
 shipment of currency from one part of the country 
 to another to meet seasonal calls. 
 
 240. PANIC DEMANDS FOR CURRENCY. 
 The extent of the panic demands can be estimated 
 on the basis of experience obtained during the 
 autumn of 1914. At that time calls were made on 
 the Treasury Department under the section of the 
 Federal Reserve Act which extended the operation 
 of the so-called Aldrich-Vreeland Law through 
 local "currency associations," for sums aggregating 
 about $386,000,000. This was the result of an 
 extremely severe currency demand, and under no 
 
LOANS AND INVESTMENTS 273 
 
 ordinary conditions would again be witnessed. If 
 we estimate the ordinary normal seasonal demands 
 at one-third of this amount, it would probably be 
 an amply high figure. It may be stated, then, that 
 when the Reserve System is in full operation there 
 may be a call for from $125,000,000 to $375,000,000 
 of Federal Reserve notes, the amount varying ac- 
 cording to conditions. At the end of 1915 there 
 were outstanding about $214,000,000 of Federal 
 Reserve notes, while of this amount all except some 
 $16,700,000 was protected by deposits of gold or 
 lawful money dollar for dollar. There can be no 
 doubt that the quantity of legitimate commercial 
 paper in current existence is ample to sustain even 
 the maximum demand for currency thus indicated, 
 so that it may truly be said that the Federal Reserve 
 System is fully able to supply an elastic currency 
 issued to any reasonable amount that may be called 
 for. The only limitation upon the currency is the 
 demand of the community and the existence of 
 actual live transactions calling for it. 
 
 241. POLICY OF NOTE ISSUE. Many who 
 speak of the currency question seem to think that 
 it is desirable for the Federal Reserve banks to 
 force out into circulation, and to keep out, as large 
 a volume of circulating notes as possible, obtaining 
 in exchange therefor the gold of the community. 
 Thus it is often argued that it would be desirable 
 to permit member banks to count Federal Reserve 
 notes as reserves in their own vaults, the effect 
 
274 LOANS AND INVESTMENTS 
 
 being to make them willing to hold the notes there, 
 and to deposit their cash means with the Federal 
 Reserve bank, which in turn would use these means 
 as a reserve basis protecting other liabilities notes 
 and deposit accounts. Such a view, of course, 
 ignores the theory upon which the Federal Reserve 
 Act is founded the so-called "banking theory," 
 as opposed to the "currency theory." The banking 
 theory implies that notes are put into circulation 
 simply for the purpose of facilitating the exchange 
 of goods, and that when this purpose has been 
 fulfilled they should pass out of existence. Bank 
 notes, according to this view, are not a means of 
 displacing gold and enabling the hoarding of the 
 latter metal, but are a means of providing a sub- 
 stitute for gold for the purpose of making ex- 
 changes, such substitute to continue in use so long 
 as there is an actual demand for it for the transfer 
 of goods, and then to go out of use as soon as this 
 demand has been satisfied. 
 
 242. FEDERAL RESERVE NOTES AND 
 BANK RESERVES. It is often pointed out that 
 the Federal Reserve notes, not being legal tender 
 and not being reserve money, can, at the will of the 
 holder (if a bank) be promptly converted into 
 reserve funds by the simple process of depositing 
 them with the Federal Reserve bank which issued 
 them. Therefore, it is argued, the wise course 
 would be that of making the Reserve note legal 
 tender to start with, and of permitting it to be used 
 
LOANS AND INVESTMENTS 275 
 
 in bank reserves. No such conclusion can, however, 
 fairly be drawn. When the Federal Reserve note 
 is deposited with the Federal Reserve bank which 
 issues it, and is thereby converted into a deposit 
 credit (reserve), the Federal Reserve bank is given 
 a means of tracing and accounting for its liabilities 
 at every step. The bank knows when the deposit 
 credit is cancelled, and how effectively and under 
 what conditions it is transferred. It has entire 
 control of its own liabilities in this regard. The 
 reserve deposits are not legal tender, but they are 
 reserves for the member banks. The member banks 
 must provide a legal tender for their own cus- 
 tomers, but for their own use they have their credits 
 on the books of the Federal Reserve bank. This 
 is a situation totally different in theory from that 
 which would grow out of a plan such as that put 
 forward in the Aldrich or Monetary Commission 
 bill whereby the notes of the reserve institutions 
 were made legal tender, and available in the mem- 
 ber bank reserves. Under those circumstances 
 there would have been nothing whatever to pro- 
 duce elasticity. 
 
 243. NOTES BASED UPON BUSINESS 
 TRANSACTIONS. The note issue on its new 
 basis will, however, be highly elastic and con- 
 trollable. There can be no question of its sound- 
 ness and convertibility, and none of its flexibility. 
 It is perhaps the most conspicuous feature of the 
 new banking system, because the one that has been 
 
276 LOANS AND INVESTMENTS 
 
 most discussed, but it is far from being the most 
 important, in view of the fact that the law, as 
 already stated, accepts the banking theory of note 
 issue rather than the so-called currency theory. 
 "No note issue without a transaction to call for it" 
 is the first principle upon which the Federal Reserve 
 note issue is based. "No commercial transaction 
 that cannot obtain a note issue to facilitate it" is 
 the second principle. Taken together, they imply 
 that the business community need not in the future 
 fear, under any conditions reasonable to expect, a 
 deficiency in the circulation. 
 
 244. TAKING OVER GOVERNMENT 
 BONDS. The question exactly how the Federal 
 Reserve banks are to proceed in taking over the 
 bonds, and the policy of the Treasury Department 
 in effecting this great transformation of the cur- 
 rency of the country, is a matter of profound inter- 
 est to the banker, not only from the general stand- 
 point of theory, but also as a matter of affecting 
 the value of his assets. More than seven hundred 
 millions of dollars of Government bonds are now 
 held by the National banks of the country for the 
 purpose of sustaining their outstanding notes. The 
 great bulk of Government bonds now in existence 
 are not of the type which are attractive to the 
 public from the investment standpoint, and it is 
 fair to say, as a general matter, that they could not 
 be sold to private persons, but must be held by 
 banking institutions for the most part. Under the 
 
LOANS AND INVESTMENTS 277 
 
 Federal Reserve Act there are two methods by 
 which the National banks now holding these bonds 
 may be gradually relieved of them: 
 
 (1) Purchases by Federal Reserve banks in the 
 "open market" that is to say, purchases from any 
 individual or institution from whom they may 
 choose to buy. 
 
 (2) Assignments or allotments to the Federal 
 Reserve banks made by action on the part of the 
 Federal Reserve Board, in approving applications 
 for the sale of bonds ttp to $25,000,000 which are 
 filed with the Treasurer of the United States by the 
 banks now owning these bonds. 
 
 245. PROBLEMS OF CONVERSION. In 
 connection with the administration of the act, 
 several matters of a serious nature have called for 
 attention. One is the T fact that the act permits 
 Federal Reserve banks to go much further than 
 their allotment of $25,000,000 annually in th'e pur- 
 chase of bonds, so that the question has arisen, how 
 far it would be wise to take over bonds through 
 actual purchase. Another question calling for dis- 
 position has been whether such purchases would 
 constitute a reduction of the amount that might be 
 allotted to them by the Board. The Federal Re- 
 serve Board, in passing upon this question, has 
 taken the view first of all, that actual purchases 
 made by the Reserve banks might be counted as 
 reducing the amount that could be allotted to them 
 as the result of applications for sale made by the 
 
278 LOANS AND INVESTMENTS 
 
 member banks through the Treasurer of the United 
 States. A matter which has been of great import- 
 ance from the standpoint of the Reserve banks has 
 been whether such bonds as they take over, either 
 through purchase or allotment, could be immedi- 
 ately converted into three per cent, bonds by the 
 Treasury Department, or whether, under the terms 
 of the law, they must be partly converted into 
 one-year notes, and whether the conversion might 
 go on to any amount that the banks chose to 
 demand. The decision reached by the authorities 
 of the Treasury Department has been that it lay 
 within the jurisdiction of the Department to deter- 
 mine the amount of bonds so to be converted, and 
 the proportions in which the conversion should be 
 made into long term bonds and one-year notes. 
 For the first year it was determined to convert 
 only $30,000,000 of the existing bonds and to make 
 this conversion as nearly as possible into equal 
 portions of long term three per cent, bonds and 
 one-year three per cent, notes. The aggregate, as 
 well as the division between bonds and notes, may 
 be varied from year to year at the discretion of the 
 Secretary of the Treasury. 
 
 246. CURRENCY AND BANK RESERVES. 
 Paul M. Warburg, in an address at the Conven- 
 tion of the American Bankers Association, held in 
 Kansas City in 1916, said in part: 
 
 (1) "Monetary and banking reform made its greatest 
 step forward when public opinion recognized that it was not 
 
LOANS AND INVESTMENTS 279 
 
 essentially a question of note issues but one of reserves. 
 But, though this reserve problem has thus been before us 
 for many years, it is a strange fact that there still exists a) 
 singular confusion in the minds of bankers, writers and; 
 students as to what the word 'reserve' actually means in this 
 connection. There are all kinds of reserves. There are 
 military and naval reserves. We speak of reserves in deal- 
 ing with water supply, with food, raw materials, rolling 
 stock, electric power, and what not. In each case its mean- 
 ing depends upon the requirements of the organization 
 maintaining the reserve. Reserve is, as the name implies, 
 what one holds back. It generally means an extra supply 
 of something kept idle for the purpose of being immediately 
 available to take care of an increased demand in excess of 
 normal requirements. Now, if we wish to get a clear con- 
 ception of the meaning of reserves in connection with the 
 Federal Reserve System, we must understand that it is 
 necessary to recognize central banks as entirely different 
 organizations from commercial banks and trust companies 
 and, consequently, that their respective reserves differ as 
 much as those of an ice factory and a summer hotel the 
 one a producer and the other a consumer of ice. Reserves 
 of central banks and reserves of the general stock banks, 
 are two entirely different things. For the sake of greater 
 simplicity I shall in this address call the National banks, 
 State banks and trust companies, the 'stock banks' and their 
 reserves 'banking reserves/ and I shall term the reserves of 
 the central banks 'gold reserves,' leaving it open at this 
 point whether or not these latter reserves should include 
 silver and greenbacks. The Federal Reserve System is a 
 co-ordination of twelve central banks and the same principle 
 as to reserves, therefore, applies as if we were dealing with 
 one central bank. I shall, therefore, in this address, class 
 the Federal Reserve System with the central banks. 
 (2) "Let us consider first the functions of the stock 
 
280 LOANS AND INVESTMENTS 
 
 banks in central bank countries. Deposit banking is the art 
 of wisely employing the depositors' stored-up purchasing 
 power. It is based on the principle that there is a sufficient 
 variety of conditions amongst the depositors and borrowers 
 of a bank so as normally to preclude the probability of the 
 depositors withdrawing and using their own money faster 
 than it can be collected from the borrowers to whom tho 
 depositors' purchasing power temporarily has been trans- 
 ferred. The bank's own capital and the uninvested part of 
 its deposits from the insurance, or reserve, fund to act as 
 an equalizer in balancing these scales. It is essentially a 
 question of exchanging credits and, where there is a central 
 banking machinery enabling the stock banks to liquidate a 
 sufficient amount of their assets to make good any deficits 
 that may occur, the whole system is safe and complete. The 
 central banking organization provides the member banks 
 either with balances to be used in the clearing, or, if currency 
 should be required, with notes which will be accepted by 
 their depositors in settlement of the stock bank's obligations. 
 In countries where these notes of the central banks are 
 generally accepted in settlement of debts by business men 
 and banks, the 'banking reserves' of the stock banks may 
 safely consist of the central bank currency or of a balance 
 kept with the central bank convertible into such currency. 
 These form the first line of banking reserves. The second 
 line consists of those assets which, with certainty and 
 promptness, may be converted into credit balances with the 
 central bank. It is simply a question of having a reserve of 
 such credit currency, or of power to produce such credit 
 balances, as will provide an acceptable means of satisfying 
 depositors. Balances with the central bank, and its notes, 
 entitle the stock banks, like any other holder, to payment 
 in legal tender ; and if legal tender is demanded by creditors 
 o the stock banks, the latter must rely upon the central 
 bank to furnish it. The duty to keep its own deposit and 
 
LOANS AND INVESTMENTS 281 
 
 note obligations sufficiently protected by a proper propor- 
 tion of metallic cover rests with the central bank, and its 
 reserves, therefore, must consist exclusively of the metal in 
 which its obligations are payable. In central bank countries 
 there does not exist any law that requires stock banks to 
 keep in actual specie in their own vaults a certain proportion 
 of their deposits. All the central bank usually requires is 
 that the stock banks and other firms maintain with it free 
 balances commensurate with the scope of their transactions. 
 As a matter of fact, if we study the statements of European 
 stock banks we find one single cash item which includes 
 the combined holding of gold, silver, bank notes and the 
 balance with the central bank. 
 
 (3) "In the United States our old State banking systems 
 did not provide for any central organization to protect the 
 banks' gold obligations, nor did they furnish the machinery 
 by which, in case of need, banks could convert their com- 
 mercial assets into cash or credit balances. The National 
 Bank Act, therefore, required every National bank to main- 
 tain against its deposits a certain percentage of actual lawful 
 money reserve, which it was considered should constitute its 
 contribution to the general gold protection of the nation ; in 
 addition, credit bank balances in reserve and central reserve 
 cities were to provide a certain liquidity in case of emerg- 
 encies. The vicious shortcomings of this old method are 
 well known to everybody here, and need not be elaborated. 
 The Federal Reserve Act brought about a most radical 
 change. It created a system of twelve central banks which, 
 co-operating with one another, were from then on to exercise 
 two important functions in relation to their member banks ; 
 first, to provide a sufficient gold cover for the country's gold 
 obligations ; and, second, to provide the machinery for turn- 
 ing, whenever desired, the member banks' commercial assets 
 into available credit balances or cash. The first function 
 relieved the member banks of the necessity of keeping in 
 
282 LOANS AND INVESTMENTS 
 
 their vaults large amounts of gold for the general protection 
 of the country; the second rendered unnecessary the so- 
 called reserve balances with correspondents in reserve and 
 central reserve cities. The safe and effectual transfer of 
 these burdens to the Federal Reserve banks must be predi- 
 cated, however, upon a sufficient mobilization and concen- 
 tration of gold in the hands of the Federal Reserve banks, 
 and, furthermore, upon the existence of a large volume of 
 standardized commercial and banking paper, easily redis- 
 countable without red tape with the Federal Reserve banks. 
 This is where the Federal Reserve Act stopped half-way. 
 It did not say to the member banks, 'Maintain with the 
 Federal Reserve bank a minimum balance sufficient for the 
 general safety of the country and whatever cash you keep 
 in excess of that in your own vaults be that gold or silver 
 or Federal Reserve notes is your own concern. But bear 
 in mind that the larger the gold fund produced by the com- 
 bined contributions from your own vaults, the stronger will 
 be the protection to you and the entire country.' The law 
 continued, instead, the anomaly of requiring member banks 
 to lock up in their vaults hundreds of millions of dollars, 
 thus preventing them by legal enactment from giving addi- 
 tional strength to their own protective system, even if they 
 should want to do so. It further created the anomalous 
 situation that, while a balance with a Federal Reserve bank 
 could be considered as reserve, the Federal Reserve note 
 could not be so counted, despite the fact that it is a prior 
 lien against the assets of the bank and is the obligation of 
 the United States, while the balance is not. This inconsist- 
 ency to a certain extent at least has been cured ; Congress 
 having passed, upon the recommendation of the Board, a 
 most important amendment authorizing the Board to permit 
 member banks to keep any portion of their required vault 
 reserve as balances with their Federal Reserve banks. In 
 passing this amendment Congress has opened the path for 
 
LOANS AND INVESTMENTS 283 
 
 great strides in advance, and it remains to be seen now how 
 far the bankers of the United States will be able to seize 
 this opportunity of doubling the strength of their Federal 
 Reserve banks. 
 
 (4) "In dealing with the problem of adequate reserves, 
 we must first and always consider the question of whether 
 or not our Federal Reserve banks are sufficiently strong for 
 the protection of the country or whether they are stronger 
 than necessary. Whenever the latter question can be 
 answered in the affirmative, then only will we be justified 
 in considering the advisability of reducing the member 
 banks' reserve requirements. What is the Federal Reserve 
 System's lending power today ? If we set aside a gold reserve 
 of only forty per cent. which may do in times of stress, but 
 is not a proper and sufficient basis in normal times we find 
 that we have a free gold reserve of about $206,000,000, or if 
 we include the gold now held in cold storage by the Federal 
 Reserve agents, about $380,000,000. This means that by 
 additional rediscount operations, or purchases in the open 
 market, for home requirements or for export, we are able to 
 stand a loss of gold of from two to three hundred million 
 dollars. Two hundred million dollars is a very large amount, 
 but when we realize that the nation's gold holding in one 
 year has increased by about $500,000,000, it is well for us to 
 consider whether or not we shall be able to hold this gold 
 at the end of the war. It is impossible to predict what will 
 then be our economic and financial situation. Perhaps we 
 may find ourselves in an overexpanded or generally unsatis- 
 factory condition, and we may have to face a readjustment 
 in which all our banking strength may be required. On the 
 other hand, things may go well with us, but in the rest of the 
 world there may be a great deal of financial distress. In that 
 case (and it may be the more likely of the two) we shall 
 have almost boundless opportunities, but serious obligations 
 as well. Foreign loans in the old and the new world may 
 
284 LOANS AND INVESTMENTS 
 
 draw away our capital at interest rates "far in excess of our 
 own. Our exporters will have to meet the keen competition 
 of other nations, and even though at first there will prob- 
 ably be a strong demand for certain of our raw materials, 
 the purchasing power of many a country will be found 
 materially reduced. These are conditions which, in the long 
 run, may be the cause of heavy gold exports from the United 
 States and which, if we remain unprepared, may seriously 
 check our progress. If, on the other hand, we forearm, we 
 may grasp the opportunity of taking our place as the strong- 
 est of the world's bankers and furnish our industries with 
 the basis for a solid expansion. 
 
 (5) "Does it not appear ridiculous that a country owning 
 over two billions and a half of gold should not be able to 
 mobilize a larger free gold reserve than two or three hun- 
 dred millions of dollars, particularly when it is apparent that 
 its future financial and economical growth will depend upon 
 the extent of the 'preparedness* that it can provide in this 
 respect? Our critics say that, by concentrating the gold in 
 the Federal Reserve banks, we shall make them the target 
 for gold withdrawals. But they will be that target anyhow. 
 The only question is, will they be able to resist without 
 being forced to take premature and unnecessarily drastic 
 measures of defense? Let us suppose that our member 
 banks' excess cash reserves have been wiped out, either by 
 gold export or by expansion of the loan and deposit struc- 
 ture ; let us suppose that our discount and investment rates 
 are fairly low as compared with those prevailing in Europe ; 
 let us suppose that our shipments to foreign countries will 
 no longer exceed our imports. Then, as money flows where 
 it can safely earn the highest returns, our bankers will 
 probably have to finance foreign countries both in govern- 
 ment loans and individual transactions. Suppose, then, that 
 Mr. Ivanoff, in Petrograd, draws $100,000 at ninety days' 
 sight on an American banker against a credit granted to him, 
 
LOANS AND INVESTMENTS 285 
 
 rediscounts that paper in New York, and, against this bal- 
 ance, Russia wants gold. Where will it come from? The 
 member banks have no more excess reserves ; shall we then 
 begin to withdraw it from circulation and how and against 
 what? The New York member bank will rediscount $100,- 
 000 of bankers' acceptances or commercial paper with its 
 Federal Reserve bank and ask for gold. Ultimately, there- 
 fore, the demand for gold will be made upon the Federal 
 Reserve banks. We are faced with the simple question: 
 Will we be strong enough to share our plenty, during the 
 coming period of stress, with other nations and be the 
 world's banker, or will we be so weak that, when these 
 demands come, we must stop them at once by raising our 
 discount rates high enough to retain our gold at home? 
 Keep all the gold in your vaults where it is useless for your- 
 selves and deprived of the additional force that it may gain 
 in the hands of the Federal Reserve banks ; keep every cash- 
 till in hotels, railroad stations, drygoods stores and what 
 not, filled with gold certificates, and you will rob the country 
 of its legitimate opportunity of growth, of helping itself, and 
 of helping the world. Our foreign competitors will proclaim 
 that only a country willing to part freely with its gold may 
 safely be accepted as a world's banker, and they will point 
 to the fact that, in past critical periods, our banks stopped 
 paying in gold. It is our duty to give to the world an over- 
 whelming evidence of our ability and determination in the 
 future to maintain our gold obligations under any and all 
 circumstances. 
 
 (6) "The vast accumulation of gold in the hands of the 
 Federal Reserve banks which I am urging is of great mo- 
 ment in its bearing upon the future of the National bank 
 currency. The objects contemplated in this respect by the 
 Federal Reserve Act are highly to be commended; but 
 carrying this scheme into effect is subject to too many de- 
 lays. More comprehensive action from the beginning would 
 
286 LOANS AND INVESTMENTS 
 
 have brought about better results. The ultimate aim which 
 we must have in mind is the conversion of a large portion of 
 the two per cent, government bonds now securing circula- 
 tion into new three per cent, bonds, a substantial portion of 
 which will gradually be absorbed by the people. This would 
 have the consequence of reducing the amount of National 
 bank circulation, so that, at a given point, whatever two per 
 cent, bonds the Federal Reserve banks acquired would ulti- 
 mately be carried by Federal Reserve note circulation, and 
 this, in turn, would be of material assistance to the Federal 
 Reserve banks in earning their dividends. As the absorption 
 of the three per cent, bonds by the public proceeded, and as 
 the growing acceptance market offered a wider field of in- 
 vestment for the Federal Reserve banks, Federal Reserve 
 notes would take the place of Federal Reserve bank notes, 
 bankers' acceptances and commercial paper would take the 
 place of government bonds and an elastic and live currency 
 would replace the present inelastic government bond se- 
 cured currency. In order to carry out this process, however, 
 it will be necessary normally to maintain against Federal 
 Reserve notes at least the forty per cent, reserve required 
 by law, as against the five per cent, of reserves now required 
 against National bank notes. And this, again, is an added 
 reason for facilitating the concentration of gold in the Fed- 
 eral Reserve banks, so that they may be strong enough to 
 sustain this large volume of circulation on the higher reserve 
 basis. The larger powers which we should enjoy would not, 
 therefore, be employed to inflate circulation. On the con- 
 trary, as a net result, it would be used for the purpose of 
 building up a circulation covered by a far stronger gold 
 reserve than that of the National bank notes. Until the 
 volume of the latter has been materially reduced, and until 
 Federal Reserve notes may be accepted as reserve money by 
 the member banks, the lending power of the Federal Reserve 
 banks will remain hampered. 
 
LOANS AND INVESTMENTS 287 
 
 (7) "The Federal Reserve banks have made investments 
 aggregating at present about $180,000,000 and have out- 
 standing a net circulation of about $16,000,000. That means 
 that for $164,000,000 of investments they have paid gold and 
 thereby have reduced their reserve power to that extent. If 
 they could have paid in Federal Reserve notes instead of 
 gold, as they should have been permitted to do, they would 
 have wasted only forty per cent, of this amount and would 
 have retained the balance, that is, about one hundred mil- 
 lions, as a potential reserve for additional note issue. As 
 stated before, it does not necessarily follow that Federal 
 Reserve banks would have made larger investments at this 
 time; it is not at all likely that they would have done so. 
 But emphasis must be laid upon the resulting reductions of 
 their power to assist the country in an emergency. The 
 argument is used that if Federal Reserve notes had been 
 paid out and could have been counted as reserve money by 
 the stock banks, these notes would have gone into the vaults 
 of the member banks as reserve money and caused a further 
 expansion of loans. But we must not forget that the same 
 result has followed by the Federal Reserve banks paying out 
 gold. As far as the member banks are concerned, the effect 
 is the same whether they receive $164,000,000 in gold or in 
 Federal Reserve notes which may be counted as gold. But 
 the difference is, as we have stated, that under the present 
 system the lending power of the Federal Reserve System is 
 being impaired too fast. Federal Reserve notes 'shall be 
 obligations of the United States and shall be receivable by 
 all National and member banks and the Federal Reserve 
 banks and for all taxes, customs and public dues. They shall 
 be redeemed in gold at the Treasury/ etc. Did we not stop 
 half-way when we provided that banks are thus to receive 
 Federal Reserve notes in payment of debts among each 
 other, and from their depositors, but cannot count them as 
 reserve for the purpose of discharging their deposit liabil- 
 
288 LOANS AND INVESTMENTS 
 
 ities ? As a consequence, banks when settling with each other 
 through clearing do not accept Federal Reserve notes, but 
 must settle with lawful reserve money that is, substantially 
 in gold. If, however, a bank settled directly with another 
 bank it could pay in Federal Reserve notes and the payee 
 bank could then send the Federal Reserve notes to its Fed- 
 eral Reserve bank, create a balance and then count that as 
 reserve. It is fortunate that the new amendment will permit 
 member banks to carry any part of their required vault 
 reserve as a balance with the Federal Reserve bank and to 
 count it as reserve. It is hoped that this will cause member 
 banks promptly to adopt the habit of settling their balances 
 with each other by transfer of credit, through their Federal 
 Reserve banks, thereby releasing gold needlessly tied up in 
 clearing operations and in their vaults and remedying, to a 
 certain extent at least, these anomalous conditions. 
 
 (8) "In dealing with this question of reserves and note 
 issue, it is proper and necessary that we proceed step by 
 step. Splendid progress has been made in these last two 
 years and we realize, of course, that the tracks must be 
 shifted many a time before we can reach our final goal. But 
 we must be clear about this ultimate aim and we must recog- 
 nize the absolute necessity of taking certain consecutive 
 steps before monetary and banking reform will be complete. 
 Ultimately we must rid our country of the confusing multi- 
 plicity of currency with which we are now afflicted, and the 
 Treasury will have to stop issuing small denomination gold 
 certificates. The circulating currency of the country ought 
 to be silver certificates in the small denominations, and 
 Federal Reserve notes. The best place for gold and gold 
 certificates will be in the Federal Reserve banks. The 
 National bank currency ought to be systematically with- 
 drawn, and the greenbacks ought to be gradually turned 
 into gold certificates as the missing gold cover from time to 
 time is produced by the excess profits to be received from 
 
LOANS AND INVESTMENTS 289 
 
 the Federal Reserve banks or by some more rapid process 
 that the future may evolve. While this process is taking its 
 course I think we are fully justified in permitting the Fed- 
 eral Reserve banks to count greenbacks as part of their 
 metallic reserve. It is freely admitted that this is not abso- 
 lutely good banking theory. But with the $153,000,000 gold 
 behind these notes and the power given to the United States 
 to provide the additional gold cover by a sale of govern- 
 ment bonds, we may be warranted in temporizing and not 
 making an over-rigid discrimination. 
 
 (9) "One cannot deal with the future of our Federal 
 Reserve System and our reserve problem without being 
 puzzled by the question, what will be the coming standard 
 of differentiation between central reserve cities, reserve 
 cities and country bank places when, after November 16, 
 1917, balances with correspondent banks will no longer 
 count as reserve. I cannot undertake to discuss that prob- 
 lem today, but I think it is timely to point to this phase and 
 invite you to give it your most careful consideration. The 
 time is not distant when we shall have to deal with this 
 conundrum and we shall welcome indeed, we shall need 
 your very best thoughts in the matter. The Federal Reserve 
 System is the beginning of an imposing structure to be 
 erected upon a broad foundation. It will prove a costly edi- 
 fice unless it is developed to its full growth along these 
 broad lines. Member banks and the country at large have a 
 very vital and obvious interest in this, and they may well 
 insist that there be no stopping half-way or haphazard addi- 
 tions or little patchwork here and there. The banks and 
 country are now entitled to enjoy, and will soon require, 
 the strongest possible system, and the further it progresses, 
 the more the concentration of gold in the Federal Reserve 
 banks proceeds, the further the discount market develops 
 and the further grows the habit of banks, large and small, 
 to invest in bankers' and trade acceptances, the less will it 
 
290 LOANS AND INVESTMENTS 
 
 be necessary for them to keep unduly large sums locked up 
 in their vaults and the easier will it be for Federal Reserve 
 banks to return a portion of their paid-in capital. The roads 
 to reduced reserve and capital requirements lie in these di- 
 rections. If member banks are to rely for their protection 
 primarily upon their ability to create balances with their 
 Federal Reserve banks they must be certain that they have 
 in their possession an easy means of approach, a reliable 
 key that will open for them the floor leading to the Federal 
 Reserve banks* vaults." 
 
EXERCISES 
 
 Questions to be Answered by Students 
 
 (Chapter I Commercial Loans) 
 
 1. Define "liquid assets" and explain why the 
 assets of a commercial bank should be liquid. 
 
 2. What are "lines of credit" and why is it 
 difficult to curtail lines of credit in times of financial 
 stringency? 
 
 3. Discuss ways and means by which a com- 
 mercial bank may replenish its reserves. 
 
 4. Describe the ultimate effect of the general 
 contraction of loans. 
 
 5. How does the Federal Reserve System bene- 
 fit commercial banks in maintenance of liquid assets 
 and adjustment of reserves. 
 
 6. Define "current assets" and give one or more 
 examples. 
 
 7. Define and exemplify "current liabilities." 
 
 8. What information should bank credit depart- 
 ments have, and how may such information be best 
 obtained? 
 
 9. In extending credit, what circumstances and 
 conditions should be considered beyond ordinary 
 statements of assets and liabilities? 
 
 10. Discuss the ratio of collections to maturities. 
 
 11. What are the advantages of "trade accep- 
 tances" as compared with single name commercial 
 paper? 
 
 291 
 
292 LOANS AND INVESTMENTS 
 
 12. What are the advantages of "single name 
 commercial paper" as compared with trade accep- 
 tances? 
 
 13. Define "bank acceptances" and explain their 
 utility. 
 
 14. In your judgment what portion of a com- 
 mercial bank's available funds should be invested 
 in (1) marketable securities, (2) commercial paper 
 purchased in the open market, (3) loans to cus- 
 tomers? 
 
 (Chapter II Agricultural Loans) 
 
 15. Define "commodity paper" and give ex- 
 amples of instruments thus termed. 
 
 16. In what way does the Federal Reserve 
 System favor agricultural loans? 
 
 17. Name the principal grain growing States. 
 
 18. Explain (1) prevailing methods of market- 
 ing grain, (2) process of distributing it, (3) manner 
 of storage. 
 
 19. Describe the security generally required by 
 banks in making grain loans. 
 
 20. Do banks generally give grain dealers open 
 lines of credit, and if so, why? 
 
 21. Name the cotton growing States, and state 
 the amount of cotton produced in the United States. 
 
 22. Describe the manner in which banks make 
 loans to cotton planters. 
 
 23. How do banks make advances to cotton 
 buyers, and on what security? 
 
LOANS AND INVESTMENTS 293 
 
 24. Define "cotton futures" and discuss trans- 
 actions in connection with them. 
 
 25. Discuss the advantages and disadvantages 
 of "cattle loans." 
 
 26. Define "cattle loan companies" and explain 
 their operations. 
 
 27. What kind of business statements should 
 be required from farmers? 
 
 28. In making loans to farmers, what are the 
 principal circumstances to be considered? 
 
 (Chapter III Stocks and Bonds) 
 
 29. What is the fundamental difference between 
 "stocks" and "bonds?" 
 
 30. Distinguish between "common" and "pre- 
 ferred" stocks. 
 
 31. What may be said in favor of the issuance 
 of shares of stock without par value? 
 
 32. Describe the requirements in connection 
 with the transfer of stocks. 
 
 33. Specify some of the conditions that deter- 
 mine the titles under which bonds are classified. 
 
 34. Define "coupon bonds," "registered bonds,", 
 and "registered coupon bonds." 
 
 35. What particular facts and circumstances 
 should be considered in buying municipal bonds? 
 
 36. What is the usual procedure in the issuance 
 and marketing of bonds? 
 
 37. Define in your own language the financial 
 terms "bull" and "bear." 
 
294 LOANS AND INVESTMENTS 
 
 38. Explain the meaning of the terms "short" 
 and "long" as applied to stock market transactions. 
 
 39. Describe "watered stock" and specify two 
 issues that in your judgment may be so classified. 
 
 40. Discuss stocks and bonds as investments. 
 
 41. Specify bonds suitable for investment by a 
 commercial bank. 
 
 42. What classes of bonds are suitable for sav- 
 ings banks or trust funds? 
 
 (Chapter IV Collateral Loans) 
 
 43. Distinguish between "pledge," "lien" and 
 "chattel mortgage," and show which gives the 
 greatest rights. 
 
 44. May a National bank hold in pledge as col- 
 lateral security for a loan made, or to be made, 
 shares in the stock of another National bank? 
 
 45. Can a National bank make a valid loan on 
 the security of its own stock? 
 
 46. What are the essentials of a valid delivery? 
 
 47. What is "constructive delivery" and is it 
 sufficient to constitute a pledge? 
 
 48. Explain the manner in which a broker may 
 hypothecate his customers' securities. 
 
 49. When goods in a warehouse on which a 
 warehouse receipt has been issued are attached by 
 order of a court, what are the rights of a bank hold- 
 ing the receipt as collateral? 
 
 50. In what respect does a warehouse receipt 
 differ from a bill of exchange as to negotiability? 
 
LOANS AND INVESTMENTS 295 
 
 51. Distinguish between warranties and liens. 
 
 52. Of what importance is a bill of lading at- 
 tached to a draft in payment of goods for export? 
 
 53. How does a bill of lading differ from an 
 ordinary receipt? 
 
 54. If a bill of lading held by a bank as col- 
 lateral for a loan turns out to have been forged by 
 one of the carrier's representatives, who is re- 
 sponsible, and why? 
 
 55. What is the difference between a "Straight" 
 bill of lading and an "Order" bill of lading? 
 
 56. Explain why a bank should not surrender 
 a bill of lading attached to a draft without accep- 
 tance or payment of the draft. 
 
 (Chapter V Seasonal Demands for Money) 
 
 57. Describe seasonal variations in demands 
 for money in New York City. 
 
 58. What are the seasonal variations in demands 
 for money in your own locality? 
 
 59. Explain how seasonal variations in demands 
 for money influence prices of bonds. 
 
 60. How do seasonal demands for money affect 
 bank reserves? 
 
 61. Define "secondary reserves" and explain 
 their utility. 
 
 62. What are the three essential characteristics 
 of secondary reserves? 
 
 63. What is meant by "emergency market- 
 ability?" 
 
296 LOANS AND INVESTMENTS 
 
 64. Discuss the relative merits of bonds and 
 commercial paper as secondary reserves. 
 
 65. Specify a few issues of bonds that would in 
 your judgment be suitable for secondary reserves. 
 
 66. How does commercial paper serve the pur- 
 pose of secondary reserve in Europe? 
 
 67. Why has commercial paper in the United 
 States been largely local in character? 
 
 68. How may a commercial paper market be 
 developed in the United States? 
 
 69. In what manner will the Federal Reserve 
 System tend to change the character of secondary 
 reserves? 
 
 70. Define "business cycles" and discuss their 
 cause and effect. 
 
 (Chapter VI International Exchange) 
 
 71. Define "foreign exchange" and explain the 
 difference between foreign and domestic exchange. 
 
 72. What is the "mint par of exchange" and how 
 is it computed? 
 
 73. What is the "gold import point" and under 
 what circumstances is gold imported from foreign 
 countries to the United States? 
 
 74. What is the "gold export point" and under 
 what circumstances is gold exported from the 
 United States to foreign countries? 
 
 75. What factors determine the price of gold in 
 international exchange? 
 
 76. What are "cable transfers" and why is the 
 
LOANS AND INVESTMENTS 297 
 
 cable transfer rate of exchange higher than the de- 
 mand rate of exchange? 
 
 77. Name and describe the different kinds of 
 time bills of exchange. 
 
 78. Define "arbitrage" and illustrate an arbi- 
 trage transaction. 
 
 79. What are "finance bills" and how are they 
 handled? 
 
 80. Describe the three forms of "revolving 
 credit." 
 
 81. Describe the methods of financing imports 
 and exports. 
 
 82. How is the demand rate of exchange deter- 
 mined? 
 
 83. Explain the relation of interest rates to for- 
 eign exchange rates. 
 
 84. Define "dollar exchange" and discuss its de- 
 velopment. 
 
 (Chapter VII Bonds and Circulating Notes) 
 
 85. Explain the difference between the liability 
 of a bank in issuing bank notes and the liability of 
 a bank receiving deposits. 
 
 86. Why do bank notes remain outstanding 
 longer than bank checks? 
 
 87. What are the principal methods of protect- 
 ing bank notes? 
 
 88. Explain the Canadian "guaranty fund" for 
 the protection of bank notes and describe its oper- 
 ation. 
 
298 LOANS AND INVESTMENTS 
 
 89. How has bond-secured currency under the 
 National Bank Act proved unsatisfactory? 
 
 90. Specify the different forms of currency in 
 the United States. 
 
 91. What are "greenbacks" and how are they 
 secured. 
 
 92. Define "inelasticity of currency" and explain 
 its effects. 
 
 93. Discuss the difference between protection 
 accorded to bank notes and to bank deposits. 
 
 94. What forms of notes are issued under the 
 Federal Reserve Act? 
 
 95. Explain "Federal Reserve Notes." 
 
 96. What are "Federal Reserve Bank Notes" 
 and under what conditions are they issued? 
 
 97. Explain the provisions of the Federal Re- 
 serve Act for the conversion of two per cent, bonds. 
 
 98. Discuss the relationship between Federal 
 Reserve notes and bank reserves. 
 
 99. Explain the procedure of Federal Reserve 
 banks in taking over the bonds held by National 
 banks as security for circulation. 
 
 100. Why should gold be concentrated in the 
 Federal Reserve Banks? 
 
 INSTRUCTIONS. In City Chapter Classes the 
 foregoing questions are to be used in connection 
 with the respective subjects to which they pertain. 
 Correspondence Chapter students will submit an- 
 swers to all of the one hundred prescribed questions 
 at the same time. 
 
INDEX 
 
 Numbered Paragraphs 
 
 Adequacy of Reserves 169 
 
 Adjustment of Reserves 13 
 
 Advantages of Single Name Paper 39 
 
 Advantages of Trade Acceptances 38 
 
 Agricultural Paper for Rediscount 82 
 
 Aldrich-Vreeland Act 17 
 
 Altered Bills 150 
 
 Arbitrage 198 
 
 Arrival Rates 212 
 
 Assets Must Be Liquid 5 
 
 Assistance of Federal Reserve Banks 62 
 
 Attachment of Goods Under Bills of Lading. . 153 
 
 Bank Acceptances 41 
 
 Bank Advances to Cotton Buyers 59 
 
 Bank Balances and Bonds 10 
 
 Bank Notes and Checks 224 
 
 Bank Notes and Deposits 222 
 
 Banks and Stock Exchanges 119 
 
 Bills of Lading " 146 
 
 Bond Issuance Ill 
 
 Bond Selling Syndicates 114 
 
 Bond Underwriting Syndicates 113 
 
 Bonds and Bank Notes 229 
 
 Bonds and Their Classification 97 
 
 Bonds as Investments 120 
 
 Bonds as Secondary Reserves 180 
 
 299 
 
300 LOANS AND INVESTMENTS 
 
 Borrowing and Lending Exchange Markets. . 211 
 
 Business Cycles 182 
 
 Buying Cattle Loans 79 
 
 Cable Transfers 194 
 
 Cash and Credit 4 
 
 Certificates of Stock 91 
 
 Classes of Notes 234 
 
 Classification of Time Bills 196 
 
 Collateral Loan Agreements 159 
 
 Collateral Notes 158 
 
 Commercial Paper in Europe 175 
 
 Commodity Paper 42 
 
 Common Carriers 145 
 
 Cotton and Its Production 52 
 
 Cotton Exchanges 66 
 
 Cotton Merchants and Exporters '. . 63 
 
 Credit Analysis and Single Name Paper 34 
 
 Currency and Bank Reserves 246 
 
 Current Assets 24 
 
 Current Liabilities 25 
 
 Danger from Borrowing in Both Ways 40 
 
 Demand for Notes 236 
 
 Demand Rates of Exchange 185 
 
 Development of Dollar Exchange 219 
 
 Documentary Acceptance Bills 197 
 
 Domestic Exchange 184 
 
 Drainage and Reclamation Bonds 109 
 
 Equipment Bonds 107 
 
 European Financing of Am. Foreign Trade . . 202 
 
 European War and the Exchanges 214 
 
LOANS AND INVESTMENTS 301 
 
 Export and Import Points 191 
 
 False Bills 148 
 
 Farmers' Statements 80 
 
 Federal Reserve Act 18 
 
 Federal Reserve Bank Notes 238 
 
 Federal Reserve Notes and Bank Reserves. . 242 
 
 Finance Bills . . 199 
 
 Financial Terms 118 
 
 Financing Exports of Cotton 65 
 
 Financing of Exports 204 
 
 Financing of Imports 203 
 
 Foreign Exchange 183 
 
 Foreign Exchange Departments 205 
 
 French Exchange 188 
 
 General Contraction of Loans 14 
 
 General Loan Contraction to Be Avoided. . . 16 
 
 German Exchange 189 
 
 Goods Lost or Damaged in Transit 152 
 
 Goods Not Owned by Shipper 151 
 
 Grain Crops 43 
 
 Grain Elevators and Warehouses 44 
 
 Grain Exchanges 47 
 
 Grain Loans 48 
 
 How Demand Rate of Exchange is Determined 206 
 
 Industrial Bonds 106 
 
 Inelasticity of Currency 231 
 
 International Borrowing 207 
 
 Lack of Commercial Paper Market 179 
 
 Land Mortgage Bonds 110 
 
 Legal Tender and Other Reserve Credits 170 
 
302 LOANS AND INVESTMENTS 
 
 Limited Significance of Balance Sheets , 32 
 
 Lines of Credit 6 
 
 Liquidation of Assets 29 
 
 Liquidness of Loans to Depositors 7 
 
 Live Stock Loans 69 
 
 Loans and Deposits 3 
 
 Loans by Foreign Banks 208 
 
 Loans on Cotton in Warehouses 61 
 
 Managers' Shares 94 
 
 Marketing Cotton 57 
 
 Marketing Grain 45 
 
 Mint Par of Exchange 186 
 
 Municipal Bonds 103 
 
 National Foreign Trade Policy 221 
 
 Negotiable Warehouse Receipts 138 
 
 Negotiation of Order Bills 147 
 
 Non-Liability of Pledgee as Warrantor 154 
 
 Non-Negotiable Warehouse Receipts 137 
 
 Notes as Needed 237 
 
 Notes Based Upon Business Transactions . . . 243 
 
 Notes Under the Federal Reserve Act 233 
 
 Panic Demands for Currency 240 
 
 Policy of Note Issue 241 
 
 Position of London 213 
 
 Problems of Conversion (of Government 
 
 Bonds) 245 
 
 Procedure in Issuing Bonds 112 
 
 Process of Conversion 235 
 
 Protection of Notes 225 
 
 Public Utility Bonds 105 
 
LOANS AND INVESTMENTS 303 
 
 Quarantine Line 73 
 
 Railroad Bonds 104 
 
 Rates on Time Bills 195 
 
 Ratio of Collections to Maturities 33 
 
 Ratio of Current Assets to Liabilities 28 
 
 Rediscounts 9 
 
 Relation of Interest Rates to Exchange Rates 209 
 
 Relation of Notes to Currency 223 
 
 Reserve Banks and Commercial Loans 20 
 
 Reserve Banks and Liquidness 19 
 
 Revolving Credit 200 
 
 Rights and Liabilities of Pledger 128 
 
 Sales Made by Grain Buyers 49 
 
 Seasonal Movements in Money Markets 160 
 
 Seasonal Strains on Bank Reserves 168 
 
 Seasonal Variations in Foreign Exchange . . 166 
 
 Seasonal Variations in Prices of Bonds 167 
 
 Secondary Reserves and Their Character . . 171 
 Secondary Reserves Under Federal Reserve 
 
 System 181 
 
 Security for Bank Notes 228 
 
 Shares Without Par Value 93 
 
 Shipper's Loan and Count 155 
 
 Significance of Changes in Exchange 
 
 Quotations 190 
 
 Situation in the United States 178 
 
 Sources of Payment of Bank Loans 21 
 
 Spent Bills 149 
 
 Statements of Borrowers 27 
 
 Status of American Note Currency 230 
 
304 LOANS AND INVESTMENTS 
 
 Sterling Exchange 187 
 
 Stock Exchanges 115 
 
 Stocks and Their Classification 86 
 
 Surrender of Bills of Lading to Drawees 157 
 
 Taking Over Government Bonds 244 
 
 Theory of Note Issue 227 
 
 The War and the London Acceptance 215 
 
 The War and the London Discount Market 216 
 
 The War and the London Sight Rate 218 
 
 The War and the New York Exchange 
 
 Market 217 
 
 Timber Bonds 108 
 
 Time Factor in Gold Shipments 193 
 
 Time of Retirement (of Government Bonds) . 239 
 
 Trade and Single Name Paper Compared ... 36 
 
 Trade Paper 35 
 
 Transfer of Stocks 95 
 
 Travelers' Letters of Credit 201 
 
 Ultimate Effects of Contraction 15 
 
 United States Cotton Futures Act 68 
 
 Utility of Bankers' Time Bills 210 
 
 Variable Prices of Gold ' 192 
 
 Volume of Sales 31 
 
 Voting Trust Certificates 92 
 
 Warehousemen and Warehouse Receipts 135 
 
 Warehousemen's Liens 143 
 
 Warranties of Genuineness 141 
 
 What May be Pledged 125 
 
 Why Notes Are Issued 226 
 
 Word "Notify" on Order Bills 156