8 BONt) HOUSE itiiiiiiiiii CHi^MBER i'i'li ,.LJ |l|ill<(li|Httlliltltl>IMt IlllllitltttllllUII :M:it:i(ii!i;titill!illllllli;iiiiialilliiiiiMi..iMM SITY OF CALIFORNIA S ANGELES THE GIFT OF MAY TREAT MORRISON IN MEMORY OF ALEXANDER F MORRISON J • » THE WORK • i» ••1*1 OF THE BOND HOUSE BY LAWRENCE CHAMBERLAIN WITH KOUNTZE BROTHERS, BANKERS, NeW YoRK AUTHOR or 'THE PRINCIPLES OF BOND INVESTMENT" NEW YORK MOODY'S MAGAZINE BOOK DEPARTMENT 1912 « ■ . i . • « ' "• • I 'if*. Copyright, 1912, by A . W. F ER RI N »•• • * • 4^5-/ PREFACE ABOUT eighteen months ago IMr. Ferrin, the proprietor of Moody's Magazine, requested me to write an article for his publication summarizing the services to the com- munity that are performed by the American bond houses. It was his intention that men associated with other representative houses should write monographs on each separate bond house func- tion. Their articles were to be elaborations of the several kinds of service that I had described in brief. Whether because of engagements or reticence, the specialists in the various departments of the business, after reading my contribution in proof, suggested that the interest of a comprehensive and uniform presentation would best be served if I undertook the entire series, which I did. This is the explanation of the unusual form this book has taken. While writing the articles I had no thought of making a book from them; but again I have been governed by suggestions from the bond houses. Certain of them wished the text in con- venient form for distribution in (juantity among their clients. If the articles bound arc of some 3 431741 4 PREFACE value for this purpose they may be of interest to the public in general ; therefore this book. These circumstances explain why a number of phrases, and perhaps even sentences and para- graphs, have been repeated in the following chapters, or have been taken from my book, The Principles of Bond Investment, that was pub- lished last year. Indeed the introductory chap- ter of this series was printed in that work. I trust that I have faithfully presented bond house conditions as they are. If I have erred on the side of idealism, perhaps these pages will lead the public to require and a greater number of the investment houses to offer the quality of service I have described. Lawrence Chamberlain. Montclair, N. J., September 1, 1912. CONTENTS CHAPTER PAGE I. The Functions of the Bond Houses 9 The Importance of the Bond Business — Ignorance of the Bond Business — Prev- alence of Bond Buying in New Eng- land — Bankers vs. Brokers — The Functions of the Bond Houses — The Purchasing Function — The Advisory Function — The Banking Function — The Bond Houses as Fiscal Agents — The Selling Function — The Protective Function. II. The Purchasing Function 28 Bond Investment as a Science — Laboratory Methods — Special Counsel — One Man Buy- ing — Financial Report Agencies — Railroads as Scientific Financiers — Buying to Satisfy Clients — The Professional Standard — The Effect of Interest Rates on Bond Buying — Stock Bonuses. III. Buying Municipals 41 The Ten Investment Elements — The Prin- cipal Function of the Bond Houses — Muni- cipal Buying — The Buying of "Legals" — The Bond Attorney — The Selling Cost and Price of Legals — Carrying Charges — Un- intelligent Proposals for Municipals — Municipal Bond Bureaus — General Market Municipals — Municipal Defaults. 6 CONTENTS CHAPTER PAGE IV. Buying Railroad Bonds 56 Common Characteristics of Railroad and Municipal Bonds — Railroad Bond Under- writing — Underwriting by Retail Houses — The Profits of Underwriting — A Penn- sylvania Railroad Flotation — Railroad Blanket Refunding Issues — Equipment Bonds — Railroad Bond Investment — Pro- prietorship and Management — Community of Interest — Management — Physical Char- acteristics — Earning Power and Capitaliza- tion. V. Buying Corporation Bonds 74 What Corporation Bonds Are — Classifica- tion of Bonds — Corporation Bond Invest- ment Principles — Knowing the Business of the Corporation — Water Companies — Gas Companies — Street Railways — The Income of Public Service Corporations — Bond Houses as Specialists — The Newness of Corporation Bonds — Industrial Issues — The Competition for Public Utility Bonds — The Preference for Public UtiHties — The Profit in Corporation Bonds — Costly Dis- tribution — Construction Propositions — The Bond Houses as Reorganizers. VI. The Advisory Function 91 Advising a Woman — The Ethics of Sales- manship — Financial Jackals — English Sell- ing Methods — Financial Advisory Systems CONTENTS CHAPTER PAGE — Bond Advertising — General Publicity — Advertising Investment Principles — Special Circulars — Investment by Correspondence. VII. The Protective and Banking Functions.. 104 The Mercantile vs. the Protective Policy — The Spirit of Trusteeship — Bond Guaran- ty — The Cost of the Guaranty — The Pro- tective Function Applied to Marketability — The Cost to Clients of Artificial Market- ability — Bonds as Collateral — The Banking Functions of the Bond Houses — The Cost to Bond Houses of Artificial Marketability — The Bond Houses as Banks of Deposit — The Protective Function Applied to all Bond Qualities — Protecting Security — As- suming Losses — Protection in Reorganiza- tion. VIII. Selling Bonds — The Banker's Viewpoint. 119 The Development of Bond Selling — The Trouble with Bond Selling — The Cost of Selling — The Profit in Specialty Selling — Failures from Competition and Miscarriage of Issues — Selling Economies : Consolida- tion of Houses — Local Representation — Bank Representation — The Economy of Selling Collateral Trusts — Consolidation of Issues not Houses — The Selling Depart- ment of an Ideal Bond House — The Sales Manager — Territorial Managers — The Road Men — College Men as Salesmen — The Training of Green Men. 8 CONTENTS CHAPTER PAGE IX. Selling Bonds — The Investor's Viewpoint 137 The Strength of the Investment Demand — Savings Banks as Bond Buyers — The Volume of Municipal Bond Sales— Annual Listings on the Exchange— The Obscure Issues — The Investor Should Know His Own Requirements — Complex Nature of Security — Complex Nature of Market- ability — Second Consideration: Form of the Investment — Third Consideration : Proper Type of Bond — Fourth Considera- tion : The Proper Bond — Choosing a Bond House. Index 150 CHAPTER I. THE FUNCTIONS OF THE BOND HOUSES. 1. The Importance of the Bond Business. That part of the pubHc which does not buy- bonds has a very meagre idea of the importance and value to the community of the bond busi- ness. It is not necessary to resort to many figures. It is necessary only to realize that bonds are the chief resource of our govern- ment in times of war, of our states and muni- cipalities in furtherance of public works and buildings, of our railroads, of almost all public service corporations and many industrial cor- porations. In round numbers $1,500,000,000 of American bonds are marketed every year and almost all of them pass through the hands of American bond houses. Even those issues of which the ultimate nominal market is the New York Stock Exchange are first offered and sponsored by dealers in bonds. In vol- ume and number the transactions cm the ex- change are only a mere fracti(jn of those in direct merchandising. Of this $1,500,000,000 of bonds one-third is absorbed by insurance companies, savings banks, trust companies and other banks (in approximately equal amounts) 9 10 FUNCTIONS OF BOND HOUSES and the remaining two-thirds by corporations (for reserve, etc.) and by private investors in this country and abroad. 2. Ignorance of the Bond Business. In view of the vast importance of the bond business in the economic life of the country, it is some- what surprising that so little is known about bonds and the bond business. No one who has had experience in selling bonds will deny that the "average man" who has accumulated a surplus is far more conversant with stocks and the basic principles of stock speculation than with bonds and the principles of bond in- vestment. The reason, however, is not far to seek. While human nature remains what it is^ the element of chance, with its exhilara- ting risk, will be more attractive to men than the element of approximate certainty that is ar- rived at by painstaking, uninspired care. Since the stock market is more interesting and prob- lematical than the bond market to the majority of readers, journalism, in the course of its duty to purvey to the majority, perennially fills its financial pages with time-honored summaries of yesterday's exchange doings, to-day's gos- sip and circumspect conjectures as to the mor- row. 3. Prevalence of Bond Buying in New England. Although, relatively speaking, the number of people at all conversant with bonds FUNCTIONS OF BOND HOUSES 11 is small through the country at large, it is sometimes surprising to find what a large proportion of the well-to-do in the North- eastern States, which have been educated to bond buying, have at some time or other bought bonds. Every Eastern bond house has, or ought to have, a list of at least 70 per cent of all the bond buyers of consequence in every city or town in New England. A comparison of this list with a list of all persons estimated to be worth $50,000 or more, whether bond buyers or not, will prove the prevalence of bond buying in this section. 4. Bankers vs. Brokers. The leading bank- ing houses were not always primarily bond houses. Two generations ago financial busi- ness of all kinds was transacted by "bankers and brokers." Bond selling was an incident to the general banking, exchange and broker- age routine. It was all done "over the coun- ter." There was comparatively little implied responsibility on the part of the vendor. In the age of Commodore Vanderbilt, the elder Gould, Fisk and Drew the "caveat emptor" principle of exchange was accepted and the devil took many beside the hindmost. But now the speculative l)usiness in New York, so far as it is reputable and consequential, is done by "Members of the New York Stock Exchange" and the investment business is 12 FUNCTIONS OF BOND HOUSES done by "Bankers, Dealers in Investment Bonds." Of course, a house marketing invest- ment securities may have a seat on one of the exchanges, but it is accepted and understood that the firm specializes in one or the other of these two forms of business. The financial atmosphere, the financial temper and the train- ing necessary to superior service in either oc- cupation have accomplished the severance of stock dealing and bond selling. 5. The Functions of the Bond Houses. Of course the primary function of the bond house is to obtain capital for the creation of new en- terprises or the enlargement of old. So far as concerns these houses in their proper capacity the capital obtained is in the form of loans. The houses purchase the loans outright for their own account and resell to their clients. As in any sort of merchandising, there are few wholesalers and many retailers. The promi- nent "wholesale" bond dealers, numbering less than a dozen, hitherto have confined themselves for the most part (as far as American cor- poration loans are concerned) to the great rail- road systems. There are signs that the policy will be broadened in the near future. These houses have few, if any, traveling representa- tives. Their sales, in this country, are effected by public subscription, stimulated through ex- tensive advertising, and by distribution to large FUNCTIONS OF BOND HOUSES 13 investment institutions, such as the insurance companies, and to the smaller bond houses. 6. We are not justified in omitting to state that the wholesale international bankers have not been trained by the necessities of the per- sonal relation between client and financial ad- visor to accept and offer only such securities as they would be willing to keep for their own account. It is not necessary to illustrate, but none of the typical American "retail" bond houses could have the hold many of them do have upon their customers if they had recom- mended and sold a tithe of the bonds and stocks that have been distributed by some of the in- ternational bankers. Mere magnitude in the capitalization of a bond house or of an obligor corporation is still a thing to conjure with in America. Financial history does not support the view that there is safety in size, except with respect to municipal corporations. Since the international houses, with special spheres of usefulness, do not best represent the things for which the bond houses stand, and since the contact of private investors is with repre- sentatives of the retail houses, this work is concerned only with the latter. 7. "Retail" is not a term properly descriptive of the firms we have in mind, although it sug- gests the relative size of the issues handled and the relative volume of business. It mis- 14 FUNCTIONS OF BOND HOUSES leads if it suggests that the main business of such houses is to distribute among small in- vestors issues that originally were investigated and purchased by "wholesale" houses. This is not the case. For the most part each of the American bond houses buys its issues in- dependently, in accordance with its policy re- garding investments, or it buys them "in joint account" with other houses having similar policies. These houses are autonomous ; their prosperity is built on their ability to find and obtain, on the one hand, funded obligations that merit investment, and on the other, a clientele that has faith in them and their busi- ness judgment and probity. 8. The success of the bond houses in weath- ering all sorts of financial storms while stock exchange houses have gone down by the score, is strong support of the contention that bond investment rests on a basis of principles re- ducible to a science. The writer knows of not one important investment house that has failed except through deliberate violation of perfectly well-known investment principles or through equally deliberate fraud. There is no business in all the country that has placed itself on more enduring foundations of business wis- dom, or that is conducted on a higher plane of business ethics. 9. Enough has been said to imply the great FUNCTIONS OF BOND HOUSES 15 services of the American bond houses. With- out their help it would be impossible to finance American enterprises upon equally favorable terms. By their ultra-conservatism they are establishing themselves in public confidence in a w^ay to bring together with the greatest ex- pedition and least middleman's cost the pro- moters of our national resources and the credi- tor classes from which must come the capital necessary to municipal and industrial develop- ment. They extend the boundaries of credit and exercise a directive and steadying influence upon enterprise. By preaching the principles of bond buying in advertisements, pamphlets, correspondence, and in personal interviews by bond salesmen they are slowly but surely con- verting the American people into a nation of investors. When the rest of the country can acquire, to a degree, the thrift of New Eng- landers we shall be referred to the Dutch and French less frequently, and our industrial structure will be no longer in unstable equili- brium. It will be worth while to examine in greater detail the several functions these houses perform. 10. The Purchasing Function. If a muni- cipal loan is to be offered, the purchase is a comparatively simple matter, provided the municipality is well known to the fraternity. Then no preliminary investigation is required ; 16 FUNCTIONS OF BOND HOUSES a bid is made for the loan at the current mar- ket rates and acceptance on award is subject to the approval of the bidder's attorney in all respects affecting the validity of the obligation. 11. If the municipality is not well known to the bidder a qualified representative will be, or should be, sent to learn at first hand the physical and financial condition of the city and to form an estimate of its probable future willingness and ability to meet its present and future obligations. 12. If a corporation loan is offered probably it will be submitted at the offices of the bankers by a representative of the company or by a promoter. If the applicant is of a social turn of mind he is not likely to lack the company of his kind in the ante-room. Competition, for- tunately, is fairly active. 13. The first step in the process of elimi- nation (there is more elimination than accept- ance) is to discard the propositions of com- panies that conduct a kind of business unfamil- iar to the bankers. Except under unusually favorable circumstances the highest grade of bond houses will not purchase bonds of in- dustrial corporations, mining or irrigation com- panies, etc. 14. The next step is to discard loans that have not a claim on property worth, under the most unfavorable conditions, more than the FUNCTIONS OF BOND HOUSES 17 amount of the obligation secured. Most cor- porations will bond themselves in as large a sum as their bankers will permit. Loans are continually being rejected because of insuffi- cient equity in property values. 15. The third step is to discard those propo- sitions which do not give reasonable assurance of earning at all times at least 50 per cent more than all fixed charges, after making extremely liberal estimates for depreciation and future increased operating expenses. 16. The fourth step is to decline loans to companies conducted by men or with methods that do not meet with approval. If the banking house is satisfied by inter- view and correspondence in matters of the above nature, and if a suitable price can be agreed upon, then engineers and accountants may be sent to the plant and offices to make a thorough examination ; and the members of the firm, with counsel, meet officers of the com- pany and their attorneys to settle the matters of form. On acceptance of an issue a careful banking house may demand representation on the directorate of the company until such time as the company shall have discharged its bonded obligation. 17. Illustrative of the care with which prop- erties are examined, the writer recently had occasion to inspect an interurban line in Penn- 18 FUNCTIONS OF BOND HOUSES sylvania and incident to mileage cost of con- struction inquired in jest the number of ties between the terminal and a certain city some miles distant. "We don't know," replied one of the owners of the road, "ask your engineer, Mr. . He has photographs of every foot of the line and can count the ties for you, but probably he has already counted them." 18. Of course there is a difference in the de- gree of care exercised by various houses. The ultra-conservative will not permit their names to be associated with "construction proposi- tions." They will consider for purchase the obligations only of seasoned companies with established earning power. 19. The reactionary effect of the stringent requirements of bond houses is of inestimable benefit to corporation finance, but its good in- fluence has a wider sphere : it embraces municipal corporations and municipal finance. American bond houses have put municipal bond buying on an entirely different plane from what it was in 1875. In this they have been helped by, and have helped, the development of municipal bond law. In these days cities and towns that have had much experience placing bonds will be certain in advance of their ad- vertisements for bids that the loan has been issued in conformity with the exacting re- quirements of the bond attorneys. Certain FUNCTIONS OF BOND HOUSES 19 strong Canadian houses command such respect in their country that they have been able to direct the legislation of the Western provinces to the end that the Western loans may be more acceptable to the investors in the Eastern provinces and in England. 20. The Advisory Function. This advisory and directive function, however, is more promi- nently operative in bond selling than in bond buying. It has its source in the statistical de- partments which every house of quality must maintain. It finds its chief expression, as al- ready stated, in tabloid investment lessons, printed in the advertising columns of newspa- pers and periodicals, or with somewhat greater fullness in pamphlets and monographs. If a prospective client has an investment policy that apparently is not suited to his particular needs, the home ofhce may tactfully direct his attention by letter or through their representa- tive in his territory to a means by which he may better his position. Some bond houses maintain a daily news sheet for the benefit of their salesmen in which are printed not only pertinent items of current interest, but timely discussions of diflferent problems. 21. Activities of this nature, developed to their logical conclusion, can lead to only one result, the establishment of the American bond houses in the confidence of the public as their 20 FUNCTIONS OF BOND HOUSES chief advisers in financial matters, in some such relation as the great banks of France and Germany bear to investors in those countries. Even now a few of the better houses can count upon the absorption by their friends among institutions and investors of a certain amount of any issue they recommend and offer. 22. This advisory function can become gen- eral and economically sound only as the bond houses as a class recognize the scientific and professional nature of their calling and guide their movements and policies, as do the gov- ernors of the Bank of England, let us say, alive to the power of their position and their responsibility as repositories of a nation's con- fidence. 23. The Banking Function. Illustrative of the confidential relation between house and client, there has arisen the demand that bank- ing departments be established for the safe keeping of funds destined, upon enlargement, to go into investment, and also to accommo- date those who wish to purchase securities be- fore they have sufficient funds to pay in full for them. From the necessities of these two situ- ations it is only a short step to the conduct on a small scale of a bank of deposit subject to check. But properly and ordinarily, the banking department of a bond house is conducted as a matter of accommodation to its customers, and FUNCTIONS OF BOND HOUSES 21 not primarily to do a general banking business. From these beginnings it sometimes has hap- pened that a full-fledged bank has been evolved, in which the savings, deposit and trust functions of the bank have balanced, nomin- ally at least, the sales function of the bond house, but an exception of this sort would only prove the rule. Although bond houses are banks, technically, and are entitled to their common designation, "bankers," nevertheless, on the principle that security selling is not best undertaken by obligor companies but is prop- erly left to the bond houses which make it a profession, so the general banking business is best left to banks proper. 24. The Bond Houses as Fiscal Agents. Be- cause of their purchasing, advisory and bank- ing functions the bond houses are called upon to act as fiscal agents for corporations, muni- cipalities and even states. The long standing, friendly banking relations of the older firms with the Western cities recall the fact that in- terest, and sometimes the principal, of the loans of these cities is payable at the offices of the bond house. Here and there an Eastern in- stitution is met that will not buy Western municipals which are not payable in the East. This is not so much to save the cost of con- version into New York funds, for that might be arranged in the price, as because of the 22 FUNCTIONS OF BOND HOUSES inconvenience and possible loss of interest in shipping the bonds west for collection. Some of the older bond houses act as depositaries for Western cities. In general, the conduct of the bond houses as fiscal agents has merited the trust placed in them. 25. It is more to be expected that private corporations will look to the bond houses as their financial agents. The disposition of a company's funded loans is not merely a matter of merchandising; it is natural that the rela- tionship begun, by the purchase of bonds and banking representation on the directorate shall be continued indefinitely in the thought of future financial needs. Just as the great rail- road systems have their long established finan- cial connections with certain large houses, so the public service and other private cor- porations form alliances with the bond houses. The continuance of such relations implies conformity on the part of the obligor corporations with the policy of the bond houses. This also tends toward a betterment of financial conditions throughout the country. 26. The Selling Function. American bank- ing houses are not eleemosynary. Whatever may be their usefulness in the community, it is the result of that enlightened self-interest which used to be expressed in the phrase "Honesty is the best policy." Their reason FUNCTIONS OF BOND HOUSES 23 for being is to make money by selling bonds, and the competition is getting keener every day. Many of the ordinary effects of compe- tition are noticeable in the bond business. There is standardization of wares and policies, there is diminution in ratio of profits. But two ordinary effects of competition are con- spicuously absent. There is no deterioration of the product and no tendency toward con- solidation among the vendors. 27. The relation of supply and demand for securities is totally different with us from what it is in England or France. Our industrial development more than keeps pace with our investment resources. We are less dependent on foreign capital than ever before, but not so rich that funds awaiting conservative em- ployment have not a choice of excellent oppor- tunities at home. 28. By reason of this very competitive bid- ding by capital the quality of our loan product offered by good bond houses is not cheapened. In the process of soliciting business by adver- tisement and interview, American investors are becoming educated in investment prin- ciples and reward with most patronage the houses that give the best evidence of living up to investment ideals. It is the same in this as in the legal and medical professions. It pays best in the long run to be technically competent. 24 FUNCTIONS OF BOND HOUSES 29. Since the principal point of contact be- tween investors and banking houses is through travelling representatives whose advice is fol- lowed to a very material extent by the invest- ors, the salesmen sent out are of more than average intelligence and business ability. The large majority of those representing the better concerns are college bred men. The alert sales manager will keep in touch with the col- leges and universities and will seek to obtain for his firm men of the graduate schools or of the graduating class who give promise of ability in salesmanship not only by their record in college activities but by their appearance and address. Most of these men will serve office apprenticeships of length before they are sent out on the road. 30. The other usual effect of competition that we mentioned as lacking is the tendency toward consolidation. The absence of it is further evidence of the peculiarly professional relation which subsists between the banking- house in its advisory capacity and the client. It raises bond selling from a business to a profession. 31. There are some who profess to see in the gradual evolution of the bond business a tendency to relinquish direct selling from house to client through travelling salesmen in favor of distribution, on a commission basis, FUNCTIONS OF BOND HOUSES 25 through local independent bankers. This may come. If it should, it would be one of the evil effects of competition. It would relieve the "retail" houses of a large part of that sense of personal responsibility which they now feel. They would be in a position analogous to that of the wholesale houses at present. Investors would have to accept offerings from those who had no part in the investigation which preceded the original purchase of the issue, and who, presumably, would not have the capital or organization of distribution to "pro- tect the market" for the benefit of those who might wish subsequently to sell their securi- ties. 32. The Protective Function. There is a radical difference in the attitude of different bond houses in this matter of repurchasing securities of clients to whom they have sold them. Some take the stand that a sale is a sale, and the responsibility of a house that has acted in good faith ceases upon delivery of the bond and the receipt of payment. This position is logical and just, but again compe- tition steps in to benefit the customer. Other houses say: "We shall put out our issues as nearly as possible on a plane of marketability with active listed securities. We make no promises, but, except in times of panic when it may be impossible to raise money to satisfy 26 FUNCTIONS OF BOND HOUSES everybody, we hope and expect to be so situ- ated as to buy back at the fair market price the securities we have sold." The substance of this statement is now occasionally seen in advertisements over the signature of some of the better and stronger houses. Few investors realize the full significance of this protective market policy. They are inclined to remem- ber that they may buy most of the active listed bonds on the exchange and sell them the same day at an average total loss, due to the "higg- ling of the market," of perhaps only 2 points or so. They do not realize that on a declining bond market they may have to take an addi- tional loss, in listed bonds, of say 8 points, or 10 points in all, whereas in the same circum- stance a bond house would think twice before quoting a client a price 10 points below the previous selling price. And, to say nothing of investment guidance, nine times out of ten the issue of the bond house is yielding at least J^% more per annum than an equally sound listed issue. 33. But the protective function of the bond house is most important in respect to the moral responsibility of "seeing clients through" default, reorganization and rehabilitation in the extremely rare cases in which trouble arises. In some instances losses amounting to hundreds of thousands of dollars have been FUNCTIONS OF BOND HOUSES 27 made good; in many instances the firms have volunteered to pay interest which has been suspended ; in every case a reputable bond house will feel called upon to take active leadership in upholding the mortgage rights or other legal claims of the bondholders. 34. The creditor class will do well to take as much pains in the investment of its wealth as in the acquisition of it. Buyers of corpo- ration bonds should exercise almost as much care in the selection of a financial adviser as in the choice of a security. They should seek a bond house with a strong personality, strong convictions on investment matters and the capital and equipment to back them up. The chapters following will discuss, in de- tail, the several functions that have been touched only briefly here in order to present, at first, the bird's-eye view. CHAPTER 11. THE PURCHASING FUNCTION. 35. Bond Investment as a Science. It is only as one studies the purchasing function of the bond houses, and the achievements and possibilities of economic service through the process of selection in purchases, that one real- izes how rapidly bond investment is growing into a well-defined and thoroughly developed science. Then why not treat the principles of bond investment in scholarly fashion and credit the orderly study of them as the Science of Bond Investment? We hear much these days of scientific management in manufacture and transportation. It is a wonderful and profitable thing; witness the Standard Oil Company and the Atchison, Topeka and Santa Fe. The greater pity that below Fulton Street a man who speaks of science and finance in the same breath carries the reproach of being theoretical. 36. However, the attitude of Wall Street is changing toward those whose profession it is to know securities. One of the greatest houses on the street may still have no statis- tical department, except that which is carried home nights under one or two well-rounded 28 THE PURCHASING FUNCTION 29 hats; but, on the other hand, a firm of national reputation and esteem has recently admitted into partnership a man whose claim to the distinction is his profound railroad scholar- ship. The traditions and methods of the dry- goods and clothing merchants who founded our financial institutions in New York, are giving way as the younger college-bred gener- ation, trained in, or at least in sympathy with scientific methods, advances to influential ad- ministrative positions. 37. Laboratory Methods. Scientific method in bond buying presupposes well-equipped laboratories and trained analysts. I have the good fortune to be familiar with the organiza- tion and work of one of the best financial laboratories in New York. The nucleus from v/hich it has developed is the statistical depart- ment. This is in charge of a man who fattens on income accounts and balance sheets. He is prepared, if necessary, with a defensible ex cathedra report and opinion on almost any company or security that has a vogue in the Street. He directs a group of assistants in the compilation and analysis of ten-year records of all American corporations of note. So far as these records relate to public service and in- dustrial companies, they are not and cannot be built up from any standard framework, but each is shaped out of the characteristics of the 30 THE PURCHASING FUNCTION particular business and the nature of the meagre material that usually offers. 38. In behalf of the statistician and his col- laborators, the library shelves are weighted with bound volumes of company mortgages, corporation reports, gazettes, financial period- icals and technical journals. The atlases, annuals, institutional directories, current quo- tation sheets and dividend notices of two con- tinents are at his elbow. He has standing orders with the second-hand book dealers for works that are out of print — old railroad sur- veys, special monographs — and all new publi- cations that have even a collateral bearing on his work, are submitted as soon as published. 39. Special Counsel. The firm that avails itself of this systematic service also retains special counsel, who give their entire time to the legal problems that are constantly incident to the prosecution of business affairs of scale. Likewise an engineer is retained for consulta- tion regarding the physical aspects of proper- ties with which the firm has, or contemplates, affiliation. The list of consultants and depart- ment specialists by no means ends with these advisers. Others, with experience in syndicate association, accounting, and management, or with developed sense of market values, or of intrinsic investment values, are at hand for the immediate help that their particular training and aptitude makes possible. THE PURCHASING FUNCTION 31 40. One Man Buying. I happen to know fairly well, also, the buying department of a bond house that has not yet grown to the size admitting this admirable specialization. In this smaller house all enterprises requiring new capital must be investigated by one man with the slight statistical help obtainable from a clerk or two. Any proposition that secures his conditional approval is submitted in due course to outside engineers and lawyers, and ultimately lacks nothing in the nature of pro- tection to investors that special facilities and professional training can contribute. Not because of the lawyers and engineers, primari- ly, but because of the character of the investi- gator himself, I would trust to the safety of the bonds this firm oflFers as implicitly as to that of similar bonds of any other house in the Street. This merely illustrates what we all know, that elaborate specialization and scientific methods are supplements of, not substitutes for old-fashioned horse sense and business judgment. 41. That this smaller house has no well- articulated statistical department is not be- cause of narrow unbelief — far from it — but because it must perform all its functions ac- cording to scale : its buying must bear definite relation to its selling. The handicaps of such 34 THE PURCHASING FUNCTION stopped. About a year ago I was discussing with the vice-president of one of the Wall Street national banks the very intimate rela- tion between the course of active listed bond prices and the ratio of loans to deposits in the national banks of the country — both expres- sions of credit conditions — and suggested to him the possibility of building an antecedent chart from banking and other credit conditions that would determine this ratio of loans to deposits and therefore determine at any time the advisability of entering the market to buy bonds. The subject was of such importance that I was encouraged with an ofifer of assist- ance, and even collaboration, which I could not accept at the time. Fortunately this labor has now been saved and the object apparently attained by others more competent and better equipped than I for such work. 46. Let it be said for the benefit of business men in general that studies into fundamental conditions can be related to any business. Certain sets of statistics will have more weight in some activities than in others. Presumably immigration figures are of more immediate interest to steamship companies than to rail- roads, and crop conditions of more interest to railroads than to steamship companies; but country-wide prosperity is of immediate in- terest to all, and so also is the price-level. THE PURCHASING FUNCTION 35 In so far as success in any business is separated from failure by the purchase of materials, labor and capital when they are cheap and the sale of them when they are dear, success is to be won by deference to a reliable and comprehensive system of financial service. Bond buyers are only one among many classes that may be benefited. 47. Railroads as Scientific Financiers. It is natural that the railroads should first awake to the possibility of really scientific financing. Their association with bankers and banking principles is so intimate and of such long standing that they have become conversant with the art of buying and selling capital. They buy long-time credit far in excess of immediate needs when money is plenty, and short-time credit at higher rates when money is scarce. The New Haven Road is especially alert to take advantage of changing interest conditions. Of late the example of the railroads has been followed by other large corporations. In either case the less sophis- ticated investing public are willing to seize the short end of the exchange. With the growth in power to diagnose fundamental con- ditions all business men at least will be on the same plane of opportunity to profit by the revolutions of the trade cycle. 48. Buying to Satisfy Clients. The buyer of 36 THE PURCHASING FUNCTION bonds for a banking house has other big gen- eral problems besides these concerning the proper time and price for making commit- ments. The wares he offers for sale must be suited to the needs of his clientele. To a cer- tain extent he may modify these needs. He may "educate the taste" of his patrons. To a certain extent he may seek the patronage of the class of investors who want the kind of thing he is willing to sell. If he is a big man, and his wares are not moving as rapidly as they should, he may change his entire selling program — he will do almost anything but take a deliberate risk for which his customers, and therefore his house, must ultimately pay. 49. The Professional Standard. Perhaps many, whether engaged in financial work or not, will consider the investment standard too idealistic — impossible of maintenance outside of print. This is absolutely wrong. My own bond associations have been largely with houses that refuse to take what appear to be speculative risks, and my experience is not exceptional. To be sure, there is nothing il- legitimate in the assumption of risk or in the offer of speculative paper by firms engaged in that kind of business ; but deliberate hazard or avoidable speculation are foreign to the better American retail bond houses. 50. There is a firm operating in the East, whose senior members have grown gray in THE PURCHASING FUNCTION 37 the selling of savings bank bonds. In the past this policy yielded adequate profits, an envi- able reputation, and, not least, the satisfaction of never having sold a security that occa- sioned loss. But the profit in savings bank bonds, always relatively narrow, has lessened considerably in recent years by increased com- petition. The patronage of a savings bank can no more be monopolized than that of private investors, for the nature of "legal" securities makes almost superfluous the endorsement of the vendor. So competition in savings banks selling is of the freest kind, and a house that specializes in it has no insuperable advantage over a house that caters to more diversified and profitable patronage. A change of bond- buying policy is possible in this house and others similarly situated, upon the retirement of senior interests, but the problem is vital and requires ultimate solution. 51. There is, on the other hand, a house not confined to Eastern selling that some years ago changed its major financial associations • because of a difference of opinion as to what constituted "legitimate" issues. For a while it was reasonably successful in disposing of a class of securities in which there was a very wide margin of profit, but for which there was no general market at all. This firm is now confronted with a dissatisfied and diminished clientele and the difficult task of rehabilitating 431741 38 THE PURCHASING FUNCTION a threadbare reputation by return to old-line securities. 52. The Boston bond firms, as a whole, have to meet a new and serious difficulty arising from the increased activities of Massachusetts assessors. The tax rate in Massachusetts ranges close to 2 per cent. Undoubtedly there is a greater amount of security invest- ment per capita in Massachusetts than in any other State in the Union. Consequently, tax- exempt bonds seldom yield 3>4 per cent., and yet a bond on which taxes are paid must yield 53^2 per cent. — in other words, must be at least second grade, to suffer the tax and make return equivalent to tax-exempt bonds. 53. It is well enough to deplore the short- sightedness of legislation that handicaps in- vestment and encourages speculation, but the bond houses must meet conditions as well as theories. As the result of this Massachusetts situation the Boston bond houses are begin- ning to handle the stocks of Massachusetts corporations, which are tax-exempt within the State. In some cases these stocks are not mentioned in the general circulars of the bond houses, but are sold entirely by personal soli- citation. In New York, as we all know, one or two bond houses of high repute publicly adver- tise for sale the preferred stocks of industrial companies. Will this practice become general, and if so, will it alter the confidential relation THE PURCHASING FUNCTION 39 between firm and client that has been estab- lished at such pains? 54. The Effect of Interest Rates on Bond Buying. A cause more general than the ac- tivity of tax assessors has been at work for the past few years compelling a shift of sentiment and policy in bond buying, namely, the rise in interest rates. This is a phenomenon that Moody's Magazine has the distinction of first bringing to public attention in this country. Elsewhere I take issue with the extreme stand of some of Moody's contributors who see little in the advance of rates except the effect of an increased annual production of gold.* There is not space here to rehearse the controversy, but it is of importance to bond houses in shaping their buying policy and their methods of financing corporations to know whether this advance in rates is founded on permanent con- ditions that must be recognized and met, or on transitory circumstances such as an exces- sive tariff and congestion of population, that may disappear before it is necessary to adopt radical changes in selling policy to meet them. 55. If the good railroad refunding issues are permanently headed from a 4 per cent, to a 4J^ per cent, basis it may mean that inactive public service bonds hitherto worth a 5'>4 per cent, basis, will be worth only a 6 per •Note. The Principles of Bond Investment, chapter on "The Future of Bond Prices." 40 THE PURCHASING FUNCTION cent, basis. This in turn may mean the vogue of 6 per cent, bonds selling at about par rather than 5 per cent, bonds selling at a discount ; or it may mean a 5 per cent, bond with a stock bonus. Apart from the unholiness of stock in general, once the investor gets the bonus habit he is hard to cure. It is still a sign of transition in interest rates, not a sign of be- nevolence or necessity, when stock is "given away" with bonds. When trading stamps are of economic benefit to trade, stock bonuses will be to finance. 56. Stock Bonuses. Yet this in turn, is hardly a fair statement. Stock bonuses come to the bond house in part payment for the capital loaned, and the offer of these bonuses to clients is merely the offer to share pros- pective profits from future operations of the obligated company. It is sounder financing, however, for the bond house to charge less for the capital it loans, when it buys the bonds, and to offer the bonds to its clients at a corre- spondingly lower figure. I believe that, in the long run, more is lost than gained by encour- aging speculative interest from the ultimate furnishers of investment capital. 57. Enough has been said to outline the gravity of general bond buying problems. The succeeding chapter will deal with the purchasing function in relation to particular types of public and private corporation loans. CHAPTER III. BUYING MUNICIPALS. 58. The previous chapters outlined some of the principal problems and kinds of assistance, statistical and advisory, that are met in the routine of bond buying. It is left to differenti- ate the problems and helps that apply to par- ticular types of bonds. 59. The Ten Investment Elements. In the first place, we must come to some con- clusions regarding the investment qualities we seek in examining the loans submitted for purchase. A careful survey of all possible ex- cellences yields us ten elements for the ideal investment.' Security of principal. Stability of income (or security of interest). A fair return. Marketability. ~| ^ ., .,. ,, , ,, , y Convertibility. Value as collateral, j Tax exemption. Freedom from care. Acceptable duration. Acceptable denomination. Possil)ility of appreciation. 60. Whether the possibility of appreciation is not purely a speculative quality may be open I The Elements of an Iflcal Investment, Chapter III of The Principles of Bond Investment. 41 42 BUYING MUNICIPALS to discussion, but otherwise the list is prob- ably unquestionable and comprehensive. We may say then that if a bond house can obtain for its clients an issue with (1) principal reasonably secure, (2) interest payments regu- lar and certain, (3) a fair return in income, (4) a fairly responsive market, (5) hypothe- cary value at the banks — an issue, (6) that is free from direct tax, and (7) requires merely semi-annual coupon clipping, and (8) matures after a satisfactory lapse of time, and (9) comes in convenient units of denomination (small for the frugal poor, and large for the rich, so as not to crowd the strong box), and (10) has as good a chance of appreciating as of depre- ciating when its qualities become more gener- ally recognized — well, a bond house cannot furnish such an issue, for it does not exist.* 61. Evidently, then, there is plenty of room for discrimination and selective judgment in bond buying. Incidentally, however, is there any other kind of investment that will so nearly meet these ten requirements? Will mortgages? 62. The three investment qualities that re- ceive the most consideration are security, income, and marketability. Obviously all three cannot exist in a high degree in the same •Note. The Principles of Bond Investment, Chapter on "The Elements of an Ideal Investment." BUYING MUNICIPALS 43 paper. If the investment is safe it cannot re- turn a high rate of interest and at the same time have a broad and active market, for such a market implies competitive demand, and the competition for a security that was at once of safe and high yield would immediately bid up the price and thus lower the yield. 63. Therefore, assuming a good security, the first problem of the bond house is the choice it must make for its specialization be- tween large transactions with small profits in issues with broad markets, and small trans- actions with much larger profits in issues with- out vogue or reputation. 64. The Principal Function of the Bond Houses. If, because of prejudice, or want of knowledge concerning its qualities, an issue is without vogue, and has to be sold painstak- ingly by personal solicitation, it may be both safe and of high return. // is the principal and thoroughly commendable function of the better American bond houses to sell to their clients is- sues of bonds which have unimpeachable security and yet an income considerably higher than would be the case zvere the issues well knoivn to the in- vesting public. 65. Setting aside United States bonds, which (with the possible exception of the insular issues) are not truly investment paper, we have as representative of security, vogue and 44 BUYING MUNICIPALS market, at the expense of income, the great body of American Civil Loans, viz., state, county, city and town, and tax district bonds. 66. At the opposite extreme, representative of reasonable security and greater income, at the expense of vogue or market, we have pub- lic service corporation bonds, and some "in- dustrials." 67. In the middle ground are railroad bonds, offering, as a class, less security than civil loans, more than public utility loans, and in- clining toward marketability rather than in- come. Let us consider each of these classes in turn. 68. Municipal Buying, History makes rap- idly in civil bond law. If it were not for the Riddlebergers, the Tennessee Settlements, and a few others. Wall Street would have forgot- ten before this that nine states repudiated their debts between 1870 and 1884. The constitu- tions and statutes of so many commonwealths now forbid the incurrence of more than nomi- nal state debt, and the loans that do issue are of such special market, that these, as well as the governments, may be omitted from this brief discussion. 69. The problem of buying the other civil loans, the municipals proper and the quasi- municipals such as county and tax district bonds, may be divided according to the charac- BUYING MUNICIPALS 45 ter of their investment destination. From the business point of view municipals are broadly either "legals" or "general market" bonds. 70. The Buying of "Legals." By "legals," of course, are meant municipals that conform to the high requirements of the older, richer states governing the investment of savings bank deposits and trust funds. In the nature of the case the legals are, in general, superior to the general market municipals. 71. In purchasing legals the question of security is almost nil. No banking house, for instance, would or could be held morally re- sponsible for the default of any municipal issue that is a legal investment for the savings banks of Massachusetts or New York. Legality for savings bank investment and legality of issu- ance by the municipality are entirely distinct matters. The questions of legality of issuance and validity are quite apart from those of the financial competency or the good faith of a city. It is not a function of the bond houses to establish legality of issuance but that of their attorneys. It may astonish many to learn that a record of sales I kept in 1907, of the more important municipal issues of that year, shows that of a total of $200,000,000 of municipal and state bonds issued, some $4,- 000,000 or 2 per cent., divided among 65 loans, were finally declined by those who had pur- 46 BUYING MUNICIPALS chased them subject to approval of counsel ; and usually, but not always, declined on the ground that the issue was invalid because of some lack of compliance with minor require- ments of law. This $4,000,000 does not take into account a very much larger amount of issues that the attorney of the purchaser found insufficiently protected by law, but that by further acts at his suggestion, the issuing com- munity was able to validate completely with- out formal resale. 72. The Bond Attorney. Not all bond attor- neys, however, are competent. Even an ap- parently "legal" municipal may be unsafe if its validity has been passed upon by a lawyer who is more interested in making immediate profits for his client the bond house, than con- siderate for his reputation and its future wel- fare. Any bond house dealing in municipals can name certain attorneys whose "legal opin- ion" is worthless in its eyes because of in- competence or lack of scruple. Not long ago one such attorney in New York State accepted as valid an issue of bonds signed by a man who had never been appointed or elected to the ofiice designated under his signature. It is the business of the bond house to pro- tect its clients against the work of these char- latans. They are very few and far between, and lower but little the high plane of legal BUYING MUNICIPALS 47 skill and ethics that are devoted to safeguard- ing American bond issues. 73. The SelHng Cost and Price of Legals. The buying of legals as a mercantile rather than legal problem narrows down to technical skill in sensing the current demand and steer- ing the bid in that very narrow channel of profit that lies between the Scylla of com- petitive bids and the Charybdis of too high an asking price. It is easier to guess what price the bonds will bring when sold to the public, than what price the other houses will bid at the public sale ; but conceding the municipal buyer could be fairly certain of both, he is not yet saved. He must compute the selling cost to him per bond, and be sure, humanly speaking, of a margin of profit. How many houses do this? How many of the two thousand bond firms in the United States have any intelligent cost accounting? It may be interesting to know that a certain house that does a large and very general bond business throughout the country computes the selling cost at nearly $14 a $1,000 bond. This includes the cost of the slow moving "specialties," but also the cost of mere brokerage transactions on which the profit may be only 1-32, or 31 cents a bond. 74. At the present time the gross profit in selling legal municipals surely docs not exceed 48 BUYING MUNICIPALS $10 a bond or one per cent. I believe it is not over $7.50 a bond. If these statements of costs and profits are approximately correct, are the bond houses charging too much for the serv- ices they perform? If these statements are correct, are institutions and individuals ordi- narily wise in bidding direct for bonds at pub- lic sale, rather than accepting the established market after the sale? The answer will be found by study of the list of bidders, and the amounts bid, in any sale of New York City bonds. If these statements are correct, are municipalities wise in trying to sell their loans, bond by bond, "over the counter," rather than by paying, as a matter of economy, the middle- man's profit? 75. Carrying Charges. It would not be pos- sible for houses to live on such small profits if the bonds did not in the long run "carry them- selves," i. e., produce a suflficient coupon in- come to oflfset the interest charges of their hypothecation at the banks. A diamond or wool merchant, it is to be observed, or a merchant in any other commodity, has not this advantage of a self-supporting collateral. 76. With a gross one per cent, profit, that may be wiped out by a change in the market conditions, it is essential that the bidding for legal municipals should be most circumspe(;t. With this in view a properly equipped house BUYING MUNICIPALS 49 will keep on its books a record of past bidding for all municipal issues of consequence. This record will show the amount of the flotation, the face or coupon interest rate, the duration, the purpose of the issue, the date of sale, the price the bonds brought at the sale, the net yield at this price, the name of the purchaser, and, when possible, the basis price or net yield that the bonds brought when retailed. Every one of these facts is of prime importance in gauging the price to pay for municipals, for one should never, or almost never, bid with a first thought on competitive bids, but rather with heed first to the price that the market will bear, and next to the margin of profit that is acceptable under the conditions. One house has just recompiled such a sales record, which consumed the time of two men for six months. 77. The application of these details of issue to prospective bidding becomes instinctive to a professional bond buyer. He will run through a few pages of proposals for bids and check ofT with almost unerring accuracy the cases in which no bids will be received. Usu- ally he will err only when a local bank, for advertising or jjolitical purposes, bids above the market. 78. We will say that the rural County of X in New York State proposes at the 50 BUYING MUNICIPALS present time to issue $20,000 4%% bonds maturing serially from date $2,000 each year. This item may not interest the experienced buyer. In the first place, the issue is a small one — hardly worth printing circulars for. Sec- ondly, bonds in New York State may not be sold by municipalities below par: in this case a 4.25 per cent, basis. The best basis that a bond house can possibly expect to get for this bond in this market is 4.15 per cent. But the difference in a 4^4% bond of this duration be- tween a 4.25 and a 4.15 per cent, basis is .474 or $4.74. This gross profit is or should be too narrow to draw out any bids. 79. Unintelligent Proposals for Municipals. Another aspect of the unintelligent offering of municipal loans is presented in the following illustration. Some time ago a municipality within gunshot of New York awarded an issue of bonds to various bidders at a price several hundred dollars less than the offer of another house for "all or none." Their action caused some comment at the time, although it was perfectly legal and apparently in good faith. In the light of that experience what shall we say of the stewardship of their officials when a year or so later the same mistake was re- peated? The municipality made three awards at the sale, amounting to $153,262.76, whereas if the bonds had been awarded in one lot to BUYING MUNICIPALS 51 the highest bidder the citizens would have re- ceived $153,589.96. Was not this $327.20 dif- ference worth saving? A sHghtly different method of advertising the sale would have accomplished the result. 80. Municipal Bond Bureaus. I have already- mentioned financial service bureaus that make relatively easy the statistical work of bond houses. There are at present two daily publi- cations that keep bond concerns well posted on forthcoming municipal sales and the terms and forms in which proposals may or must be couched. They also publish lists of bidders at recent sales, with the prices obtained. Through the services of these bureaus the necessary data for intelligent buying of "legals" may be collected by merely clerical effort. 81. General Market Municipals. The prob- lem of buying "general market" municipals is no such simple matter. In these bonds security may seldom be taken for granted. It is taken for granted much more generally than proper. The financial memory (to repeat) is proverbi- ally short. Each generation forgets the fiscal follies and disasters of the preceding. History in finance makes so rapidly : When in 1839, during that long business depression in Amer- ica that produced the first repudiation period, Raring Brothers of London inquired of Daniel 52 BUYING MUNICIPALS Webster concerning "the measure of security which the purchasers of bond issues by the states of the American Union would have for their investment," he wrote in reply : "I believe there is no country upon earth — not even that of the injured creditor — in which such a proceeding (repudiation) would meet with less countenance or indulgence than it would receive from the great mass of American people." Yet within two years Governor McNutt of Mississippi had recommended, and within three years the legislatures of Mississippi and Florida had voted the repudiation of nearly $9,000,000 of bonds. 82. Municipal Defaults. Did the default of these or of five other states in the forties deter European or American investors from further purchases? Not at all. Instead of using busi- ness sense, they continued trusting and buying, and losing. Nothing daunted they bought after the War, overlooking the war time de- fault of three states ; they bought in the eigh- ties and nineties in spite of the repudiation of nine states in almost as many years. If the men of Lombard and Wall Streets and count- less other bond buyers had taken the same pains in 1870 or thereafter to acquaint them- selves with the factors of state credit, and of the errors of the legislatures and investing BUYING MUNICIPALS 53 public in the preceding generation, as they now do in the purchase of railroad securities, fewer bonds would have been floated at that time and less state paper would now repose in an- cient pigeon holes. 83. The story of municipal loans is the same, only worse. How many men now active in the financial district realize that thirty years ago the Mississippi Valley gave up a long list of defaulting cities, among which were Duluth, Keokuk, McGregor, Quincy, Cairo, St. Joseph, Cape Girardeau, Lawrence, Topeka, Nebraska City, Little Rock, Helena in Arkansas, Mem- phis, Shreveport, New Orleans, Mobile and Houston? "Of one hundred counties, town- ships and cities issuing bonds in Missouri, nine-tenths have defaulted," says the North American Review in August, 1884. 84. The point is not, of course, that this country will ever again see a repetition of this wholesale breach of faith, but that the pro- posed debts of the weaker communities, such as rural counties, small towns and taxing dis- tricts, should receive the same expert investi- gation that is given the debts of private cor- porations. Although it is true that not for some years has an American municipality of importance failed to meet its valid (obligations, nevertheless numbers of small communities in all parts of the country except New England 54 BUYING MUNICIPALS are at the present time failing to keep their pledges. In some cases it is through no obli- quity on the part of the community ; in most it is the result of official incompetency and political unwisdom ; but whatever the causes, they should be studied by bond buyers that loans produced under improper conditions may be avoided. 85. There are millions of dollars of "Gravel Road" bonds issued under the Indiana High- way Act of 1905 (Chapter 167) that have hung in the balance between payment and non-pay- ment for some years because they were issued under local and special authority. Originally declared unconstitutional, they have been fully validated by a review of the case in the Su- preme Court of the State. But they illustrate the need of special fitness and professional training in the purchasing function, even in this day, and even for municipal loans. 86. What knowledge and experience may have been accumulated hitherto by the bond- houses has only recently found its way into print. The principles of municipal bond in- vestment may be thoroughly explored, but only within the year have they been codified and published. We have at least reached this stage, that the bond buyers of the big New York banking houses will refuse municipal loans they believe unsound. They have com- BUYING MUNICIPALS 55 mon grounds for their faith. About three years ago a community that is ahiiost within rifle shot of the city olTered a loan in New York without success. It was finally placed with a Western house that has since failed. The bonds have defaulted, but never- theless the community has just offered another loan. It would have been interesting to note what house would dare to purchase the bonds. It is reassuring to state that no bids were received. 87. The true financial competency of a com- munity to issue, support and acquit bonded ob- ligations is not so easy to ascertain as most people suppose. I venture the assertion that there are more bond men who can analyze an annual report of the United States Steel Cor- poration than who can analyze the financial statement of the City of New York. It is not important to seek the reason for this condition of things. But let us not underestimate the importance of the purchasing function of the bond houses as related to municipal issues. That the huge machinery of municipal debt creation and investment exchange runs so smoothly and with such exceedingly infrccjuent and unimportant casualties is sufficient testi- mony to the financial health of our bodies politic and of our investment houses. CHAPTER IV. BUYING RAILROAD BONDS. 88. In the preceding two chapters we dis- cussed in as much detail as circumstances per- mitted the purchasing function of the bond houses, in its broad aspects of public and firm policy, and as related particularly to municipal issues. There remain to be considered the special principles that govern the buying of railroad and other private corporation bonds. This paper will be devoted to the railroad issues. 89. Common Characteristics of Railroad and Municipal Bonds. Railroad and municipal bond buying have some phases in common. Perhaps in both it is fair to say that an investi- gation of the ability of the obligor corporation to meet its engagements is not usually the chief consideration at the time of purchase. In other words the equities are usually suf- ficient to be accepted without that degree of exhaustive scrutiny which must be given to the equities of public service and industrial corporations. Secondly, the ultimate destina- tion of a large part of both municipal and railroad debt is institutional, therefore the rapidity and capacity of absorption or "diges- tion" is relatively great, and these two types 56 BUYING RAILROAD BONDS 57 may be handled on a relatively narrow margin of profit. The margin for railroad bonds is not the scant three-quarters to one per cent. ($7.50 to $10.00 per $1,000 bond) we assumed for municipals of the "legal for savings banks" type, but let us say four or five per cent. Moreover, the market for railroad bonds (so large a part of which is listed) is self-regulat- ing, even to a greater extent than the market for municipals, therefore the initial sale profit does not have to contain provision for subse- quent cost of market support — a generally un- considered expense of floating "specialty" cor- poration bonds by houses that take care of their customers. 90. A third point of likeness between these types is their division into two broad classes, the one in which security, in the ordinary sense, may be taken for granted almost abso- lutely, so that current money rates, and profits, determine the purchase, and the other in which the degree of security, marketability, etc., are determining price factors. 91. On the whole, however, the purchase of railroad bonds is more closely associated with that of corporations generally than with that of municipals, because of the very char- acter of the debt and of the issuer. 92. Railroad Bond Underwriting. The buy- er of railroad bonds of the prominent systems 58 BUYING RAILROAD BONDS faces a more difficult situation than the buyer of legal municipals. At present all the great American railroad systems are dominated by one or another of, say, half-a-dozen great banks or banking houses. It is therefore practically impossible for the "retail" bond houses (the kind described in these pages) to purchase large issues at first hand from these railroads, and therefore to obtain the profits indicated above. Indeed, in a recent interview, a promi- nent Wall Street corporation lawyer went so far as to declare that it was next to impossible for any corporation in this country to raise $10,000,000, outside the great banking groups provided the subscription would be inimical to the interest of any of them. 93. Underwriting by Retail Houses. How- ever that may be, if a "retail" bond house chooses to specialize in the better railroad flotations it must align itself with those houses that are willing to act as secondary underwriters. It is then expected to partici- pate in the sub-underwriting or actual pur- chase of the majority of issues fathered by the wholesale banker with which it is affiliated, almost irrespective of the quality and price of the issue, or the condition of the bond market. A railroad bond buyer needs tact as well as professional skill, to seize the horns of this dilemma, and keep his house in line for what BUYING RAILROAD BONDS 59 is safe and profitable, without giving offense in declining what is either unsafe or unprof- itable. 94. This dilemma is by no means imaginary or occasional ; it is an ever present difficulty. On the one hand (as to safety), there is con- stant temptation to relax in critical caution and to follow the crowd into some new sub- scription to an uninvestigated security that promises profits overnight. If one could only know the amount, how startling would be the sum annually committed to subscription bond purchases for purely speculative objects, with- out any thought of regular merchandizing or investment, because of telephone tips, news- paper gossip, and neighborly hearsay ! The bond houses make their share of these blind purchases. 95. If you ask for a copy of the mortgage it isn't yet ready for distribution, and you are a squeamish obstructionist. Yet one of the largest railroad systems in America, which issues many millions of bonds almost every year, through the usual New York banking channels, in the usual subscription manner, has had a net income for the past three years that has averaged less than 2)4 per cent, of the gross earnings! Another system, operating about 10,000 miles, during the year 1910 con- sumed 94^ per cent, of its gross earnings in 60 BUYING RAILROAD BONDS mandatory charges. During the year of the last panic almost 99 per cent, of all it earned was eaten up in charges. Yet instead of lay- ing by for the next panic this road is again paying dividends on many millions of stock. 96. On the other hand (as to profits), cur- rent railroad subscription prices are put as high as the market will possibly bear/ and the eighth, quarter, half, or one per cent., or more, that goes to the retail houses for sub-under- writing from the big wholesalers is likely to be wiped out before the bonds are disposed of in such a sagging bond market as we have become thoroughly familiar with in the past two or three years. 97. The Profits of Underwriting. The public may not seem to be as directly concerned with the distribution, as with the total amount, of middlemen's profits when great railroad cor- porations borrow, but perhaps a warrantable interest can be made to appear; moreover, we are considering the work of the bond houses as such rather than the economics of finance, primarily. Well, let us assume for argument's sake that 6 points (or per cent, on par) repre- sent the difference between what the railroad gets and the public pays at the initial sale, and that prior, or possibly subsequent, to public I There has been one notable exception during the year 1911-12. BUYING RAILROAD BONDS 61 flotation the big wholesaler assigns to three retail houses at 1^ points concession all bonds of the issue on hand soon after the public sale. The three retail houses in turn permit associate houses a discount of 34 from established prices. These associate houses, however, act merely as brokers, whereas the three retailers mentioned have bought, paid for, and taken up the bonds or temporary certificates. 98. The question arises: Are the profits of the wholesalers, the secondary underwriters, and the brokers, respectively, proportionate to the services performed? Perhaps the interest of the brokers in the transaction may be omit- ted. They take no risk unless they choose to speculate for their own account; the bonds they buy are usually sold for the account and risk of others; therefore their profits are and should be nominal. 99. But should the wholesaler, who may own the bonds for a week, who is reasonably cer- tain of their disposition, and has little direct future moral responsibility to the public, and who is under small direct selling expense, be entitled to four times the profits of the re- tailers on whom falls the real burden of selling and the real risk of loss through sagging prices? Whether the ratio is 4 to 1 or less, is it an evidence of sound economic conditions in any business when wholesale profits are greater than retail? 62 BUYING RAILROAD BONDS 100. It may be argued that the great whole- salers have at command the immense capital necessary for the exploitation of steam trans- portation systems and are entitled to rewards commensurate with the advantage of their capitalistic entrenchment. There are dozens of retail houses that, under an unsubsidized banking system, and in "joint account," would be capable of handling the largest corpora- tion loans that find ultimate placement on this side of the water — indeed the same houses that now are the immediate repositories of the loans until ultimate public absorption. Their federated banking resources are drawn upon almost as extensively, under present circum- stances, as if the wholesalers were not in- volved. 101. A Pennsylvania Railroad Flotation. Two or three years ago when the Pennsyl- vania Railroad contemplated the issuance of a loan of many millions one of my good Boston friends (you may remember the newspaper story) ofifered with perfectly good financial warrant to bid for the bonds at public sale an amount in excess of the price reputed to have been arranged with the usual wholesale under- writers. This offer was not accepted, although he was courteously given interview with the president and other officials of the road. The publicity of the case made this much recog- BUYING RAILROAD BONDS 63 nition advisable. The reason the offer was not accepted may perhaps be found in the state- ment of the corporation attorney, already quoted, concerning the impossibility of ob- taining large loans without the acquiescence of financial autocracy. 102. Direct buying of railroad debts by the retail bond houses would tend, more than at present, to separate the banking interests from the proprietary interests and more closely to associate the banking interests with the invest- ment interests, — both movements highly to be desired. 103. There is no opprobrium to be attached to the centralization of banking power. It is an inevitable phase of the industrial evolution of the past decade. It seems possible now that centralization may be followed by disin- tegration, but more probably by governmental regulation, built on any convenient legal prin- ciple that comes to hand when the time is ripe. I believe that, whatever the event, pres- ent artificial conditions cannot continue indef- initely, and that it will soon again be possible for the American bond houses to bid freely for the big railway loans as they now bid for legal municipals. 104. Railroad Blanket Refunding Issues. Even under present conditions the proper pur- chase of big railroad loans by the retail house 64 BUYING RAILROAD BONDS implies technical qualifications of a high order in the bond buyer. Opportunities (in street trading or otherwise) for the quick purchase of current issues at advantageous prices, de- mand a thorough working knowledge of all the big general and refunding issues, of which there are about forty — all but three or four of which are listed — and a knowledge of two or three dozen more of the important under- lying and miscellaneous loans. 105. The preponderance of transactions in the refunding issues may not be appreciated by everybody. Convertibility (that is, market- ability and hypothecary value), is of such tremendous advantage to certain types of in- vestors, particularly institutions like national banks, that much higher prices may be ob- tained for issues of such magnitude and vogue as to assure a future fairly steady demand at current interest rates. Therefore, on the in- sistence of bankers, the railroads for the past decade have been satisfying their wants for new capital less and less by means of new first mortgage divisional issues, or the like, and more and more by new long term, virtually "open end" blanket mortgages covering the entire property and of sufficient amount, re- served in escrow, to retire at or before matur- ity the senior and miscellaneous issues of the road. BUYING RAILROAD BONDS 65 106. The provisions of these blanket refund- ing mortgages are becoming standardized, to the great benefit of railroad finance. By grad- ual retirement of miscellaneous mortgages and issuance, in substitute, of escrow refund- ing bonds, not only is the tendency of railroad debt to become simplified and easier of ap- praisal, but to become more negotiable, as the escrow bonds of a refunding mortgage take the place of smaller loans. Hence the fact that there are now outstanding over $1,500,- 000,000 of these refunding bonds and forty or more issues a good railroad bond buyer should know in all essentials respecting security and price, gives us some notion of what is required of the buyer of the big issues. If a buyer has the responsibility of shaping up for the accept- ance of his house a new issue, that is another matter. Railroad scholarship then is only a small part of his equipment. Even to skirt about his problem here would usurp space. But to resume: 107. The average profit in "turning over" these current issues is small — less even than in handling legal municipals — therefore a nice sense of market values and of the price trend is essential to success. Some of the best young aggressive houses on the Street have found it impossible to make enough money in current listed railroad issues to support a body 66 BUYING RAILROAD BONDS of bond salesmen. Ordinarily selling of this sort must be incidental to the distribution of other more profitable securities. Such profit as there is must be obtained very largely by a study of the course of bond prices in general and of the range of movement in the issue in question. It is easier to sell than to buy these bonds right. A table of monthly and annual price fluctuations of the securities (they are listed, remember) is an excellent index of rel- ative cheapness and dearness. The number of sales on the Exchange and the volume of sales per annum, w^ill also have significance. 108. One must not gain the impression from what has been said that the retail bond houses have no opportunity for direct and profitable relations with the railroads. The bonds they can buy and sell direct are usually of the sec- ond class. The big systems have subsidiaries which from time to time must put their name to paper, some of it very excellent indeed. Let us remember that the number of operating corporations with a mileage of 1,000 is about 50, but not very much over 50; that there are over 1,000 railways reporting to the Inter- state Commerce Commission that have a mile- age of under 250; that the number of carriers of the switching and terminal class is about 500; that the total number of industrial (as distinguished from commercial) railways is BUYING RAILROAD BONDS 67 not far from 2,500, exceeding in mileage 25,000. Although not all these transportation agencies are direct obligors and emitting funded debt, nevertheless the sum of their annual output of bond issues is very large, and their debts are well v^rorth the solicitation of banking houses that are equipped to handle them. 109. Equipment Bonds. Perhaps the most satisfactory form of railroad loan for these houses is equipment trust obligations. Inas- much as the average life of the average issue is 5^ years the opportunities to profit from the reinvestment of funds thus placed is re- current. It is the very general impression that "not a dollar of money invested in equipment bonds has ever been lost." This is not true. However, I have examined the history of every equipment issue of every road that has passed through reorganization or receivership since 1872, when equipment bonds were "invented," and state with conviction that the record and the present legal characteristics of the stand- ard ten year serial equipment bond (of any of the three current types) is without parallel as respects security, except first mortgage gas bonds in metropolitan cities. 110. Equipment issues of some of the best systems are still to be l)ought direct by the bondhouse; also terminal, divisional and mis- cellaneous issues. All classes of railroad bonds 68 BUYING RAILROAD BONDS of the smaller roads are to be had. The vari- ous kinds included here form the second divi- sion of railroad bonds corresponding, in some respects, as already stated, to the non-legal, or general market municipals. 111. Railroad Bond Investment Principles. The investment principles governing the pur- chase of the big refunding and of the miscel- laneous railroad bonds are of course the same. In distinction from the principles of municipal bond investment, they are thoroughly estab- lished and recognized. Therefore an attempt to detail them is superfluous. Still a few com- ments of a general nature may not be amiss. In approaching railroad investment study the general problems will be found to be definite in number, orderly in sequence, and now, with the jurisdiction of the Interstate Commerce Commission, of certain application at least to all roads that do an interstate business. 112. Proprietorship and Management. The first considerations, of Proprietorship and Management, are not the less important be- cause irreducible to figures. The first thought of the investigator is, or should be, to the char- acter and credit of the dominant proprietors. Financial heredity, in this matter, counts for more than most people realize. In Carl Sny- der's excellent book on American Railways as Investments, 1907, he has this to say : BUYING RAILROAD BONDS 69 "It is one of the most curious facts of rail- way history, but one exemplified fully enough, that careful and conservative conduct of a road tends in some sense to perpetuate itself. .... It is not for nothing that the Pennsyl- vania has never failed to pay a dividend for more than fifty years. It is not for nothing that roads like the Reading, the Erie, the Union Pacific, have been the footballs of stock- jobbing speculators, and dishonest directors. The ownership of a road, the personnel of its management, may change absolutely, yet it is curious to note how amid all these changes its character for good or evil will sometimes survive." It is a matter not of years but of decades to change the nature of a railroad. A knowledge of the conduct of a railroad stock on the Exchange, over a period of years, and of its dividend record, its history in receiver- ship, will be a crude but reasonably safe guide to the general health of the road. 113. There is much to be learned from the history of any proprietorship or control. The holders of the underlying bonds of one of the Western systems have equities in earnings and securities that make the obligations appear of a very high type. But an analysis of the methods by which a comparatively small out- lay of money obtained control of this property, 70 BUYING RAILROAD BONDS by means of a system of holding companies and stock pyramiding, will not reassure a care- ful bond buyer that his interest will be con- served. When only a few millions of cash were necessary to control a property bonded for some hundreds of millions, the market price of the best of its bonds was sure to suffer severely when it appeared that the sys- tem might not be able to meet all of its obli- gations. 114. Where there is a truly dominating in- terest, such as Mofifat in the Denver, North- western, and Pacific; Flagler in the Florida East Coast; Atkinson in the Atlantic and Birmingham ; Stilwell in the Kansas City, Mexico and Orient, or Hill in the Great North- ern, the inevitable questions are: Is this a cap- able railroad man ; is he constructive, and does he conserve minority interests ; who are his bankers; in what other roads is he interested, and what other connections has he? The same questions hold good for a dominating group of men. 115. Community of Interest. No railroad development of the past ten years has greater significance to bond buyers than the general recognition of the necessity for that entente cordiale among the companies which arises from a "community of interest." The young- est of those who have interest in financial BUYING RAILROAD BONDS 71 matters remembers the days of rate wars which drove so many roads into bankruptcy. When freight tariffs could not be maintained legally by competing carriers, through the agency of a pool, the desired result was obtained by the creation and recognition of a community of interest. The ownership by one road of the stock of another, with consequent dovetailing of directorates, led to amicable understanding and concert in action, when otherwise there might have been costly warfare. 116. But traffic alliances may exist without stock control by any party. Then the visible evidence of co-operation is to be found in the duplication of officers or directors. It is espe- cially important that the smaller independent roads which do not originate sufficient traffic to make them self-sustaining should have the benefit of friendly connections with a power- ful system to relieve them of the possibility of destructive competition. In thfe case of an aggressive independent road thia possibility may be an impending probability. There are well known small roads that today have great- er difficulty in maintaining their corporate independence against the aggressions of larger .systems than they do in maintaining^ the standard of their service or the sufficiency of their earnings. The recognition of the com- munity of railroad interest has done more than anything else, except the general development 72 BUYING RAILROAD BONDS of the country and of the railroads themselves, to place railroad finance upon its present stable footing. 117. Management. Management, as distin- guished from proprietorship and control, may be looked upon as relating to the internal railroad policies governing the machinery of transportation. Subordinate in public interest to the financial heads and affiliations, the rail- road managers and their work will be best known to the investigator by the records of physical and operating efficiency. 118. Physical Characteristics. The main physical characteristics to be subjected to the analytics of the bond buyer are the location of the railroad, the size or mileage, the character and condition of the equipment, and the oper- ating efficiency. The uses to which informa- tion of this nature may be put will readily suggest themselves. It may not be so obvious, however, that a reliable source for this infor- mation exists. It is due to the uniform statis- tical requirements of the Interstate Commerce Commission that reliable data of this nature is available. Unfortunately their supervision does not extend back over a sufficient number of years to validate much historical compari- son. 119. Earning Power and Capitalization. Besides the personnel and the physical charac- BUYING RAILROAD BONDS 73 teristics, the studies of the railroad bond buyer will cover the company's earning power and the valuation and capitalization to which it is related. In these subjects also he is indebted to the Commission for thoroughly reliable and thoroughly detailed figures such as ordinarily may not be obtained regarding any other class of private corporations, and only with the greatest difficulty from municipal corporations. Earning power, or more broadly and techni- cally the Income Account, and valuation, or the Capital Account, are elaborately and logic- ally dissected by the Commission in such manner that no competent bond buyer can fail to comprehend the true financial condition of the obligor. 120. Publicity makes possible to any investor who is capable of it the same sort of statistical investigation that any banking house ought to give a railroad security it buys or recom- mends. But in want of ability, inclination or opportunity to study, the investor may accept the dictum of his bankers on railroad bonds, if ever, for a house that cannot give a compe- tent opinion on an American railroad bond is not qualified to advise on any type of security. Not that such judgments are easily arrived at, but that the investment principles are of com- mon acceptance and the material facts indis- putable. CHAPTER V. BUYING CORPORATION BONDS. 121. Students can buy municipal or railroad bonds, but it takes business men to buy cor- poration bonds. In other words, we have now come to that point in the bond business where mere theory (with no reproach in the term) must be subordinated to special experience and native endowment to perform the purchas- ing function without inviting regrets. There is more here, also, of the spirit of the market place where Greek meets Greek in trade, and the firm with the shrewdest instinct for barter stands the best chance of success. Less capi- tal is needed for corporation bond buying, for the average issue is smaller; therefore the field is open to a wider range of talent and a display of greater individual ingenuity in financing. But before considering the problems of this kind of buying we must come to some conclu- sion as to what are corporation bonds. 122. What Corporation Bonds Are. One who is at all sensitive to nice distinctions in terminology will object to a division of funded debt that excludes railroad loans from the class 'called corporation bonds. If railroad bonds are not corporation bonds none are. On the other hand, if one is going to be academic, 74 BUYING CORPORATION BONDS 75 cities and towns and some other municipalities are corporations — public corporations — and their bonds must therefore be corporation bonds, 123. Classification of Bonds. To show the difficulty of establishing a good nomenclature I give on the following page a rough classifica- tion of bonded debt according to the character of the issuer, or obligor.* From this classification it will be seen there is no word or phrase, now current, that is properly descriptive of the transportation, public utility, industrial and miscellaneous is- sues that are not civil loans and are not rail- road loans. Moreover, it will probably tax the ingenuity of any one to discover or coin such a word or phrase. Even as this classification stands, many will object to the separation of street railway and interurban railway securi- ties and will wish to associate irrigation dis- trict bonds with municipals or quasi-muni- cipals. 124. In want of logic a safe guide is custom, and custom loosely speaks of government, municipal, railroad, and corporation bonds, meaning by the last phrase, in a very general way, the issues that are classified in this • There are three other logical anil comprehensive classifica- tions: according to the security for the hoiuis, according to the purpose or function of this issue, and according to conditions attending payment of interest and principal. CO CO w a bo o::: H> <-< ii o o o o o -OTD >>C C .ti o o OfQpq fflfq -4-* f— « C " O rt CJPL, o tn .2* 'S 3 en o C •a ■? J3 ^-. 5 o D > Ui dj O O u. g o Em aj o < C9 CU n C/3 C5 •^§ CO pq •O 03 C > OX om-a d^ C^ £/) 1/3 ^ O p ^ O 3 «) O CO < O <^ O .. be O i>^ u T CQ ^ C CI, c o .2 m C3 i (/J PQ u o c •n m o. C C 1> h o d +-* o •*-» H-l rt U 0! s w bo c OJ ^ •♦J C cQ 3 ^5 •a ^s in a hurry than $100,000 Norfolk and Western First Consolidated 4s; but if you own only one Norfolk and Western you do not have this to consider. It is usually easier to sell coupon than registered bonds, railroad than municipal bonds, municipal than corporation bonds. THE INVESTOR'S VIEWPOINT 143 252. You are concerned in knowing exactly the kind and amount of safety and market- ability you require because you have to pay for them. You do not demand more safety and marketability than you require because then you are dissipating a part of your invest- ment in paying for what you don't need; per- haps you are sacrificing some security of principal for superfluous marketability. To pay $1,100 for an investment that gives you only $1,050 worth of investment service is not conservatism but extravagance. Nothing but unfamiliarity with investment principles is an excuse for private buying of United States bonds to net 2>^ per cent. The Federal Gov- ernment encourages this merely to prevent the worse habit of hoarding. It does not seek or want for its 2>^ per cent, funds the money of investors. 253. Of the ten principal investment quali- ties that I have mentioned repeatedly in these articles, safety and marketability have been chosen for amplification here, as those most in the public mind. What has been said of them applies, if with somewhat less force, to security of income, hypothecary value, con- venience of duration and denomination, free- dom from taxation and care, possibility of appreciation, and whatever other qualities you may care to consider. 144 SELLING BONDS— 254. Second Consideration: Form of the In- vestment. Having taken this first and most im- portant step of considering your investment needs, it is next in order for you to consider what form of investment is best to satisfy these needs, mindful that investment, with the advantages and disadvantages peculiar to it, is a thing apart from speculation. If invest- ment is the proper channel for your surplus, and if you canvass your situation most thor- oughly, you will probably find that bonds, which have just served us for illustration of the scope of investment qualities, are probably the best form of investment for you. At least it may be said in truth that the infinite vari- eties of bonds cover more requirements than any other investment form. 255. Third Consideration: Proper Type of Bond. The third step is to find the type or types of bonds that are best adapted to your definitely predetermined needs ; the fourth, to find the best issue of the type selected. 256. Here is the only thoroughly sound pro- cedure for the selection and purchase of secur- ities, yet how few advocate it, or pursue it ! Some banks and insurance companies that buy largely and constantly have a well developed and consistent buying policy, as bond men know, but they are exceptions to custom. 257. Many investors have definite rules THE INVESTOR'S VIEWPOINT 145 governing their purchases, but such rules ! One of my good friends to whom I used to sell will buy any Massachusetts municipals, but will not go over the line into New York or Connecticut. It is not taxation that troubles him, either. Just an amiable insularity. An- other friend will buy municipals anywhere, but nothing else. A commission house that buys many thousands a year looks for the best issue that at the time yields 5 per cent. In the panic it was Eastern municipals from banks that had to disgorge. Now it may be mortgage liens on the minor railroads. Some will buy no paper from the South ; many will buy only first mortgages. This is all wrong. As Dr. Johnson would say, such rules are merely evi- dences of temperamental anfractuosities. 258. As we stop to think of it, there is something, though not much, to be said for the man who narrowly and arbitrarily limits the range of his investments. He can, and probably does, become more familiar with the channel he has chosen for his funds, and so is able to avoid the seduction of "unusual op- portunities." At the same time he limits the chance to distribute his risk. This limit is the more serious if his chosen channel is in itself unsafe. The range of quality in bond types is almost as great as the range of quality in issues of any type. 146 SELLING BONDS— 259. One of the most striking illustrations of ill-considered bond-buying is the quick dis- posal by subscription sale of immense corpora- tion issues before the indentures securing the issues ara made public. Truly we do business on faith these days. To be sure, confidence of this sort is not often misplaced, but how would you like to put a considerable part of your personal fortune into a bond, only to find, when the deed of trust finally appeared in print, that, the Court permitting, the owner of a majority of the outstanding bonds could compel acquiescence from the minority to any change in the terms of the deed of trust? 260. The indenture of one of the bond issues that has been most prominently before the public this past year reads as follows : "From time to time the holders of a majority in amount of all the . . . bonds hereby se- cured for the time being outstanding, by their vote at a meeting of the holders of said . . . bonds, . . . or by an instrument or instru- ments in writing signed by such holders, shall have the power (1) to assent to and authorize any modification or compromise of the rights of the holders of such class of bonds and of the Trustee for the holders of such class of bonds, against the . . . Company or against any property subject to this indenture, whether such rights shall arise under these presents or THE INVESTOR'S VIEWPOINT 147 otherwise, and (2) to assent to and authorize any modification of any of the provisions of this indenture that shall be proposed by the . , . Company and recommended by the Trustee. . . . Any action taken with the as- sent or authority given as aforesaid of the holders of a majority in amount of the . . . bonds hereby secured, for the time being out- standing, shall be binding upon the holders of all the . . . bonds hereby secured and upon the Trustee as fully as though such action was specifically and expressly authorized by the terms of this indenture." 261. It is customary, of course, for trust deeds to contain waivers of certain specific rights of the bondholders upon vote of a sub- stantial majority, but observe in this clause what might happen if the obligor should pur- chase or otherwise control 51 per cent, of the issue. Of course the moral is : Never buy a bond without reading the mortgage and trust deed. Recent discussion of this issue, in and out of the courts and the press, would fill volumes ; yet nowhere have I seen comment on these significant lines quoted above, which he who runs may read. 262. Fourth Consideration: The Proper Bond. The "average investor" may well feel that, even if he has a definite idea of the 148 SELLING BONDS— qualities he needs in his bond, and even if he reads with assiduity the mortgages and finan- cial statements of various current issues, he is still unprepared to do himself justice. He is right. He cannot be expected to know his own business, if he has any, and the bond business also. Hence the need of establishing clientelary relations with a bond house that has a sense of professional responsibility, and the equipment for superior service. 263. Choosing a Bond House. To find, then, the best bond for his needs, the investor will obtain the assistance of a good house that handles as part of its regular business the type of bond in question. If he does not know of any such house, he will do well to consult the local bank presidents and directors, who can obtain the information from unprejudiced sources if they do not have it at hand. A num- ber of inquiries should be made to average away incorrect information. Other things being equal, it is better to align oneself with a house or houses that have local or transient representatives, for oral discussion, always supplemented by home-office correspondence, is much more satisfactory than the correspond- ence alone. 264. With thorough knowledge of his own requirements and a proper banking relation established the investor can hardly go astray. THE INVESTOR'S VIEWPOINT 149 He has quite reversed the customary pro- cedure, for instead of choosing a random bond from a random house and trusting that it will serve his purpose, he has first inquired of himself what his purpose is and he has set in motion in his behalf the highly intelligent machinery of one of the best and most honor- ably conducted kinds of business organization. If anything, he will be rather skeptical about a new loan (unless it be municipal) and encourage his advisers to submit a consider- able number of seasoned issues of the proper type. 265. In closing these comments, let me ex- press the hope that they will leave an impres- sion on readers that may be summed up in a remark made to me by the manager of a great Canadian banking house, when I joined the bond fraternity: "Chamberlain, this business, like every other, has its disadvantages, but one thing you may be sure of, you will never have to make apologies for your profession." INDEX Advertisement by bond houses of the marketabihty of their bonds, 32. Advertising, bond, 166-171; of investment principles, 169. Advising a woman, 152. Advisory advertisement, 169, 171. Advisory function, 20-22, Chap. VI, 152 et seq. Amount of municipal bond sales in the United States, 241. Analyzing a municipal statement, diiiScuhy of, 87. Annual bond listings on the Exchange, 242. Artificial marketabiHty, cost of, to investors, 185; to the bond houses, 190, 191. Assuming losses, 199. Attorneys for municipal bond houses, competency of, 12. Auditor, the, in bond buying, 139. Bank representation, local, in bond selhng, 218. Bankers vs. Brokers, 4. Banking function, 23; Chap. VII, 174 et seq; 189 et seq. Bankruptcy, see Default, Receivership, Reorganization, etc. Banks, local, as bond distributors, 31. Banks of deposit, the bond houses as, 193. Bidding for bonds, see Buying, Municipal Bonds, etc. Blanket railroad refunding issues, 104 et seq; amount outstanding, 106. Bond advertising, 166-171 ; attorneys, municipal, com- petency of, 12; dealers vs. brokers, 4. Bond business, ignorance of, 2; importance of, 1. Bond guaranty, 176-181. Bond houses as banks of deposit, 193; as constructors, 150; as fiscal agents, 24, 25; as reorganizers, 149; as specialists, 134. Bond houses, consolidation of, 26 ; functions of. Chap. I and esp. 5; influence of, on municipal finance, 19; American enterprise, 9. Bond houses vs. brokers, stability of, 8; wholesale vs. retail, 6, 7. Bond investment as a science, 35 et seq. 150 INDEX 151 Bond sales, municipal in the United States, 241. Bonds, American, who buys them, 1 ; total annual issu- ance in America, 1; as collateral, 187-189. Brokers vs. Bankers, 4. Bureaus of financial information, 42-44; 165; of muni- cipal bond information, 80. Business conditions, forecasting, 45, 46. Buying bonds in New England, 3; bonds to satisfy clients, 48; corporation bonds, 12 et seq; municipal bonds, 10 et seq; railroad bonds, Chap. IX, 88 et seq. Capitalization as affecting railroad bond security, 119. Carrying charges in relation to bond selling profits, 75. Census reports as a statistical help, 43. Choosing a bond house, 34; 263. Circulars of bond issues, special, 171. Classification of bonds, 123 et seq. Collateral, bonds as, 187-189; collateral trust issues, economy of selling, 222 et seq. College men as bond salesmen, 29; 235-237. Common characteristics of railroad and municipal bonds, 89. Community of interest as affecting railroad bond security, 115. Competition among industries forcing amalgamation, 148, 149; in bond selling, 26 et seq: 212, 213. Complex nature of marketability, 250; of security, 246 et seq. Consolidation of bond houses, 26, 30 et seq; of bond issues, 214 et seq. Construction propositions, 18; bond house financing of, 150. Corporation bond investment principles, 126. Corporation bonds, newness of, 135 ; buying, 12 et seq. Correspondence, investment by, 172, 173. Cost of artificial marketability, to investors, 185 ; to the bond houses, 190, 191; bond guaranty, 178, 179; of bond selling, 207 et seq ; of distribution of bonds, 145; of marketability, 32, 33; of selling bonds, 73; of supporting the market for municipal, railroad and specialty bonds, 89. Dartmouth College, Tuck School of Finance, studying the effect of business conditions on corporation earnings, 132. 152 INDEX Dealers vs. brokers, 4. Declination of municipal issues on the score of legality, etc., 71. Default (see receivership, reorganization, etc.), atti- tude of bond houses toward, 33. Depositors in United States Savings Banks, number of, 240. Depositors in United States Savings Banks, amount of, 240. Development of bond selling, 203 et seq. Directorate, bond house representation on, 16; 25. Distribution of bonds, cost of, 145. Domination of large corporations by wholesale houses, 92 et seq. Earning power as affecting railroad bond security, 119. Earnings in relation to fixed charges and safety, 15. Economy of selling collateral trust issues, 222 et seq. Effect of interest rates on bond buying, 54, 55. Elements of an ideal investment, 59, 60; 253; three most prominent, 62. Engineer, the, in bond buying, 139. English selling methods, 163. Equipment bonds, 109, 110. Ethics of salesmanship, 154-163. Failures of bond houses from competition and miscar- riage of issues, 212. Financial agents, see fiscal agents. Financial news and report agencies, 42-44 ; 165 ; for municipal buying, 80. Financial jackals, 156-160. Fiscal agents, bond houses, as, 24, 25. Forecasting business conditions, 45, 46. Form of investment, must be considered bv buyers, 254. French and German banks as advisers, 21. Function of the bond houses, the principal, 64. Functions of the bond houses. Chap. I and esp. 5. Fundamental conditions, forecasting, 45, 46. Gas companies, 129. General market bonds vs. "legals," 69 et seq. General market municipals, 81. General publicity as a form of bond house advertise- ment, 163. INDEX 153 German and French banks as advisers, 21. Government bonds, 249; reports as statistical help, 43. Gravel road bonds of Indiana, legality of, 85. Guaranty, bond, 176-181. History of bond dealers, 4. Hypothecation of bonds in relation to bond selling profits, 75. Ideal bond house, selling department of, 229 et seq. Illegitimate bond dealer, an, 51. Importance of the bond business, 1. Income of public service corporations, a study of, 132. Indiana gravel road bonds, legality of, 85. Industrial issues, easy for bankers to get good, 137. Industrial corporation bonds, 13. Insurance principle in bond guaranty, 177. Influence of bondhouses on management of corpora- tions, 25. Interest rates, effect of rise in, on bond buying, 54, 55; affected by general interest rates, 55. Invalidity of municipal bonds, amount of, 71. Investor should know his own requirements, 245. Investment, bond dealers vs. brokers, 4 ; correspondence, 172, 173; in the United States, strength of, 238 et seq; elements, the ten, 59, 60; 253; the three most prominent, 62; in bonds of United States Savings Banks, 240. Irrigation bonds, 13. Issues of bonds, total each year in America, 1. Knowing the business of the corporation, 127 et seq. Laboratory methods in bond buying, i7 et seq. Legality of issuance and legality for savings bank in- vestment, 71. "Legals" vs. general market bonds, 69 et seq. Libraries of bond houses, 37, etc. Listings of bonds on the Exchange, annual amount, 242. Local bank buying of municipals, 77. Local bond representation, 217. Losses, assumption of, by bond houses, 199. Magnitude in relation to safety, 6, 7. Management and proprietorship as affecting railroad bond security, 112-117. 154 INDEX Management in relation to bond safety, 16; of corpor- ations, influence of bond houses on, 25. Managers, of the bond house, 230 et seq. MarketabiHty, artificial, cost of, to investors, 185 ; to the bond houses, 190, 191 ; as affected by the protective function, 182-188; as part of the protective function, 32 et seq; complex nature of, 250; cost of, 32, 33; in relation to big refunding issues, 105 ; of collateral trusts, 225 et seq; specialty vs. listed bonds, 32, 33. Massachusetts legals and bond house responsibility, 71. Massachusetts taxation in relation to bond dealers, 52, 53. Mercantile vs. the protective policy, 174. Mining bonds, 13. Moody's Magazine calls attention to the rise in interest rates, 54. Mortgages, reading, before bond buying, 95. Municipal bond attorneys, competency of, 72 ; bond bureaus, 80. Municipal bonds, buying, 10 et seq; declined on score of legality, etc., 71. Municipal bond sales in the United States, amount of, 241. Municipal default and repudiation, 83. Municipal sale, an unintelligent, 79. Municipal sales record as an aid to bidding, Id. Municipalities selling bonds over the counter, 74. New England, prevalence of bond buying in, 3. New York legals and bond house responsibility, 71. New York Stock Exchange, annual listings of bonds on, 242 ; bonds first offered and sponsored by bond houses, 1. Newness of corporation bonds, 135. Norfolk and Western First Consolidated 4s, 251. Obscure issues of bonds, the, 243. Oklahoma's experience with bank deposit guarantees, 181. One man buying, 40, 41. Output of American bonds each year, 1. "Over-the-counter" selling of bonds by municipalities, 74. Overcapitalization, 14. INDEX 155 Pennsylvania Convertible 3^5, 251. Pennsylvania Railroad flotation, a, 101. Per capita debt of water companies, 128. Physical characteristics of railroads as affecting railroad bond security, 118. Physical condition, examination of, 17. Preference for public utilities, 140. Press as an influence in bond selling, 166. Prevalence of bond buying in New England, 3. Principal function of the bond houses, 64. Profession, the bond business as a, 22; 28; 30; 35 et seq; 155; 162. Professional Standard of bond houses, 49-53. Profit in selling bonds in general, 141 ; in selling blanket refunding issues, 107 ; in selling corporation bonds, 142-145; legal municipals, 74; in selling railroad bonds, 89; in selling specialty bonds, 208, 209. Profits in railroad bond underwriting and selling, 96 et seq. Protecting security, 198; the market when local banks distribute, 31. Protective function, 31 et seq; Chap. VII, 174; applied to all bond qualities, 195 et seq; applied to market- ability, 182-188. Proper bond, the, for each individual, 261. Proper type of bond must be considered by buyers, 254. Proprietorship and management as affecting railroad bond security, 112-117. Public Utility bonds, banking competition for, 138. Purchasing function, Chap. I, 10 et seq; Chap. II. Quasi-municipals, the problem of buying, 69. Railroad blanket refunding issues, 104 et seq; amount outstanding, 106. Railroad bond investment principles. 111 et seq. Railroad bond underwriting, 92 et seq. Railroads as scientific financiers, 47. Real Estate bonds commonly guaranteed, 180. Records of past municipal sales as an aid to bidding, 76. Receivership (see Default, Reorganization, etc.) atti- tude of bond houses toward, iZ. Refunding issues, railroad, 104 et seq; amount outstand- ing, 106; Reorganization Csee Receivership, Default, etc.) atti- tude of bond house toward, 33; importance of, 200. 156 INDEX Reorganizers, the bond houses as, 149. Repudiation of State debts between 1870 and 1884, 68; 81, 82. Retail vs. wholesale bond houses, 6, 7. Riddlebergers, the, 68. Rise in interest rates, 54. Road men, of the bond house, 233 et seq. Sales Manager, in bond buying, 139 ; of the bond house, 230; 232; 237. Sales of municipal bonds in the United States, 241. Salesmanship, ethics of, 154-163. Salesmen, bond, 29; of wholesale houses, 5. Savings bank bonds, see "legals." Savings bank bonds, small profit in selling, 50; United States, amount of deposits, number of depositors, investments of, 240. Science, as applied to bond selling, a thing of the future, 204; bond investment as, 35 et seq; in railroad finance, 47. Security, as affecting "legals," 71 ; complex nature of, 246 et seq. Selling bonds, cost of, IZ. Selling department of an ideal bond house, 229 et seq. Selling function, 26 et seq; Chap. VIII, 203 et seq; Chap. IX, 238 et seq. Selling legal municipals, profit in, 74 ; of bonds by muni- cipalities "over the counter," 74; profits in railroad bonds, 89. "Services," financial news, etc., 42-44; 165; for muni- cipal buying, 80. Size, importance of in municipal bonds, 84. Special census reports as statistical help, 43. Special counsel in bond buying, 39. "Special circulars" of bond issues, 171. Specialists, bond houses as, 134. Specialty selling, the profit in, 208, 209. Spirit of trusteeship, 175 et seq. Stability of bond houses vs. brokers, 8. Standardization, in the bond business, 26; of business service, 136; of the railroad refunding issues, 106. Statistical material as a help to bond buying, 130; 132, 133. Statistician, the, in bond buying, 139. Statistics and statistical departments, 36 et seq. Statistics of municipal sales as an aid to bidding, 76. INDEX 157 Stock bonuses, 56. Stock Exchange, see New York Stock Exchange. Street railways, printed information concerning, 131. Strength of the investment demand in the United States, 238 et seq. Subscription to bond underwriting (see Underwriting), 259 et seq. Sub-underwriting, 93 et seq. Taxation in Massachusetts in relation to bond dealers, 52, 53. Telephone business, 127. Ten investment elements, the, 59, 60; 253. Tennessee Settlements, the, 68. Territorial managers, the, of the bond house, 231, 232. Three most prominent investment qualities, 62. Traveling salesmen, 29; 233 et seq; of wholesale houses, 5. Trouble with bond selling, 206. Trusteeship, spirit of, 175 et seq. Tuck School of Finance, Dartmouth College, studying the effect of business conditions on corporation earn- ings, 132. Type of bond, proper, must be considered by buyers, 254. Underwriting, 259 et seq; by retail houses, 93 et seq; railroad bonds, 92 et seq. Unintelligent proposals for municipals, 79. United States bonds, 249. United States Steel Corporation, character of owner- ship, 239. Volume of municipal bond sales in the United States, 71 ; 248. Water companies, 128. What corporation bonds are, 122 et seq. Wholesale vs. retail bond houses, 6, 7. THE PRINCIPLES OF BOND INVESTMENT By LAWRENCE CHAMBERLAIN WITH KOUNTZB BROTHERS, BANKERS, NlW YORK, N. Y. Third edition in the Press in eight months. C The extraordinary demand for Mr. Chamberlain's book may be explained in part by the following comments of the press and of individuals. The Boston Advertiser "This is a monumental work, and one that will remain an authority for years to come." The New York Evening Post "Prior to the appearance of this work, it would have been difficult to point to one such treatise that was complete in technical details, ample in historical allusion, and satisfactory in its literary features. An extended work possessing all these qualities is en- titled to a very cordial reception." The Philadelphia Public Ledger "All classes of bonds are dealt with, and from State bonds and the history of State debt to the mathematics of bond values, the science of bond investment is presented in a scholarly yet interesting and absolutely practical manner." Boston Transcript "Rarely have the elements of investment been so well presented. The classification and description of securities is discriminating. The favored class, civil loans, is elaborately discussed." Trust Companies Magazine "A contribution to economics and a literary produc- tion that will rank the author with Walker, Adams, and Scott." Boston Globe "The man who makes himself familiar with the text will have a liberal financial education." Springfield Republican "In preparing this volume the author spent five years of such unremitting labor as steady occupation, covering every side of the business, would permit. The book was written from day to day out of the market place. The facts of the market place have been well digested, however, by the mind of a sound scholar. They are analyzed and presented in such a way as to show their significance clearly to the lay reader. . . . Mr. Chamberlain's careful and broad search has made his book the first authoritative state- ment of the subject." Journal of the American Bankers' Association "Bankers to whom the comments on the prevailing types of bonds, as bank investments, and the relation of bond prices to credit, etc., were submitted, have approved the statements made. The book forms a desirable addition to the bond department of any bank." Investments "The amount of concrete facts relating to securities is amazing, as the index will show, and justifies the term 'encyclopaedic,' that is being applied to the book." United States Investor "Mr. Chamberlain's book is voluminous and has an immense amount of information on methods of bond buying and on the peculiar merits of each class of bonds." The Boston News Bureau "Information about bonds has in the past been divided into four classes : the raw material in the statistical manuals, a few elementary books on investments, articles in financial periodicals, and financial adver- tising. Obviously none of these have offered the man with funds to invest an unprejudiced opinion, to assist him in the principles of bond selection. In 'The Principles of Bond Investment' Lawrence Cham- berlain has written a book clear enough to be easily understood, and substantial enough to be of practical value." Bankers* Magazine "Mr. Chamberlain's work deals with the general investment field, and while it is perhaps intended primarily to meet the wants of the banks and invest- ment houses and scientific students of investments, it will, nevertheless, be found of great benefit to the individual investor. As a contribution to the perma- nent investment literature of the country, Mr. Cham- berlain's book will be of the highest value." A Bond Salesman "I sold a water company bond the other day mainly on the strength of the chapter on that subject." The Manager of a New York Bond House "Bond houses have every reason to be grateful . . . for . . . 'The Principles of Bond Investment.' In the short time since its publication I have consulted it freely and have found just what I was looking for." A Professor of Economics at Yale "I have just finished reading The Principles of Bond Investment,' by Mr. Chamberlain, and perhaps I can best express my feelings by saying that I con- sider it the best book on this subject which has been written by an American." The Dean of an Eastern University "I shall be much surprised and disappointed if it does not very quickly become recognized as the standard treatise on bond investment." 551 pages. 19 charts. 8to. Cloth. Price, $5 net. Moody's Magazine Book Department 35 Nassau Street : : New York, N. Y. J. C. ft W. E Power! Print. New York UNIVERSITY OF CALIFORNIA LIBRARY Los Angeles This book is DUE on the last date stamped below. JAN2 8 lEji •IAN ? ^o:\\ FEB 1 1957 .,r'--'" f^XVSI nl MAY 2i MAY 191975 Form L9-25»H-9,'47(A5618)444 TJICn^- •■ S^TY &i CALIFORI^Lft. AT LOS ANGELES AA 000 558 531 ( I PLEA'='i: DO NOT REMOVE THIS BOOK CARD J ^lllBRARYQ^ •SI %ojnv3JO^ University Research Library