Chapter XXX (2)

This characteristically American discount system differs greatly from that which prevails in Europe. Abroad, single-name paper is very little used.[270] The European banker demands more than one signature, not only as a guaranty of security, but also as an assurance of the validity of the transaction out of which the paper offered for discount grew. When the prospective borrower, for some sufficient reason, does not wish to divulge the names of his clients, as would be necessary if he drew bills on them, he may arrange with his bank for an overdraft (known as a cash advance),[271] or by paying a small commission he may get the bank to "accept" a bill drawn directly on it. With a bank's acceptance a bill, even though drawn by the humblest shopkeeper, becomes a prime investment and may be sold openly on the market at the lowest terms that prevail.[272] On the Continent bank acceptances thus open the market widely to all who can arrange for them, while the open market for single-name paper in this country is restricted to large firms of established reputations.

In view of the prevailing practice in Europe it is interesting to inquire why in America there should have been this peculiar development in the discount field. It has been pointed out that before the Civil War trade paper, as it is now called, was pretty generally used, but the exigencies growing out of the war completely changed the situation. The excessive issue of the greenbacks and the uncertain value of credit instruments covering any appreciable period of time led sellers to endeavor to bring business to a cash basis. Credits were shortened to 30 or even to 10 days, and strong emphasis was placed on immediate payment. With cash discounts alluringly liberal, merchants could ill afford to forego them, and cash payments tended to become more and more common. Big houses offered single-name paper to raise the needed funds, and little by little the older system of settling by the promissory note of the debtor was supplanted by the system of selling on open account, with the choice given to the debtor of a liberal discount for cash or the payment of the due amount "net" at the expiration of a relatively short credit period.

The transition was hastened by the development of the practice of selling goods by sample instead of by personal selection from an accumulated stock. Under the old practice the buyer bought under the rule of _caveat emptor_, but when purchasing by sample he had a right to demand that the delivered goods attain the standard of the sample, and there grew up in consequence the doctrine of "implied warranties." These warranties have in some lines been pushed very far,[273] but in any case the buyer would hesitate to pay for goods until he had had a chance to inspect them, and hence he would as a rule demand that they be consigned to him on open account. The seller, however, cannot afford to wait for payment until his accounts become due. Too much of his capital would be tied up. He is forced, therefore, to go to his banker and, on the basis of his accounts receivable, to offer his own note and thus to obtain release of the capital otherwise temporarily beyond reach.... Single-name paper virtually monopolizes the field....

NO SYSTEM OF BANK ACCEPTANCES AND THE ABSENCE OF AN OPEN DISCOUNT MARKET

[274]The weakness of our banking system as compared with the systems of Europe may very certainly be attributed in part to the omission of the bank act to permit bank acceptances. It is a weakness, furthermore, which involves the country in serious economic loss. Without a national discount market, the great majority of our merchants and manufacturers are compelled to confine their borrowings to American capital, either through the discounting of their paper with their local banks or through its sale to note brokers. All but the strongest and largest are practically excluded from the benefits of foreign competition for their paper. Aside from the great concerns with international ramifications, which are able to arrange their own credits abroad, our merchants and manufacturers are not benefited by low foreign discount rates, except in so far as note brokers, who make it a practice to borrow in Europe with commercial paper as collateral, are better able to finance their purchases. What is more, they receive relatively little advantage from an accumulation of funds in New York banks. Low call loan rates have an indirect rather than a direct effect on the rate which the mercantile community has to pay for money. Low call rates, in other words, are an indication more especially of stagnation in the stock market than of a lack of demand for accommodation from merchants and manufacturers. Such rates do not act as a stimulus to trade in general any more than high call rates act as an immediate check to over-expansion.

It is not only in our domestic trade that the country suffers through the want of a discount market. Without bank acceptances we are at a distinct disadvantage in connection with our foreign trade. Our importers, unable to open credits with their banks, as is done abroad, are not in a position to finance their purchases upon as favorable a basis as the importers in other countries, as English cotton spinners, for example. The English spinner about to purchase cotton in America arranges for his bank to accept sixty or ninety days' sight bills drawn on it by the American shipper. The latter draws his bills on the English bank and attaches the documents covering the shipment, such as the bills of lading, insurance certificates, invoices, etc. He then sells them to a New York bank, thereby receiving immediate payment for his cotton. The New York bank forwards the bills to its London correspondent, which presents them for acceptance to the bank upon which they are drawn. Upon the acceptance of the bills the documents are delivered to the accepting bank, which then turns them over to the spinner upon whatever arrangement has previously been made. The accepted bills are discounted by the New York bank in London and the proceeds placed to its credit there. The New York bank can afford to pay a high rate for such bills, as they are drawn on prime bankers, rendering certain their ultimate payment. The purchase of the bills does not, moreover, necessitate any outlay of money, as against the credit to be received through the discount of the bills the New York bank can immediately sell its checks on London.

Without such banking facilities--that is, the ability to arrange with his bank to accept time bills drawn on it by a foreign shipper, the American importer is compelled to finance his purchases in either one of two ways. He may pay for the goods at once by remitting funds direct to the shipper. This, however, ordinarily necessitates the negotiation by the importer of a loan on his promissory note. If he is not in a position to secure such an advance he must shift the burden of providing funds to finance the shipment, from the time it is forwarded until it is to be paid for, upon the foreign shipper, who is then in a position to exact terms more favorable to himself through an adjustment of prices. The practice in connection with this method of making payment for foreign purchases is for the shipper to draw his draft on the American importer and turn it over to his banker to forward for collection. Such drafts, drawn as they are on individual importers and not on banks whose standing is well known abroad, must be sent for collection since there is no general market for them. Practically the only way in which a foreign shipper can realize immediately on bills of this character is to dispose of them to his own banker or get him to make an advance on them.

Either of these two methods of financing our imports is expensive even when the time between the shipment and the receipt of the goods is short. When the time is much longer, as in the case of imports from South America and the Far East, the cost is almost prohibitive--that is, so great that we can not compete on an even basis with foreign buyers. In fact, we might be practically excluded from these markets if a makeshift were not possible. Our importer gets around our lack of banking facilities by having his bank arrange a credit with its London correspondent. He receives an undertaking, called a commercial letter of credit, giving the terms of the credit--that is, the name of the London bank upon which the bills are to be drawn, the amount which may be drawn, the character of the goods which are to be purchased, the tenor of the bills, and the documents which must accompany them. On the strength of such a letter of credit, the shipper in South America, for example, is able to dispose of his bills on London and thus receive immediate payment for his goods. The local bank which buys the bills sends them with the documents to its London correspondent, which presents the bills to the bank on which they are drawn--that is, the bank with which the credit was opened. Upon the acceptance of the bills the documents are delivered. They are then sent by the London accepting bank to the New York bank which opened the credit and the latter delivers them to the importer against his trust receipt. Twelve days prior to the maturity of the bills in London the New York bank presents a statement to the importer indicating the amount of pounds sterling which must be remitted to London to provide for their payment at maturity or rather a bill stated in dollars for the amount of pounds sterling drawn under the credit. In this purchase of exchange the importer makes payment for his goods. This method while workable is obviously cumbersome, yet it is practically the only one which the American importer can follow in connection with such imports. It is expensive for the importer, for not only must he pay his bank a commission for arranging the credit, but there is included in this commission a charge made by the London bank for its acceptance. Further than that the importer must take a material risk in exchange. At the time a credit is opened the cost of remitting, say L10,000 to take up the bills in London, might be only $48,600, or at the rate of $4.86, whereas by the time the bills actually mature exchange may have risen and cost him $4.87, or $48,700.

As a result of the inability of our banks to finance imports through the acceptance of time bills, American importers are, then, made dependent to a large extent upon London, and are required to pay London a considerable annual tribute in the way of acceptance commissions. This practice not only adds to the importance of London and militates against the development of New York as a financial center, but it at the same time works serious injury to our export trade. Since time bills can not be drawn on our banks from foreign points against shipments of goods to the United States, there are consequently in such foreign countries very few bills which can be purchased for remittance to the United States in payment for goods which have been bought here. In other words, under our present banking system our imports do not create a supply of exchange on New York, for example, which can be sold in foreign countries to those who have payments to make in New York. This means that our exporters are also, to their great disadvantage, made dependent upon London. It means that when they are shipping goods to South America and to the Orient they can not, when they are subject to competition, advantageously bill them in United States dollars. They naturally do not care to value their goods in local currency--that is, in the money of the country to which the goods are going--so their only alternative is to value them in francs or marks or sterling, preferably the latter, owing to the distribution and extent of British trade, creating throughout the world, as it does under the English banking system, a fairly constant supply of and demand for exchange on London. When we come to bill our goods in sterling, however, it is at once seen that our exporters are obliged to take a risk of exchange, which is a serious handicap when competing with British exporters. Our exporters who are to receive payment for their goods in sterling must previously decide on what rate of exchange will make the transaction profitable. If, in an effort to safeguard themselves against a loss in exchange, they calculate on too low a rate for the ultimate conversion of their sterling into dollars, their prices become unfavorable compared to those made by British exporters and they lose the business. If they do not calculate on a sufficiently low rate they get the business but lose money on the transaction through a loss in exchange.

The prohibition of bank acceptances not only acts as a hamper upon our domestic and foreign trade, but is detrimental to our banks as well. It is the small country bank which is chiefly affected. The business of the country bank, so far as the employment of its funds is concerned, may be divided into two classes--that which relates to advances to local customers and that connected with the investment of its surplus. It is in respect to the latter that the matter of acceptances is important. Under the present limitations of the National Bank Act there are three principal ways in which a country bank may render its surplus funds productive. It may deposit them with its reserve agent. This means a low interest return, too low in fact to permit of only a relatively small amount being thus employed. It may invest in bonds. In this way an increased interest return can be secured, providing a wise selection of securities is made, but it partakes of the nature of speculation. The third way is to buy commercial paper. Such purchases give an ample interest return and there is no savor of speculation. Even this method of employing a bank's funds, however, is far from satisfactory. It means the investment in a security for the strength of which the bank must depend on the word of note brokers, the rating of the mercantile agencies, or the opinion of some correspondent bank. It means, furthermore, the tying up of the bank's funds for a fixed period. If national banks were permitted to accept time bills the country bank could then invest its funds in paper bearing the guaranty of some great bank with whose standing it is perfectly familiar. Risk such as now has to be taken would be eliminated. What is vital, however, is that with a national discount market an investment in a bank-accepted bill is one which could be realized upon immediately. Commercial paper and bank acceptances are both discountable. The prime difference between them, as affecting a country bank, is that they are not both readily rediscountable. Herein probably lies the reason for the strong prejudice against rediscounts which exists among bankers in the United States. In this country when a bank discounts a piece of commercial paper it is discounting something which for its security depends solely on its maker. Should the bank desire to realize on this paper it could do so by rediscounting it, but such a rediscount would be practically equivalent to a loan to the bank on the strength of its own name. In other words, to rediscount its commercial paper would affect a bank's credit. To ask for a rediscount is to ask for accommodation. This would not be the case with bank-accepted bills. If such bills were discounted by a country bank as a means of investing its surplus and it was desired to realize on them such a rediscount would be made not on the name of the country bank, but on the name of the accepting bank. A rediscount in this instance would not constitute a loan to the country bank and would have absolutely no effect on its credit. It would merely indicate that some more profitable business had arisen in which to employ its funds or that it was desirous of increasing its reserve.

Since the reserves of interior banks are so largely concentrated with them and it is essential that they keep their assets in an especially liquid condition, the prohibition of bank acceptances works injury to the banks at the country's financial center, New York, in a different way. It deprives them of what London banks, for example, have--that is, a mass of the soundest securities against which to loan their money on call or in which they may invest their funds for very brief periods--bills of exchange, covering genuine commercial transactions, bearing the acceptance of prime bankers. Unquestionably such securities as a basis for loans are preferable to stock and bonds, but without them New York banks must have recourse to day-to-day loans on the Stock Exchange. Moreover, when the demand for such loans is limited. New York banks are forced into the keenest kind of competition, a competition which, as has been pointed out, is not only of little benefit to trade but which, through the lowering of the money rate, actually stimulates speculation. Furthermore, without a steady money rate such as exists in countries possessing discount markets, New York banks are left with no reasonable or satisfactory basis upon which to fix a rate of interest to pay for the deposits of country banks. In London interest on bank deposits is fixed at a certain percentage below the Bank of England discount rate, usually 1-1/2 per cent.--that is, a rate which fluctuates with the value of money and normally leaves a certain margin of profit to the London bank. The same practice is followed in all the great financial centers of Europe. With us, country banks receive a fixed rate of interest for their deposits, usually 2 per cent., the year around, regardless of fluctuations in the value of money. The unscientific nature of such a rate is obvious. When the call loan rate is high country banks do not receive interest in proportion to the value of their deposits. When it is low the New York banks pay more interest than the deposits are worth. In the latter instance the New York banks are forced into injurious competition with one another. They are in much the same position as competing railroads were earlier in our history, with results similarly baneful. With the railroads it was worth while to secure traffic even at a losing rate, as no matter what the return it helped, if only a little, toward meeting fixed charges. Oftentimes with the New York banks to-day any rate which they can secure for their money whether losing or not is acceptable as helping to meet this fixed interest charge on bank deposits. To pay 2 per cent. for deposits and to keep a 25 per cent. reserve a bank must loan its money at 2-3/4 per cent., to come out even, taking into consideration the actual expense of making and recording the transaction. It is better to loan at 1-3/4 per cent., however, than to let the money lie idle. It is better to lose 1 per cent. than to lose the entire 2-3/4 per cent., as would be done in case no loans at all were made, clerk-hire being just as much a fixed charge as interest. With the amendment of the National Bank Act, to permit the acceptance of time bills, such ruinous competition would cease. The funds of the banks would come to be principally invested in trade paper and stock-exchange loans would be relegated to a position of secondary importance, as in London and on the Continent. The field for the investment of their deposits would be greatly broadened, to the benefit both of the banks and trade in general.

To remedy this primary defect in our banking system, to make possible the financing of our domestic and foreign trade along the lines which have proved so advantageous in other countries, to provide negotiable paper of a character suitable to the investment of foreign funds, paper which can not only be discounted but rediscounted, to give trade the advantage of bank surpluses accumulated both in the country at large and in New York, to lessen the evils of speculation, to afford a reasonable basis for the calculation of interest rates on bank deposits in central reserve cities, to bring New York into the circle of those financial centers between which funds move naturally as discount rates rise or decline, to secure the advantage of the competition of foreign capital for our trade paper, can be put in the way of accomplishment by the insertion of a paragraph or two in the National Bank Act.

* * * * *

[275]The European financial system is constructed upon discounts as its foundation; the American system is constructed upon bonds and stocks as its foundation. Bank notes in Europe are issued mainly against bullion and discounts; in the United States mainly against bullion and bonds.

The quick assets held by European banks against their deposits consist of discounts or call loans, largely secured by discounts. The quick assets of American banks ... are primarily call loans on stock and bond collateral.

In Europe the daily plus and minus of money requirements are adjusted by the use of the discount market--that is to say, in a final analysis, by purchase or sale of bills. (Calling in or putting out money on call where the loans are secured by bills amounts, in effect, to a sale or a purchase of bills.) In a last analysis this means that in Europe attempts to liquidate are primarily appeals to the whole nation to liquidate its temporary commercial investments, the brunt of such liquidation being borne by the entire community, and the pressure being constantly subdivided, every member of the community thus contributing his share.

As a majority of discounts represent goods in process of production or on the way to consumption, liquidation with them primarily expresses itself by a falling off in new production, while the consumer, on the other hand, can not stop consuming and must therefore continue to pay. The brunt is thus borne by the whole nation and adjustment follows without violent convulsions.

In sharp contrast with such a system the attempts to liquidate in the United States are directed primarily at the contractors of stock exchange loans. This means that a comparatively limited number of debtors are called upon to sell their securities. This they can do only by finding new investors, who, as a rule, are at such times comparatively rare, because when acute pressure arises it generally originates in the inability of the investor to purchase because of lack of funds or in his unwillingness by reason of his distrust of the financial situation. The concomitant of this is that those forced to sell securities at such times must offer them at sufficiently reduced prices to bring about an entire change in the attitude of the investor. The difficulty here is that violent reductions of prices in themselves cause distrust, and low prices caused by distrust not only frighten away purchasers but, in addition, unsettle the owners of securities and thus cause them to join the ranks of the sellers. An acute convulsion, therefore, must inevitably follow before the tide can be turned....

Of course, general liquidation in Europe includes a liquidation of securities, just as liquidation in the United States also includes liquidation of commercial paper as it matures. But the difference is that in Europe bills will be the main factor and securities will play a much more subordinate part, while with us just the reverse is true.

THE ESSENTIAL CONDITIONS FOR THE ESTABLISHMENT OF AN INTERNATIONAL DISCOUNT MARKET

[276]The essential conditions for the establishment of an international discount market are:

1. Every bill offered for discount should be based on a commercial transaction where value passes. Finance or accommodation bills should be extremely rare and capable of satisfactory explanation.

2. It follows that almost invariably the bill will arise out of a sale of goods and will be in the form of a draft by the seller upon the buyer, and accepted by the buyer.

3. It will thus be a two-name bill, and not an individual promissory note. How far you can change your system in this respect and how far the powers of your new Federal banks can be used to induce such a change, is a question which I cannot pretend to answer, but which you will no doubt be able to answer.

4. The bill should be drawn for a period neither too long nor too short. The period should be sufficient to allow of a resale of the goods on which the bill is based, thus making the bill in a sense self-liquidating. The usual period is three months.

5. While there should be a large proportion of trade bills, there should be a still larger proportion of acceptances by banks and finance houses, based, of course, on collateral, which usually takes the form of imported produce. In Germany, however, I understand that banks accept a good many drafts arising out of internal transactions.

6. If the market is not to be merely a home market, but international: that is, attractive to foreign bill buyers, an important and desirable step would be the opening of American banks or branches of American banks in foreign exchange centres, such as London, Paris, Berlin, Amsterdam, Buenos Aires, Shanghai, and so on, and these banks should always be prepared to encourage American bills by buying, at reasonable rates of exchange, bills on New York, Chicago, and other American centres, payable in dollars.

7. Your usury laws would have to be modified so as to allow discount rates to move freely upwards if required.

8. Your Federal reserve banks which are intended to be the equivalent of the Central banks of other countries, such as the Bank of England, Bank of France, and the Reichsbank, should be prepared to rediscount approved bills at all times and to any extent.

The advantages to you of such a market would be the same advantages that we possess, namely, liquid employment for short money; power to meet demands for money without disorganizing stock exchange prices; power to check overtrading at home, and finally, power to check a foreign drain of gold.

CASH STOCK EXCHANGE DEALINGS

[277]In England, France, and Germany there exist monthly or half-monthly settlements of stock exchange transactions, and as stock exchange loans run from one settlement to the next the amount of money employed on the stock exchange between settlements remains stationary. If, at the settlement, it develops that commitments on the stock exchange have increased and that a larger amount of money is needed there, so much additional money will under normal circumstances be withdrawn from the bill market and go into the stock exchange. If less money is wanted on the stock exchange, so much more will go into the bill market.

Without entering upon a discussion of the question of cash stock exchange dealings versus stock exchange dealings per settlement (for which, be it said in passing, a suitable method of weekly stock exchange settlements can probably be devised for this country, combined with provisions for proper margining in order to prevent over-stimulation to gambling), we are, for the purposes of this article, interested only in the effect of this method of cash dealings on the whole financial system. An exclusive system of cash dealings brings about the pre-ponderance of the call loan on stock exchange collateral. But for the existence of the seducing call loan, which is one of the gravest dangers and curses of our system, we should have been forced to develop our bill market as a regulator of our daily money requirements. In that case, instead of seeing the idle money of the whole nation poured into stock exchange loans when trade is inactive--thus unduly stimulating speculation when it should be discouraged--and again withdrawing money from the stock exchanges in order to provide for the business of the whole nation when trade becomes active--thus bringing about anxiety and convulsions on the stock exchange in the face of prosperity--we should have a system based on bills; that is to say, based on the broad foundations consisting of the commerce and trade of the whole nation, and we should then enjoy an almost uniform rate of interest all over the country, gently rising and falling within moderate bounds, instead of the violent fluctuations and unbearable conditions to which we are now subjected.

The aggregate amount invested by a nation in trade and commerce should be and is many times the amount invested in stock exchange loans, which latter represent undigested securities and securities carried for speculative investors. Our way of doing business may be illustrated by two adjoining reservoirs, one small and one very large. The small one represents the stock exchange and contains the call loans; the large one represents the general business of the country, as expressed by commerce and industry. In Europe the small reservoir is regulated by pumping water into it from the large one or by withdrawing water from it into the large one. In this way the outflow and inflow of the large reservoir are scarcely perceptible, and yet there is no difficulty in regulating the small one. With us, the reverse is done. If there is a shortage of water in the large reservoir we draw on the small one and, in order to increase the water in the large reservoir by perhaps an inch, we empty the small one altogether, or else in order to decrease the amount of water in the large reservoir by an inch, we fill the small one to overflowing.

NO POWER TO LEND ON REAL ESTATE[278]

Most of the restrictions in the national banking law have to do with loans, reserves, or the issue of notes. Of these the restrictions upon loans are by far the most serious impediment in competing for business with state banks and trust companies. For the banks outside the large cities this is particularly true of the provision which forbids loans upon real estate as security.

This restriction is based upon a sound banking principle, learned after much bitter experience. But the experience which led to a complete prohibition of real estate loans was gained amid the economic conditions of the first half of the last century, and the principle itself is one which is applicable only to a particular form of banking organization. While the country was in process of settlement, with an abundance of unoccupied fertile land, real estate was a security of most uncertain value. Moreover, the wildest of the speculative movements which preceded all our early crises were invariably in land. At present, land values are far more stable, and real estate is everywhere included among the most conservative of investments, proper for all with the one exception of commercial banks.

For banks, all of whose obligations are payable upon demand, the real estate loan, quite regardless of its safety, is wisely considered unsuitable. Such loans are commonly wanted by borrowers for a considerable period of time and, therefore, they can not readily be reduced in amount even by an individual bank. In other words, they are not liquid. But the importance of this quality in all its assets disappears when a bank begins to acquire time or savings deposits, as well as those payable on demand.... The example of the trust companies shows that a great variety of financial business can be carried on safely and profitably under a single management. Failures among them have been comparatively few in number, and it would be difficult to find a single instance of disaster which could be attributed to the variety of business carried on.

Some of the advantages which the banks would derive if they were able to lend on real estate are so evident that they require little more than mere mention. It would give them more of the most profitable kind of business, that which has its origin in the neighborhood of the bank. The immediate return is generally greater than can be secured from the employment of funds in the money centers or in the purchase of paper from note brokers. Moreover, in fostering the growth of wealth and population in its locality a bank is laying a solid foundation for the future expansion of its own business. Finally, the ability to lend on real estate will often enable a bank to secure valuable customers who would otherwise go elsewhere. It has been the unpleasant experience of many a national banker to be obliged to refuse a loan to a would-be borrower who has nothing but real estate to offer as security and to see him enter a neighboring state bank or trust company where there was no legal obstacle to the transaction. Relations once established are pretty certain to continue even after the borrower has security which falls within the provisions of the national law.

There are then at least three distinct advantages which may be expected to follow if the national banks are permitted to lend on real estate. It would be profitable for the banks; it would be of advantage to the localities served by the banks; and, finally, it would enable the banks to compete with state institutions upon a more equal footing,[279] thus checking to some extent the relative decline of banking under the national law.

THE INDEPENDENT TREASURY AS A SOURCE OF WEAKNESS IN OUR BANKING SYSTEM[280]

For many years the banks of this country have conducted a persistent agitation for the abolition of the Independent Treasury system. It has been their contention that the Independent Treasury was an archaic and inefficient system of administering the finances of the nation; that it worked serious hardship upon the banks and the business of the country, and that any system of reform should include its abolition.

The treasury is, in reality, a central bank of deposit with branches, run by the Government, in which the Government is the only depositor, and from which there are no borrowers. The central office of the Treasury is situated in Washington, while there are ten subtreasuries or branches scattered among the various large cities of the country. The most important subtreasury, from the standpoint of the volume of business handled, is located in New York City....

The United States is the only large nation in the world which has a treasury system of this sort, and this fact has been made much of in the agitation for its abolition.

DIFFICULTIES ARISING FROM THE TREASURY SYSTEM

There is no room for dispute that many features of the Independent Treasury have, in the past, been the source of serious difficulties. However, we must recognize that within the last decade, and particularly within the last two or three years, most of the glaring defects have been eliminated through a liberalization in methods, involving, in brief, a deposit of a very considerable amount of the Government's money in national banks rather than carrying it locked up in the vaults of the Treasury, through more liberal administrative regulations by which payments to the Treasury could be made with certified checks, and through facilitating in other ways the transactions of business men with the Treasury Department.

CORRESPONDENCE OF TREASURY RECEIPTS AND DISBURSEMENTS

... The real criticism against the Treasury is that it causes the tying up of money, not over a series of years, but during the months in which the banking system of the country most needs it. This condition is the result of the lack of correspondence between government receipts and disbursements.

During the first four months of the year the receipts are less than in any other period. During the month of May, the receipts sharply increase, reaching their maximum about the first of June, and continuing at a very high rate over that month. In July the income falls off, reaching by the end of the month a point a little above that which prevailed in April, after which it gradually increases during August and September. About October first the tide turns and the receipts fall off sharply during that month, while during December the revenue again increases. As contrasted with this the government expenditures change only in a general way....

EXAGGERATION OF TREASURY EVILS

It should be stated that whatever embarrassment exists because of this condition, and which as a matter of fact has been grossly exaggerated, is found almost entirely in New York City.

However, in order to reduce as much as possible the objections raised by the bankers and to prevent money being taken out of circulation and buried in the Treasury, where it would be of no service to the country, the Secretary of the Treasury, on January 9, 1913, issued the following order, which inaugurated a radical change in the manner of handling and disbursing the public funds. The objects to be accomplished were announced in the order as follows:

"For the purpose of bringing the ordinary fiscal transactions of the Federal Government more nearly into harmony with present business practices, it has been determined that the daily receipts of the Government shall be placed with the national bank depositaries to the credit of the Treasurer of the United States. Disbursements will be made by warrant or check drawn on the Treasurer, but payable by national bank depositaries, as well as by the Treasury and subtreasuries."

Secretary McAdoo, in his report for the fiscal year ending June 30, 1913, in speaking of this, stated that while it had caused some embarrassment "the difficulties at first encountered are disappearing, and the system appears to respond to the public requirements, and to be accomplishing the purposes for which it was devised."

LACK OF CENTRAL CONTROL

[281]There is no country in the world where the volume of currency in circulation and the demand for bank credits fluctuate more widely than in the United States. This is due to the great expanse of our territory, to the annual harvest requirements of the agricultural sections, to the prevailing business activity and enterprise, and to the rapid and unequal increase of population and wealth in different sections. Furthermore, there is no country in the world where intelligent control over bank credits and bank reserves is needed more than in the United States. There are in the United States nearly seven thousand national banks, besides twice as many state banks and trust companies. Each of these institutions acts for its individual interest alone, independently of the others, and the prevailing tendency of each at all times is to expand its credits to the limit permitted by law. The country banks lend their surplus resources in the form of deposits at interest to the banks in the larger cities, and the banks in the principal money centres commonly expand their credits as much as practicable by lending on call such sums as they deem it unsafe to lend on time or by discount of commercial paper. Each bank with a deposit in another bank assumes that, in case of need, it can strengthen its reserve by drawing upon this deposit; but it fails to consider that, when thus it strengthens its own reserve, it must to the same extent weaken the reserve of the other bank, and that the deposits of banks with other banks add no strength to the general credit situation. Each bank that has loaned money on call assumes that, in case of need, it can strengthen its reserve by calling such loans; but it fails to consider that, generally, when a loan is called the borrower is obliged to borrow the same sum from some other bank, although a high rate of interest may be exacted, and, therefore, that call loans affect the security of the entire bank situation practically to the same extent as time loans.

In the United States there is no way of regulating the supply of bank credits and of holding part of the potential supply in reserve for periods of financial stringency. Consequently, nearly always there is either an over-abundance of money (meaning credit which the banks are ready to lend) or a money famine. It has been argued that the volume of credits granted by the banks depends upon business activity and upon the consequent demand for credit and not upon the power of the banks to grant credits, and, therefore, that low interest rates have little effect in causing an expansion of bank credits. Experience, however, shows that the contrary is the case, at least in the United States. It is true that, when there is loss of confidence and when business is depressed, interest rates are low, because there is less currency in circulation and more in the bank reserves, while at the same time the demand for bank credits is diminished. It is true, also, that low interest rates will not stimulate speculation and enterprise unless people have confidence and are ready to speculate and to embark in new enterprises. But we know by experience that when people are in a mood for speculation and for business expansion low interest rates operate as a powerful stimulus to speculation and business expansion. A leading banker has said: "In the long run commerce suffers more from the periods of over-abundance (of money) than from those of scarcity. The origin of each recurring period of tight money can be traced to preceding periods of easy money. Whenever money becomes so over-abundant that bankers, in order to keep it earning something, have to force it out at abnormally low rates of interest, the foundations are laid for a period of stringency in the not far distant future, for then speculation is encouraged, prices are inflated, and all sorts of securities are floated until the money market is glutted with them."[282] [The need of intelligent control over discount rates and bank credits is (was) imperative.]

ABSENCE OF REGULATION OF RATIO OF DEPOSITS TO CAPITAL AND SURPLUS

[283]The reports of condition of the national banks, according to the statements of September 12, 1914, to the Comptroller of the Currency, show that, on an average, the total deposits of all national banks amount to about four and six-tenths times their total capital and surplus. This means that the average capital and surplus of these banks is equal to approximately 21 per cent. of the total amount of deposits. There are, however, national banks whose deposits amount to ten or more times their capital and surplus, and in these cases the margin of protection to depositors is only 10 per cent. or less of the sum total of deposits. Usually the amount of money which a bank has invested in loans approximates the amount of its deposits. In the case of a bank whose loans equal its deposits, and whose deposits are approximately ten times its capital and surplus, it is obvious that the loss of over 10 per cent. in loans would wipe out both capital and surplus and destroy the solvency of the bank, rendering it unable to pay its depositors.

The view is held by many practical bankers and experienced economists that it is not sound banking for an active commercial bank to be allowed to receive deposits in excess of ten times its capital and surplus. I am firmly impressed with the correctness of this view, and respectfully recommend to the Congress that the national-bank act be amended so as to provide that no national bank shall be permitted to hold deposits in excess of ten times its unimpaired capital and surplus. Perhaps it might be wiser to make this limitation eight times the capital and surplus.

Such a limitation need not interfere with the growth and development of the bank. When its deposits approach an amount equal to ten times its capital and surplus, or whatever other limitation may be fixed, arrangements may be made to increase its capital. A bank whose deposits amount to ten times the capital and surplus, if efficiently managed, should be so profitable that there would be no difficulty in providing for an increase of capital by the sale of additional stock, and when the proposed increase shall have been authorized by two-thirds of its stockholders and approved by the Comptroller of the Currency, it can be made promptly effective. A commercial bank whose capital and surplus amount to less than one-tenth of its deposits is, except possibly under very exceptional conditions, doing business on too small a capital and upon too narrow a margin for safety, and does not furnish its creditors the protection to which they are entitled against unexpected losses and contingencies which are liable to, and do, so frequently arise....

BANKING ABUSES

[284]... Among the many abuses and violations of law and regulations with which the department has to contend are excessive loans; overdrafts; loose and unbusinesslike methods of accounting; excessive borrowings by the banks; investment of the bank's funds in securities not authorized by law; charging of usurious rates of interest; unlawful loans on real estate; excessive loans to officers, clerks, and employes of the bank employing them; loans to a bank's officers or employes and others through "dummies"; loaning money, directly or indirectly, upon the bank's own stock; transaction of a brokerage or commission business by the bank's executive officers, the commissions thus collected being sometimes appropriated personally by the officers and sometimes going directly or indirectly to the bank; false statements of directors as to ownership of stock; false statements made by bank officers, such as including as cash or cash items memoranda of moneys due from one source or another which do not represent actual cash and can not be immediately converted into cash; and failure or refusal when so directed to charge off bad debts and other ascertained losses; delay on the part of directors in taking the oath of office.

For many of the offences indicated the only penalty which can be enforced by the Comptroller's office is the forfeiture of the bank's charter by suit in the United States Court. This in many cases would prove a great hardship to innocent stockholders and depositors, and can only be resorted to with much reluctance by this office....

USURIOUS INTEREST RATES

[285]All the national banks of the country have been required in each report of condition made to the Comptroller's office since January 1 last to state under oath the highest rate of interest they have charged since the preceding report and the average rate of interest charged by them on all loans since the preceding report.

The reports received at the Comptroller's office show indisputably that in some States and sections borrowers, especially small borrowers, have been and are being subjected to extortions and exactions which the average man would consider impossible in this enlightened age.

One thousand and twenty banks in different sections of the country, out of the total of 7,615 banks, admitted that they were receiving an average of 10 per cent. or more--some an average of 18 per cent.--on all their loans.

Those receiving an average of 10 per cent. and upwards included 2 banks in Illinois, 6 in Minnesota, 2 in Missouri, 23 in Georgia, 6 in Florida, 21 in Alabama, 2 in Louisiana, 315 in Texas, 17 in Arkansas, 3 in Tennessee, 90 in North Dakota, 25 in South Dakota, 18 in Nebraska, 5 in Kansas, 38 in Montana, 14 in Wyoming, 37 in Colorado, 25 in New Mexico, 300 in Oklahoma, 12 in Washington, 10 in Oregon, 13 in California, 2 in Utah, 1 in Nevada, and 33 banks in Idaho.

Let me illustrate the methods of some of these bankers by giving you the facts and figures as taken from the sworn statements submitted to the Comptroller's office by the national banks in two particular States in the Southwest.

In one of these States there were 131 banks which reported that they charged a maximum rate of interest ranging from 15 per cent. to 24 per cent. per annum, 67 banks whose maximum rate ranged between 25 per cent. and 60 per cent. per annum, 22 banks which charged between 60 per cent. per annum and 100 per cent. per annum, 18 banks whose maximum rate was from 100 per cent. to 200 per cent. per annum, and 8 banks which owned up to having charged maximum rates ranging between 200 per cent. and 2,000 per cent. Most of these disgraceful and unprecedented rates were for comparatively small loans....

These figures are not results of the rule, applied by many banks, not to pass a loan on their books for less than a dollar.... When we find loans made by national banks for $25, $50, $100, $200, $500, and $2,000 or more, at 40, 50, 100, or 1,000 per cent., it is merely a hideous gamble on how long the borrower can keep starvation from his door and live and work. Yet I am told on good authority that in one State, largely agricultural, reports from nearly 200 banks--lending chiefly or largely to farmers--show losses of only a fraction of 1 per cent. on farmers' loans, while the average interest rate in these particular banks is 12 per cent. to 15 per cent.--and the maximum rate 30 per cent. or 40 per cent., the banks paying large dividends.

We read much of the infernos of the slums of the great cities, of degradation and misery and squalor, of the grinding callousness of tenement landlords and sweatshop operators. Here in the country we find bankers, men in business that should be the most respectable, as it is the most responsible, of all secular avocations, literally crushing the faces of their neighbors, deliberately fastening their fangs in the very heart of poverty....

A well thought out, carefully constructed, conservative system of rural credits for the development of agriculture and the increase of our wealth and resources by offering encouragement and opportunity to the ambitious farmer will come presently. When it comes all of us will share the splendid results....

BANKERS' VIEW OF USURIOUS INTEREST RATES

[286]On February 25 the following statement was "given out" from the office of the Comptroller of the Currency:

The Comptroller of the Currency received to-day from the
Farmers' Grain Dealers' Association of Iowa notification of
the adoption at the convention of that association in Des
Moines, Iowa, on the 17th instant, of the following
resolution:

_Be It Resolved_, By the Farmers' Grain Dealers' Association
of Iowa, representing 40,000 members, as follows:

That we are as much opposed to bank discrimination in
interest rates as to railroad discrimination in freight
rates.

We oppose private control of the public currency.

That we strongly commend the Comptroller of the Currency for
his courageous exposure of bank usury; and we unalterably
oppose the efforts of the guilty parties to abolish his
office.

There has been no better statement of the Comptroller's position than is here given--credit standing and variations of it must have no influence on interest rates and anyone who wishes his office abolished is guilty of usury; or, conversely, only those guilty of usury wish the office abolished.

The statement is inadequate only in the failure to define what is meant by "private control of the public currency."

FOOTNOTES:

[249] Conway and Patterson, _The Operation of the New Bank Act_, pp. 1, 2. J. B. Lippincott Company, Philadelphia, 1914.

[250] John Skelton Williams, Comptroller of the Currency, _Democracy in Banking_, Address delivered before the annual convention of the North Carolina Bankers' Association, Raleigh, May 13, 1914. Printed in _Congressional Record_, 63d Congress, 2d Session, Vol. 51, pp. 10150-53.

[251] A. Piatt Andrew, _The Essential and the Unessential in Currency Legislation_, in Questions of Public Policy, Addresses delivered in the Page Lecture Series, 1913, before the Senior Class of the Sheffield Scientific School, Yale University, pp. 62-70. Yale University Press, New Haven, Connecticut, 1913.

[252] Adapted from John Perrin, _What is Wrong with Our Banking and Currency System?, The Journal of Political Economy_, Vol. 19, No. 10, December, 1911, pp. 856-865.

[253] Paul M. Warburg. _The Discount System in Europe_, Publications of the National Monetary Commission, Senate Document, No. 402, 61st Congress, 2nd Session, pp. 33, 34.

[254] Conway and Patterson, _The Operation of the New Bank Act_, pp. 203-207. J. B. Lippincott Company. Philadelphia. 1914.

[255] Fred Rogers Fairchild, _Bond-Secured Bank Notes and Elasticity_, _The Outlook_, Vol. 88, No. 11, March 14, 1908, pp. 590-93.

[256] [As was pointed out in an earlier chapter, the autumnal demand for currency in the agricultural sections of the country has fallen off appreciably since 1907.]

[257] Fred Rogers Fairchild. _Fundamental Defects of the Bond-Secured Bank Notes_, _Bankers Magazine_, Vol. LXXVI, No. 4, April, 1908, pp. 487-90.

[258] We are not considering the third alternative of issuing bonds at a heavy discount.

[259] Adapted from W. H. Lyon, _A Gamble in Governments_, _Moody's Magazine_, Vol. XI, No. 1, January, 1911, pp. 181-186.

[260] [In this extract the explanation of the so-called perverse elasticity of our national bank notes is given incidentally but very clearly.]

[261] Adapted from John Perrin, _What is Wrong with Our Banking and Currency System?_, _The Journal of Political Economy_, Vol. 19, No. 10 December, 1911, pp. 856-865.