can be more certainly retained by participation in its financing. Finally, some part of a bank's securities represent the foreclosure of hypothecated securities, acquired by the institution for its own ultimate protection.

But these instances explain only a fractional part of the aggregate holdings and do not touch the essential consideration, which is, that a bank buys securities because it can find no other profitable investment during recurring periods when business is quiescent for such of its surplus funds as it would otherwise employ in its regular channels.

When reserves become congested and the local demand for money is exhausted, neither the call money market in New York nor the masked rediscount of country bank paper nor the availability through brokerage houses of the promissory paper of a limited number of widely known mercantile and industrial establishments will absorb the excess, and recourse is had to the bond market.

From whatever point of view regarded, this apparent necessity under which American banks now labor of tying up large parts of their loanable funds in stock-exchange securities is unfortunate.' It offers an unhealthy stimulus to corporate financiering by supplying a temporary and fictitious market for investment securities. It invites speculative gains and losses by the fluctuation in market price in the interval between purchase and liquidation. It curtails mercantile accommodation by the bank's reluctance to liquidate such securities in a declining market, and it injects an additional element of risk into banking stability in the temptation to invest in less seasoned and more productive bonds.

4. The modern stockbroker is engaged in two kinds of activity— the purchase and sale of investment securities and the conduct of speculative operations for principals or in personal behalf. Ordinarily both classes of business are conducted by the same house, but there are many bond houses who do not invite speculative accounts and, on the other hand, many commission houses figure inappreciably in the investment market.

In so far as the activities of the stockbroker relate to the purchase and outright sale of investment securities, he is a dealer in merchandise. Accordingly, his vaults, like the shelves of the merchant or the warehouse of the manufacturer, are at all times stocked with investment wares awaiting the demands of his investing clientèle.

This was written, of course, before the passage of the Federal Reserve Act.EDITOR.

In addition to undistributed syndicate holdings, the ordinary bond house is the owner, by actual purchase and payment, of blocks of securities acquired for purposes of sale at profit, and the actual distribution of which is pressed with all the energy and skill of commercial vending.

Advances of credit upon the unsold part of this stock in trade are sought from the banks in supplement of the broker's own working capital. The relation of the stockbroker to the banks is, in this particular, like that of any other business man. Restriction of credit on such security would find an exact parallel in the case of a merchant denied credit upon unsold wares or a manufacturer upon undistributed produce.

This service is rendered with reasonable adequacy by our present banking system. Bond houses suffer something in common with all mercantile enterprise from the inelasticity of bank credits in periods of economic expansion, but the treatment accorded is often preferential and the discomfort on the whole less acute.

5. Speculative purchases of stock-exchange securities have resulted from the accumulation of funds in central reserve cities, notably New York, through the practice under the National Banking laws of redepositing reserves and of habitually allowing 2 per cent interest upon country bank deposits subject to call.

It is not possible for the New York banks to employ all such deposits in mercantile loans and discounts, even were it sound banking to lend call money on time loans. The only method of profitable use is demand loans, and the only large market is offered by speculative operators on the stock and produce exchanges.1

We have here all the conditions favorable to artificial stimulation of stock-exchange speculation. At periods of seasonal dulness, and, even more, at times of business reaction, the irresistible lure of payment for idle money attracts the surplus funds of the interior banks to New York, there to be pressed upon the call money market for what it will bring, and, finding regular employment only in stockexchange operations, to encourage speculative commitments at the very time when quiescence is in order. As there is unwholesome stimulation, so there is sudden and wasteful liquidation. When reviving business leads the interior banks to reduce their New York balances, the depositary banks meet the strain by calling loans, with

I For the method by which such loans are made see selection No. 39.

the result that the speculative movement for the rise is reversed and a repressive influence cast upon general business,

It is certain that a measure of stock-exchange speculation would persist even if the resources of the New York banks were alone available for financing it, but the extent of such accommodation, even when supplemented by the demand loans made available by individual capitalists, would be limited and the cost of securing it would be greater. Individual speculation would be less in amount and narrower in distribution. Most of all, the periods of speculation, in so far as determined by the cheapness of money, would vary logically with the movement of general business, instead of, as at present, running in vicious opposition thereto.

217. INVESTMENT LOANS OF COMMERCIAL BANKS1

By C. W. BARRON

The best estimates that we can get privately of bankers is that the real commercial loans in the national banks do not exceed three billions, or one-half the loan account.

While the paper appears in the form of commercial loans, a considerable part is for fixed forms of property and for as distinctively industrial expansion as are stocks and bonds. And why should it not be?

A merchant with sufficient capital to do his own banking may have several hundred thousand dollars cash in the bank, owe no money, and have a million dollars in accounts on his books, or notes in his box representing commercial loans due him. His business expands and he desires to put a half-million or a million into a new factory. Will he issue stocks or bonds or make any permanent borrowing for this? Certainly not. He notifies the bank he will want a half-million or more money covering certain months. The bank's response is, of course, that he can have all the money he wants and give any kind of a note on time or demand. His cash balance is worthy of his credit. His borrowing is, therefore, not necessary commercial borrowing, but commercial borrowing is forced by his construction.

The state banks and trust companies carry far less commercial paper than the national banks. On page 51 of the Report of the Comptroller of the Currency for 1913' will be found a record of not only the

'Adapted from The Federal Reserve Act, pp. 68-73. (Boston News Publishing Co., 1914.)

7,473 national banks but of 18,520 state banks, trust companies, private bankers, and savings banks in respect to the character of their loans. Out of a total of $14,600,000,000 loans based largely on demand deposits, $3,500,000,000 are secured by real estate and mortgages, and $4,500,000,000 by other collateral, and $8,000,000,000 on fixed forms of property. The "other loans" are $6,500,000,000, including, of course, the so-called $3,000,000,000 commercial loans in the national banks as noted above. Of these the real commercial loans are somewhere between three billions and six billions. Private estimates of bankers with far better knowledge of the real situation than is possessed by the government officials vary all the way between these two figures.

We have for some time estimated that the real commercial loans for the transactions of commerce in this country do not exceed five billions and that between nine and ten millions of bank loans are on fixed forms of property.

This represents property in process of digestion by investors. When the amount is large, or the investment fund is light, it is termed overinvestment or indigestion of securities. Nearly two-thirds of our bank loans represent constructive industry, stocks, bonds, and fixed forms of property in process of digestion, and only one-third represent commercial transactions.1

218. THE MISUSE OF COMMERCIAL BANK FUNDS2

By H. M. GEIGER

We have all been too busy to keep books accurately on a big scale. Consequently no one can tell us exactly what proportion of our assets represents permanent investment; what percentage we use for development and construction, or what sum is absolutely necessary to carry on the rapid-fire exchanges of industry and commerce.

Roughly, we know that certain sums are deposited in savings banks, trust companies, and in the savings departments or time certificates of deposit of national banks. With some degree of approximation we can guess that these funds are available for more or less permanent investment in stocks, bonds, investment notes, or other securities which will not be paid in full until a long period of time has

2

See selections Nos. 32 and 37.-EDITOR.

Adapted from a pamphlet entitled Financial Readjustments (1915), pp. 2–5. (Copyright by the author.)

elapsed. But we have no exact account of our "commercial" and our "investment" funds in general.

Even without this information, however, the daily practice of business constitutes sufficient proof in itself that the combined total of all "investment funds" as represented by the resources of savings, trust, and insurance companies, private investors and investment banks, are not sufficient to meet the demands created by our industrial expansion. The extraordinary expansion of civilization in America during the past century has made use of every penny of available capital, has borrowed five or six billions from Europe, and has still been driven to make merciless inroads on what we should have been taught to respect as our "commercial" fund. This is not a cause for sorrow or of worry. The money has been well used. Our fathers found a wilderness. Since then the wilderness has not only been reduced to a fairly well cultivated area of farms, cities, mines, and factories, but the nation as a whole has kept pace with the unprecedented commercial and industrial progress of the older civilizations of Europe, which had all the fundamentals of their culture built and paid for when we were surveying roads through forests and following Indian trails across the Western plains.

Our one error was in mistaking the proper functions of our commercial banks.

Stated bluntly, a majority of the resources of national banks are tied up in loans of a more or less permanent character. Truly, the notes are usually made for periods of four or six months, but it is the understanding between the banker and the borrower in many instances that these notes shall be renewed indefinitely, provided certain periodical reductions are made and the interest discounted in advance. Moreover, the country is filled with manufacturers who expect bankers not only to finance their temporary needs, but who have also built their plants on capital borrowed and reborrowed, again and again, from banks.

This practice has been one of the most prolific causes of industrial failures in the United States. Dun's and Bradstreet's reports for many years show that 90 per cent of all failures are due to lack of capital. In very many instances excellent enterprises were undertaken at periods when it was easy to secure loans from banks, only to fail in the midst of their development because some contingency forced the bank to withdraw its support and demand the payment of its loans.