CHAPTER X

THE MODERN FINANCIAL STRUCTURE

The great growth of credit operations which followed the development of large-scale business enterprise, particularly that organized on the corporate basis, has been attended by the development of an extensive and interdependent financial structure, designed to facilitate the raising of the funds required for capitalistic industry. The great number of financial instruments, agencies, and institutions that are utilized in connection with the borrowing operations of producing, manufacturing, and mercantile businesses is indicated in the diagrams on the accompanying pages. The diagrams are designed merely to enable the reader to visualize the financial mechanism as a whole and to afford a general view of the financial structure of society, with its complex interrelations, as a preliminary to the detailed study of the numerous particular institutions which will constitute the subject-matter of the succeeding chapters.

The diagrams, however, require a few words of explanation and qualification. In general, the purpose is to show the financial institutions and agencies that are employed in the assembling of the capital required by modern business enterprise. It is of note, first, that the financial structure involved in the raising of fixed capital for individual firms and partnerships, as shown on the first diagram, is relatively simple, since it is largely contributed by the owner, or owners, of the business. The greater complexity of the second diagram, moreover, is an indication that the development of the very intricate and extensive financial organization of the present day is largely attributable to the enormous growth of the corporate form of business organization.

1 For a diagram showing the financial structure that has been developed in connection with agricultural borrowing, see p. 650.

With reference to the corporation diagram, particularly, the arrows pointing downward from fixed capital indicate the movement of the securities that are issued by corporations through the financial institutions that assist in marketing them to the ultimate purchasers, who in the last analysis furnish the funds to the corporation. In some cases the securities do not find lodgment with individual investors but are purchased by financial institutions, as is indicated by the arrows which point to savings banks, insurance companies, etc. In these cases, however, the funds are still furnished by individual savers, namely, the shareholders, depositors, etc. These financial institutions thus serve as intermediaries in the process of rendering individual savings available for the uses of corporate industry.

The stock market has been placed at one side of the diagram in order to indicate that it is not a direct intermediary in the marketing of securities. It is rather a great central market place which is made use of by nearly all of the various types of financial institutions in connection with their operations, as well as by the ultimate investors in securities. All of these relations will be made clear in the chapter on the stock exchanges. The lines connecting the stock exchange with the different institutions are designed to indicate in a general way the interrelations that exist.

Finally, it will be seen that the commercial banks are directly concerned with the raising of working capital, and indirectly associated with investment banking institutions in the raising of fixed capital. Note the transverse line connecting commercial and investment banks. A line might also be drawn from the commercial banks to the fixed capital side of the corporation; for to a considerable extent they purchase securities directly and make loans to corporations for fixed capital purposes (see chap. xxi and pp. 487-88).

To safeguard against misconception it is necessary to state that the diagrams could not be made to reveal all the phases of the modern financial structure without complicating them to the point of obscurity. It will be well, therefore, to point out here certain things which they do not indicate.

First, although a line is drawn from the corporation direct to the purchaser of securities, the corporation chart fails to convey an adequate idea of the vast amount of capital that is raised without the assistance of financial intermediaries. A very great number of our corporations have raised their capital by direct subscription; indeed, I think it may safely be said that a large percentage of our present-day corporations secured their start by converting individual firms or partnerships into corporations and issuing shares of stock to the owners. There are many "close" corporations-those which have never raised any funds from general subscription. Among some of the more important of such corporations are: most of the great New England cotton mills; several of the larger chemical companies; the Du Pont Powder Company; many of the great department stores in all the large cities of the country; the large corporations in the aluminum, brass, zinc, asbestos, and sulphur industries; and the great majority of financial institutions. Perhaps the most conspicuous example of the close corporation in the United States at the present time is the Ford Motor Company. As a result of recent acquisitions, Mr. Ford and his son are said to be the sole proprietors of the largest privately owned business in the country.

Second, the charts do not reveal the raising of capital by the common process of creating a surplus through setting aside a portion of the earnings for an expansion of the business. A tremendous amount of capital is thus raised, especially by corporations. It will be noted that this method merely involves a decision of the directors of the corporation with reference to the disposition of earnings.

Third, the charts reveal only those credit operations which involve the borrowing of funds, as distinguished from actual goods. Working capital in part takes the form of materials bought on credit. A retailer, for instance, may do most of his borrowing by buying goods from wholesalers on time. But since the wholesalers, who sell these goods on credit to the retailer, usually borrow from the commercial banks during the