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Home -> Orville Marcellus Powers -> Commerce and Finance -> Chapter XXVIII

Commerce and Finance - Chapter XXVIII

1. Chapter I

2. Chapter II

3. Chapter III

4. Chapter IV

5. Chapter V

6. Chapter VI

7. Chapter VII

8. Chapter VIII

9. Chapter IX

10. Chapter X

11. Chapter XI

12. Chapter XII

13. Chapter XIII

14. Chapter XIV

15. Chapter XV

16. Chapter XVI

17. Chapter XVII

18. Chapter XVIII

19. Chapter XIX

20. Chapter XX

21. Chapter XXI

22. Chapter XXII

23. Chapter XXIII

24. Chapter XXIV

25. Chapter XXV

26. Chapter XXVI

27. Chapter XXVII

28. Chapter XXVIII

29. Chapter XXIX

30. Chapter XXX

31. Chapter XXXI

32. Chapter XXXII

33. Chapter XXXIII

34. Chapter XXXIV

35. Chapter XXXV

36. Chapter XXXVI

37. Chapter XXXVII

38. Chapter XXXVIII

39. Chapter XXXIX

40. Chapter XL

41. Chapter XLI

42. Chapter XLII

43. Chapter XLIII

44. Chapter XLIV

45. Chapter XLV

46. Chapter XLVI

47. Chapter XLVII

48. Chapter XLVIII

49. Chapter XLVIX

50. Chapter L

51. Chapter LI

52. Chapter LII




Business men must borrow money. With rare exceptions
every firm and corporation in the regular course of business
must at times resort to the money lender. Credit lies at the
foundation of our financial and commercial systems, and it is
prudent business policy to use credit within proper limits. When
a firm can earn more than the ruling rate of interest upon capital
employed, after safely making allowance for all expenses and
hazards, it may prudently use borrowed money as a part of its
working capital. Suppose a firm with $100,000 capital turns its
capital over six times a year and makes a net profit of 2J per
cent, each time. Its yearly profits then would be $15,000. If
now it can extend its business in the same proportion it can
afford to borrow, say $50,000 at 6 per cent, interest to increase
its working capital. Its profits would then amount to $22,500,
from which deduct $3,000 interest, and we have a net profit of
$19,500, or nearly 20 per cent, upon the capital of the firm.

The constant general tendency of prices of merchandise is
downward. Competition tends to reduce prices and lessen profits.
To offset these diminishing profits, firms aim to
Bom>wing f0r ^ a l ar g er volume of business and make the ex-
pense proportionately less. This requires greater
capital to introduce improved machinery, put more sales-
men on the road, or otherwise improve the facilities of the house,



and acts as an incentive to the firm to resort to the money

As a country grows older and the surplus earnings of the
people are carried over from year to year, there is an in-
creased amount of money seeking borrowers, and competition
of money against money tends to reduce the rate of interest, thus
enabling borrowers to meet the falling market prices of their
wares and yet pay the ruling rate of interest for borrowed
capital. The machinery for massing capital, such as the savings
banks which gather up the little rivulets of wealth,
Lenders trust companies, insurance companies and banks,

becomes more numerous and efficient and the
knowledge of the conditions of financial safety in business, such
as reports on the credit of firms and corporations, also becomes
more thorough and reliable, so that the whole process of borrow-
ing and lending in business is facilitated and made less hazardous.
To take advantage of these trade forces and use them properly
is the province of the financier.

The inexorable law of supply and demand obtains in the
money market the same as in other things. Money is. a com-
modity, and at times it is in greater demand than at others, the
same as other commodities. Supply and demand, as they affect
the money centers, affect the entire money market to a greater
or less degree. Thus a "tightness" of money in Wall Street,
or an unusual demand for money there, causes a rise in the rate
of interest, and money at once flows to New York, perhaps
causing a rise in the rate of interest through the
country. In the agricultural districts of the West,
when the great crops of corn and wheat must be
carried to market in the autumn, a large amount of money is
needed, and the banks aim to so time their loans as to have a
good supply on hand at that time. In the sugar and cotton
districts of the South the crops are ready for market in December
and January, and these make a profitable demand for money.


In the states where wool is extensively raised, the time of the
wool clip in the spring brings need for an increased volume of
money, and thus the law of demand and supply affects the money
market and regulates the rate of interest, the same as it affects
other commodities.

The largest borrowers of money are the great corporations
and syndicates which aim to secure in this way a portion of the
capital which they require at a low rate of interest and use it at
a profit to themselves. Instead of issuing commercial paper, as
in the case of firms, their borrowings are evidenced by bonds
secured by a mortgage upon the property of the company.
These bonds are sold to the public generally in large or small
quantities. A company earning six per cent, on its stock could
sell bonds to the amount of half its capital on a
basis of five per cent, interest, and thus on the same earn-
ings, pay seven per cent, dividends on its capital stock. This
is a legitimate proceeding and affords a gain which the officers
of any corporation may rightfully take advantage
corporations of. While the bonds of large corporations are sold
to the public generally, those of small corporations
seldom reach the public. Such companies borrow from
the banks chiefly, like firms and individuals, and owing to the
limited liability of the stockholders for the debts of the company,
the banks frequently require in addition to the obligation of the
corporation a personal guaranty from the officers. This gives the
bank a claim not only against the assets of the company in case
the loan is not paid, but also against the officers personally.

The precise limit up to which a corporation or firm may
properly borrow is hard to define. It is very close to that point
at which its paper floats at par drawing ordinary
interest. When a concern must sell its paper at a
heavy discount, it is evidence that it is over bor-
rowing. In order to hold its bonds at par companies sometimes
offer a higher rate of interest than the usual rate. But this is a


public confession of the weakness of the paper. Occasionally
a corporation will issue bonds bearing a low rate of interest and
sell them below par. This is questionable financiering, since the
face value of the bonds must be paid at maturity. Thus a
corporation desiring to raise $1,000,000 issues bonds bearing
4 per cent, and sells them at 80. In order to realize the amount
of cash needed, viz., $1,000,000, it must issue $1,250,000 of
bonds, and at maturity these must be paid. This is equivalent
to paying a bonus of $250,000 on the sale of its bonds. It is an.
example of that human tendency to postpone troubles, or re-
lieve the present by borrowing from the future. We may
therefore conclude that to issue bonds or other obligations at
too high a rate of interest, or sell them at a discount, is a viola-
tion of the rules of good financiering and indicates over borrow-
ing. With individuals or firms it may be said that a concern
should not, under ordinary conditions, borrow more than half its
net worth.

The great money lenders are, of course, the banks. Borrow-
ers are a necessity to a bank, and it will loan to responsible
borrowers to any reasonable and proper limit. Bank loans are
made chiefly by discounting paper for depositors. Notes and
acceptances running ninety days or less, given for the sale of
merchandise, and hence representing the value of goods or other
property bought or sold, is a desirable class of paper for discount.
The value is behind such paper, and it may be said to represent
the property. A customer of a bank need not hesitate to offer
for discount any paper of this class which is, in his opmion>
but on the other hand he should not be


Paper for offended if his banker refuses to discount the

paper, even without giving reasons. The banker
may be in possession of information concerning the other parties
to the paper which the holder is not, and yet cannot disclose that
information. Every customer of a bank who keeps an account
of any consequence is considered as entitled to a "line of dis-


count" in proportion to his usual balance in the bank and finan-
cial standing in general. The limit of this "line" is agreed upon
with the bank officials from time to time, and the customer sends
in for discount such notes and drafts as'he may have which he
regards as good up to the limit of his "line."

Banks aim to have diversified borrowers. By this is meant
those in various lines of business, whose needs come at different
times of the year. If the bank had all one class of borrowers
they would all want their money at the same time; also at that
time draw down their deposits, and the bank would find itself
without the necessary funds to advance. In order that the bank
may at all times be ready to meet the demands of its customers,
it aims to have a volume of money loaned to persons having
no "line of credit" and whom the bank can ask
Can Loans to retire their indebtedness on short notice. In
large cities some banks have from 25 to 50 per
cent, of their loans made to borrowers who do not deposit with
the bank, and to whom the bank is under no obligations to
extend the loan for any definite period of time. Such loans are
made to stock brokers, and are usually payable on demand.

If a business man borrows of a bank a sum of money on his
note, and gives as security a pledge in the form of other notes,
shares of stocks or bonds, such pledge is called "collateral." The
collateral does not become the property of the bank, and the
bank is responsible for its safe keeping and return to the owner.
Loans on collateral are usually evidenced by notes in which a
clause is inserted giving the bank the right, in case there is
default in the payment of the note, to sell the
collateral and apply the proceeds of such sale to
the liquidation of the note, the residue, if any, to
be returned to the owner or debtor. The trend of the times is
for banks to loan on collaterals and less on the individual notes of
borrowers, but there are cases where collaterals cannot be readily
furnished. The merchant has a stock of goods upon his shelves


but this cannot be placed in the vaults of banks, like stocks or
bonds. But merchants and others who borrow on individual
notes are required from time to time to furnish their banks
with statements of their financial condition, drawn from their
books. The experienced banker is not only able to read and
interpret this statement, but reads between the lines the future
of the business, and advances credit accordingly. In case interest
coupons attached to collaterals mature while in possession of the
bank the owner is usually allowed to collect or cash them.
Collaterals as security depend upon their character. The highest
quality of collaterals is United States bonds, and from this
their value descends to almost nothing. Banks aim to leave
a liberal margin below the market value of any collateral, so as to
realize the amount of their loan in case of forced sale. Many
classes of collaterals are shifting in value and of varying degrees
of security. The banks will exercise care to see that the party is
not borrowing too much, and that the bank is not getting a large
part of its assets tied up in one class of securities.

It is a good rule that all firms should be out of debt at least
once a year, and better, twice yearly; otherwise the banker,
through his loans, supplies in fact a part of the capital to the
concern, becoming a silent partner with no share in the profits,
and every chance to make a loss. This does not apply to stock
brokers, who borrow entirely on collaterals, and who use their
money to carry their customers. They are constantly in the
market for loans, which they secure for their patrons, enabling
Loans for tnem to ^7 and sell various stocks and bonds

speculative in which they expect to realize a profit. Oc-
Purposes casionally in New York, Chicago and other large

cities speculation runs very high, and many men having good
business become interested in the stock market, and unbeknown
to their bankers and friends carry stocks on a margin with
some broker, who is perchance borrowing the money for him at
the broker's bank. Such practices on the part of business men,


if discovered, will seriously injure their credit, and bankers are
ever on the alert to discover a customer who is speculating, and
to discountenance the operation.

When property is on its way to market with a certainty or
probability of early sale, it is a legitimate object on which banks
loan as collateral. In fact one of the chief functions of a bank
is to bridge over the period of time between production and
consumption. When merchandise is shipped for sale either in
the home or foreign market, bills of exchange are drawn upon the
consignee, and if accompanied by a specific pledge of the prop-
erty in the form of a bill of lading, are called
Documentary document ary bills." A very large part of the
grain, live stock and cotton of the country is car-
ried to market in this manner. The property is protected by
insurance in favor of "whom it may concern," and the bank, by
holding possession of the documents, holds title to the property
until the draft is paid.

Another form of collateral used extensively in business as
security for bank loans is warehouse receipts. Produce or other
property may be withheld from market for a better price, and
while being so held it is placed in a warehouse and the regular
form of warehouse receipt taken for it. This receipt then may be
used as collateral to a note for discount at bank.
-^ represents the property and carries constructive
possession of the property with it. No one can
withdraw the produce or other property from the warehouse
without showing the receipt properly endorsed. Loans on this
class of collaterals are not, however, regarded with much favor
by banks, since the time which the property is to be held in store
is indefinite, and the market value is uncertain, making the
loan indefinite as to time of payment, and the security liable to
fluctuation. Loans of this character are accommodation loans
and often have to be inconveniently prolonged.

Accommodation paper consists of notes or drafts made or


signed for the express purpose of securing a loan, and do not
represent a bona fide business transaction. Sometimes the ac-
commodation consists only of an endorsement upon a note or
draft created by the person who desires the accom-
niodation; it may consist of the acceptance of a
draft. But whatever form accommodation paper
may assume,, banks and money lenders do not regard it favorably.
It is not regarded as legitimate business paper like the draft or
note executed on the basis of a sale of goods. Accommodation
paper can be collected legally, for the law protects the bank or
any other innocent third party who takes the paper in the
ordinary course of business., without knowing its want of con-
sideration between the original parties, and the obligator to
such paper must pay. This protection of third parties to com-
mercial paper is a necessary safeguard to enable it to be readily
sold and transferred. Accommodation notes and accommodation
endorsements are not as common in this generation as in the
past. Many an old man plods along to-day, poor, but wiser for
his experience in endorsing paper for a friend, perhaps many
years ago. That one fatal act reduced him to penury, from which
he was never able to recover. Business men of to-day have
learned to conduct transactions upon safer and better methods,
perhaps owing to the experience and good advice of their fathers.
A class of dealers in commercial paper called note brokers
handle considerable paper of merchants and manufacturers, and
re-discount with the banks. The note broker is a convenience
to both the merchant and bank to the former by buying his
paper and thus furnishing him with funds which he may need
in his business to the bank by selling paper to it whereby it is
enabled to employ its capital profitably when there
Note Brokers is a lack of applications for discounts from its
regular customers. Merchants can afford to sell
their paper at 6 per cent, interest to a note broker, and discount
their own bills at 1 per cent, per month, or better. The question
arises at once, why does not the merchant sell his paper to his
bank directly, instead of selling it in the "street/' and will not
his banker grant the merchant all the credit he is really entitled
to, and discount all of the paper his capital and financial standing
will justify him in uttering? It may not. The bank may have
its funds loaned out up to the limit and be practically unable
to buy the merchant's paper, even if desirable, while some other
bank might be short of good paper. The note broker, as a sort
of go-between, can sell the paper wherever there is a demand for
it. He may sell it in another town or city where there is a sur-
plus of deposits and a dearth of loans. In some localities the
banking capital is much larger than can be profitably employed
in the immediate vicinity, and consequently those banks invest
large sums through note brokers.

Then again a bank may contract its loans at any time by
selling notes previously purchased from a note broker. Such
notes are usually made payable to the order of the firm or indi-
vidual signing them and then endorsed in blank. To sell this
paper does not require the bank's endorsement, and it can be
sold again through the same class of brokers as purchased from.
When a bank makes a loan to one of its depositors, the note is
usually made payable to the order of the bank, and it is not
customary, except in cases of great need on the part of the bank,
to have this paper go out of its possession. Business men who
borrow of a bank do not ordinarily wish the bank to let the
paper go out of its possession.

The making and selling of one's paper in the market, outside
of one's bank, and free from the wholesome restraint which a
bank exercises upon the inclination of a class of depositors to
borrow beyond their proper limit, is a method of business which
is fraught with danger and liable to abuses. In
prosperous times it is apt to lead to over trading
or to speculation. Funds obtained in this way can
be used for any purpose, and are often applied to other uses
than the discounting of merchandise bills.


As a rule note brokers merely transfer the paper without
guaranteeing its payment by endorsement. While the broker is
not legally liable in case the maker fails to pay, yet his business
success depends upon the manner in which the notes are paid,
and he is, therefore, exceedingly anxious that they should be
paid promptly at maturity. He is considered a guarantor that
Responsibility ^ e notes are ^ right in every respect, except as
of the to whether they will be paid or not, and of that the

bank or buyer is presumed to be equally capable
of judging. The note broker must make no misrepresentations
in order to sell his paper. His dealings with the buyer of his
paper require the utmost good faith on his part. He sends a
printed list containing a description of perhaps a hundred notes
to the bank. Each note is numbered and if the bank wishes to
see any of the paper, it is sent upon application. Or a broker
or an agent for him may visit a bank personally and exhibit a list
of the notes and acceptances which he wishes to negotiate.

Loans on real estate security are considered a desirable class,
where the intention is to put out the money for a long time.
The lender usually does not aim to loan a larger amount than
one-half or two-thirds the value of the property, leaving a good
margin as an inducement to the debtor to repay the loan, rather
than default. Loans on real estate are evidenced by a special
form of note, and secured by either a mortgage or trust deed.
A mortgage is a conveyance of the property to the creditor with
the condition that if the debt is paid the conveyance becomes
void. It is similar in many respects to a deed,
w ^h a conditional clause. A trust deed is a con-
veyance of the property to some third party called
a trustee in trust as security for the debt. When the debt is paid,
the trustee executes a release of the conveyance; that is, deeds
the property back to the owner. Before loaning money on real
estate security, the lender must satisfy himself not only as to the
value of the property and its desirability as security for the pro-


posed loan, but he should have the title examined by a competent
attorney. An abstract of title containing a history of the con-
veyances through which the title has passed will be furnished
by an abstract company.* Having found the title clear and
satisfactory and no judgment against the mortgagor, the mort-
gage or trust deed may be executed and the loan made, but no
time must be lost in getting the mortgage on record in the office
of the recorder of deeds of the county where the property is
situated. t The object of recording is to give notice of the ex-
istence of the mortgage to any one who might wish to purchase
the property or take a mortgage upon it. There may be several
mortgages on the same property, the first being entitled to prior-
ity of payment, then the second, and so on. In case the debt is
not paid at maturity the holder of the mortgage has a right to
foreclose and have the property sold at judicial sale, the residue,
if any, after paying the debt, interest and costs, to be returned
to the mortgagor. After sale, the mortgagor has a period in
which he is allowed to redeem the property (usually about fifteen
months) by paying up the debt and all costs, etc., but failing in
this the sale becomes absolute. As to the special provisions of
the law in regard to mortgages or trust deeds, their foreclosure,
etc., the statutes of the state should be consulted. In case
the security for a loan consists of both land and buildings it is
usual for the mortgagor to have the latter insured for the benefit
of the mortgagee.

*We now have title guaranty companies who guarantee or Insure the
mortgagee against loss by any defect of title in the property. They are a
species of insurance company, and their guaranty policies are extensively

tThe best method is to execute the mortgage or trust deed and place it
upon record before the abstract of title is brought down to date. Then when
the abstract is continued it will contain the mortgage or trust deed and
show the continuity of title up to the moment of the loan.

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