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

Commerce and Finance - Chapter XXXIV

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



A bond is an obligation or promise to pay money, which
differs from a promissory note in that it is given under seal, the
effect of which addition is, under the common law, that if default
is made and payment has to be enforced by suit, the maker
cannot plead want of consideration.

When a government desires to borrow money the customary

method of obtaining it is to print and offer its bonds for sale.

These are issued in convenient denominations. In this country

the most common denominations are $500 and

Bonds 01 " 6 " 1 $1,000, but sometimes, if the issue is what is called

a popular one, designed for sale among people of

small means, a portion of the issue is made in denominations of

$100, or even less in some instances.

In fixing the rate of interest which the bonds shall bear, the
government should, and usually does, take into consideration the
condition of the loan market (commonly designated as the money
market), and the state of its own credit, and makes the rate the
lowest one at which it can reasonably expect to sell the bonds at
par. If sold below par, the government will pay, and the in-
vestor will receive, more than the rate of interest named in the
bond. The reverse is true if more than par is realized for the
bonds. In general the nearer the selling price can be approxi-
mated to par the more favorable will it be for the maker, in the
long run. Although it is not possible for the government to tell
what price the bonds will bring until they are placed upon the


820 BONDS.

market and offered for sale, it is usually possible to gauge this
nearly enough for practical purposes. Still, to guard against
the contingency of unfavorable bids, it is usual to reserve the
right to reject any and all that may be submitted, and if all are
rejected, to make a new offering at a later date, with such changes
as seem likely to yield a better result.

The length of time the bonds are to run is also fixed by the
government, a-nd is a factor in the price they will bring in the
market. This is because investors prefer bonds having compara-
tively long terms to run, which relieve them from the necessity
of reinvesting at short intervals. Not infrequently bonds contain
a clause giving the maker the option to call them in and pay
them at any time after a specified date. This, while it enables the
maker to retire them and stop the interest, usually causes them
to sell at a lower price than if they ran for a fixed period, or, in
other words, the maker, in consideration of the option of pre-
payment, has to pay a higher rate of interest for that privilege.

As a rule, government bonds are not secured, but depend
wholly upon the credit and stability of the nation by which
they are issued. In the case of some of the weaker nations, as
for instance Spain and China, some issues have been secured by
a specific pledge of the revenue arising from certain customs
duties. This, however, is the exception and not the rule in the
case of government bonds. At different times the United States
government has issued bonds to relieve the needs of its treas-
ury. Those issued during the Civil War bore six per cent., but
the credit of the country is now so exceptionally high that it is
able to float its bonds at the very low rate of two per cent., and
its later issues have been at that rate.

Refunding consists in putting out a new issue of bonds to
replace an old one, which may either have matured
Refunding or which may be called for payment (the option

having been reserved) in order to gain the ad-
vantage of a lower rate of interest. Consolidated bonds or


"consols" are those issued to refund several other issues, com-
bining all into one.

Coupon bonds are those which are made payable to bearer
and the interest on which is evidenced by detachable coupons,
coupon and These coupons are torn off as they fall due, and
Registered are usually collected through some bank. Regis-

tered bonds are so called because the name of the
owner is registered upon the books of the treasury department
of the government issuing them. Sometimes the principal only
is registered and the interest is evidenced by coupons, as in the
case of bonds payable to bearer. This is the common practice
in the case of bonds issued by private corporations. With gov-
ernment bonds it is usual for the interest to be paid by
check mailed to the owner's address. The advantage of regis-
tration is that bonds of this kind, if lost or stolen, are of no
value to the finder or the thief, and hence are very secure.

In the United States the term government bonds, or "gov-
ernments," as they are called, is limited to bonds issued by
the general government. State bonds 1 , or bonds issued
by the governments of the several states, are, however,
also government bonds, and differ in no essential respect
from those of the national government, except as to their
legal basis. They rest on the credit of a part of the people in-
state and stea d of all the people taken together. This is
Municipal true also of municipal bonds, as those are called
which are issued by counties, cities, towns, school
districts, sanitary districts, or other public corporations. They
are usually put forth for the purpose of raising funds for local
improvements, such as the erection of public buildings, the
building of bridges, or of water works, or of electric lighting
plants. In many of the states municipal governments cannot
issue bonds lawfully in excess of a certain percentage upon the
assessed valuation of taxable property in the municipality, and
not then unless authorized by a majority vote of the people.

322 BONDS.

A generation ago it was common, more especially in the
middle west, for municipalities to issue bonds to aid in the con-
struction of railroads. The burden of the debts thus contracted
bore heavily upon the people in many instances, and suits were
brought by the taxpayers to test their validity. As a result of a
decision of the Supreme Court of the United States that these
bonds must be paid, several of the States passed amendments
to their constitutions prohibiting towns or cities from voting
bond issues in aid of railroads.

"Voluntary contributions may be obtained from the citizens,
but municipal bonds bonds that must be paid by the city or
county can no longer be issued in those states," for aid to
railroads. Cook.

Bonds issued by private corporations differ from those pre-
viously mentioned, chiefly in that they are as a rule secured by
mortgage on the property of the company issuing them. First
Bonds of mortgage bonds are those which are a first lien

Private against the property pledged for their payment,

corporations g ec0 nd and third mortgage bonds arc similarly
secured by second and third liens. In case of foreclosure the
first mortgage bonds must first be satisfied from the sale of
the pledged property. Then if there is a surplus the second
mortgage bonds can be paid, in full or in part, as the case may
be, and so on.

Income bonds are a peculiar class of obligations. They are
usually secured by mortgage upon the property of the corpora-
tion, but they bear interest only in the event that the net earn-
ings of the company, after satisfying prior liens, are sufficient
to pay it. Unlike ordinary mortgage bonds, they
income Bonds cannot be foreclosed for failure to pay interest
unless the net earnings applicable thereto should
be willfully diverted and applied to other purposes. Interest on
bonds of this class must, however, be paid out of the earnings
before any distribution of profits in the way of dividends can
be made to the stockholders of the company.


Mortgage bonds may be secured upon lands, buildings, manu-
facturing plants, telephone and telegraph systems, street car
lines, franchises, toll roads, bridges, railroad rights of way and
equipment in short, upon tangible property of all
Bond" tyfo kinds. Sometimes the bonds are designated ac-
cording to the nature of the security, as for ex-
ample, termina/1 bonds, which are bonds issued by railroad com-
panies upon the security of the valuable lands used for stations
and office buildings and for switch and storage yards, etc., in
the cities where their lines terminate.

Collateral trust bonds are bonds issued by a corporation and
secured by bonds or other securities owned by it and deposited
with a trust company, or, it may be, in the hands of individual
trustees, though the former is more usual. This form of bond
is sometimes resorted to by corporations owning bonds of other
corporations, which they do not wish to sell, or which they may
not be able to market without their guaranty. It is most fre-
quently used by corporations that make real estate mortgage
loans, which they pledge as security for their own bonds bear-
ing a lower rate of interest.

Debentures are unsecured bonds, and are a comparatively rare
form of obligation for private corporations, owing to the diffi-
culty of placing them on favorable terms.

Of many methods adopted to float a bond issue, the most
usual is to enlist the services of one or more of the banking
houses, trust companies, investment companies or firms making
a specialty of dealing in such securities. In the case of a
private corporation the officers are required to
isue make a ful1 and explicit statement of its affairs,
its assets and liabilities, its earnings past, present
and prospective, the amount of the proposed bond issue, an
exact description of the property to be covered by the mort-
gage, and any other facts which may be relevant or which the
dealers may require. If the showing appears favorable the appli-

824 BONDS.

cant is informed that if upon thorough investigation the facts
prove to be as stated and everything is found satisfactory the
bonds will be negotiated. The bond dealers then detail their
own representatives or agents to make the investigation, which
is made in the most thorough and careful manner, and includes
a searching inquiry into the character and standing of the offi-
cers and directors of the company making the application, its
credit and business connections. Even when these are well
known it is usual to revise previous information and make sure
that it is in all respects up to date. The expense of the investiga-
tion falls upon the applicant, which may be required to make a
deposit in advance, of a sum estimated as sufficient to meet the
cost. Appraisers are employed to estimate the value of the
property, and expert accountants are set to work to examine the
company's books. In short, every available means is used to as-
certain its true condition. The dealers also employ special counsel
to report upon the legal status of the applicant, whether it is
conducting its business clearly within the limits of its charter,
whether it holds indefeasible title to its property, etc., and to
see that all the formalities required by law are complied with
when the bonds are issued. The result of all these investigations
being found satisfactory, the next step is the execution of the
mortgage, which is usually made in the form of a deed of trust to
some trust company. Then the bonds are issued and may be
offered for sale. Sometimes the dealers sell them on commission,
and sometimes they buy them outright. In the latter case, if
the issue is a large one, they may form a syndicate, or special
partnership arrangement by which several dealers contribute the
necessary capital and share in the profits of the transaction.
Individual purchasers of bonds run less risk in buying those that
are thus placed on the market by some house of established
reputation, because as the company or firm that finances the
issue usually invests its own or borrowed capital in the bonds
until they can be sold, they can rely upon all the precautions


mentioned having been taken by the dealers for their own pro-

It is customary to include in the deed of trust securing a
bond issue a clause providing that if the interest is not paid
promptly as it matures, the entire amount of principal and inter-
est may, at the option of the bondholders, after default has
continued for a certain number of days, "become immediately
due and payable." To prevent one or two holders of small lots
of bonds exercising such option in derogation of the interest of
the holders of a majority of the issue, holders of some specified
proportion of the issue are usually required, under the provisions
of the trust deed, to unite in requesting the trustee to institute

foreclosure proceedings before such action is be-
Foreciosure gun. Foreclosure having been decided upon, the

trust company files a bill in the proper court, al-
leging the default and praying that it be allowed to sell the
pledged property in satisfaction of the debt. In the majority of
cases the bondholders file a bill at the same time, asking that a
receiver be appointed to take charge of the affairs of the company
and conserve its assets for the benefit of all concerned. Not in-
frequently such action is taken by the stockholders before the
bondholders have had time to act. If there is opposition, the
court as a rule refers the case to a master in chancery, who, as
an officer of the court, takes testimony and makes a report to
the court, whereupon, if the report sustains the allegations in the
bill, a receiver is appointed.

The receiver is also an officer of the court and makes reports
thereto as often as may be required. Should the foreclosure
proceed to a sale and all of the property of the company be
swept away his functions thereupon cease. It often happens,
however, in the case of railroads or other large corporations,
that the bondholders do not wish to bid in the property at the
sale and assume the conduct of the business, nor do they wish
to run the risk that no other bid will be sufficient to pay the

826 BONDS.

debt. And it may also be the case that holdings of bonds and
stocks are such that the interests of the respective owners are
complicated. Furthermore it may appear possi-
Reorganization ble to conserve the interest of all concerned, stock-
holders as well as bondholders, by postponing
the foreclosure sale, which lies within the discretion of the bond-
holders, and endeavoring to effect a reorganization of the com-
pany upon a basis which will enable it to continue its business
and give both the bondholders and the stockholders new and
marketable securities in place of those previously held.

Reorganizations are customarily effected through the medium
of committees composed of bankers or others skilled in finance,
who represent the various interests and endeavor to formulate a
plan which shall be acceptable to all. The first task of a reor-
ganization committee is to get authority from the bondholders and
stockholders to represent them, which is no small undertaking
in the case of a corporation the bonds and stocks of which are
widely scattered, in Europe it may be as well as in this country.

Although the procedure is called reorganization, the cus-
tomary method is to form a new company which bids in the
property of the old organization at the foreclosure sale; and then
issues its own bonds and stocks against the same and such new
capital as may have been provided. In this way the interest of
stockholders and bondholders who do not participate in the reor-
ganization is eliminated. Non-participating bondholders get only
such percentage of the proceeds of the sale as their bonds bear to
the total issue, and as there are very likely no other bidders aside
from the reorganized company it is usually enabled to make a
low bid. Non-participating stockholders of course get nothing.
Sometimes, however, when circumstances appear to justify it,
and their holdings are small, non-participants are permitted to
join the new organization after the sale on payment of a sum
exacted as a "penalty."

Many reorganizations of American railroads are the conse-


quence of the vicious system of financing employed at the time
they were constructed. Too often the bond issue was made
large enough to pay the entire cost of construction and equip-
ment and also a handsome profit, for the promoters, the stock
being either retained by the promoters or given as a bonus to
help the sale of the bonds which could not otherwise be mar-
keted. If the road could be made to earn the interest on the
excessive issue, well and good; if not, then disaster must follow,
sooner or later.

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