The Stock Exchange from Within. William C. Van Antwerp
to absorb all the bank’s loanable credit, with an inflow of cash from maturing bills equal to the outgo of new ones, there would be no occasion for bankers to look elsewhere to keep their funds mobile—and the critic would be out of work.42 But this does not often happen, because the bank’s loanable funds normally exceed the amount of acceptable paper, and at such times the banker makes advances on goods or securities, and, if goods and securities are not pressing for loans, he will place his funds elsewhere, where a demand exists. But securities for which there is always a ready market are such thoroughly good collateral for loans that bankers are glad to get them.
The stockbroker is, in a way, a dealer in merchandise. Whether he buys for investment or for speculation—and remember that the boundary line between investment and speculation is often shadowy and indistinct—he pays cash for everything he buys. He then seeks advances of credit upon his wares just as the merchant does, supplementing his own capital and the deposits (margins) of his customers with call or time money from the banks. To deny him these facilities is exactly the same as to deny credit to a merchant; both are doing a perfectly legal business, and both contribute to the economic welfare of the community.
The popular idea is that loanable funds thus borrowed by Stock Exchange houses constitute a diversion of money from the merchants who need it. Not so. Even if the banks were disposed to use all their loanable funds in mercantile loans and discounts they could not do so, because a part of these funds may be called for at any time, and it is not good banking to lend too large a proportion of call money on time. The merchant wants 30, 60, and 90 day money, and he wants it at a rate not to exceed 6 per cent.; the stockbroker is compelled by the nature of his business to borrow a large part of his money on call, and he pays whatever the banks choose to charge for it. Incidentally it may be said that no usury law is violated, even if 100 per cent. is charged, because the New York law legalizes any rate of interest on call loans of $5000 and upward, secured by collateral.43
As a matter of fact, far from being put at a disadvantage by the banking methods that provide call loans to Stock Exchange houses, the merchant or manufacturer enjoys banking facilities which the Stock Exchange may never hope to enjoy. The merchant is able to secure banking accommodations upon his personal credit, that is, by discounting his own promissory notes or single-name paper unsecured by pledge of collateral. But the stockbroker, however ample his resources and his credit, can only obtain loans upon collateral securities. Any attempt to resort to his personal credit or his personal paper would be construed as a confession of weakness, and his good name at the banks would suffer accordingly.
Persons who conjure nightmares over the practice of the banks in loaning surplus funds to stockbrokers are deceiving themselves. Instead of losing by this system, every merchant and manufacturer in the land profits by it in greater or less degree. The stockbroker deals in the bonds and shares of great railway and industrial companies, which, in order to succeed, must be able to sell their certificates to the public and so raise the money necessary to provide the extensions and new construction that are constantly demanded by the public. If fresh capital could not be enlisted in this way, additions and improvements would cease. The merchant who requires the railroads to ship his goods, and the manufacturer whose demands for new side-tracks, cars, and other equipment are unceasing, are therefore directly interested in the maintenance of a broad and stable speculative market for securities at all times, because in that way only are funds to be raised for the requirements of trade and industry. There would have been no railroads in this country had there not been speculators to build them, nor could the money have been raised had there not been other speculators to buy the shares with the aid of the banks.
Prevent the banks from lending money to facilitate stock-market operations and business ceases; interfere with it or hamper it and confidence is impaired, and when these things happen the industrial system collapses in terror. Such has been the experience of modern times. Until a system is devised whereby large undertakings may enlist public support in other ways than by offering securities in our great Exchanges and by maintaining a market for them there, it is useless to talk of interfering with that necessary relationship which exists between the banks and the stock market. On the one hand we have the cobwebs and windy sophistries of politicians and doctrinaires; on the other hand the test of proved effectiveness in the conduct of business. And the country’s business cannot stop; it must go ahead.
In the last six years more than a billion shares of stock have changed hands on the New York Stock Exchange, together with bonds of a market valuation exceeding five billions of dollars, and, under the rules, each purchase made was paid for in full by 2:15 P.M. of the day following the transaction. If all these purchases had been made for cash—i.e., if every customer of every brokerage house paid in full for his purchases, there would be no use for bank loans to brokers; there would be no speculation, and hence no progress. Securities purchased in the six-year period quoted were, in the majority of instances, bought on margin, that is, they were only partially paid for by the purchasers, the balance required being furnished by the broker from his capital and by the banks from their loanable funds.
There is a popular fallacy as to the amount of actual cash required to finance these enormous Stock Exchange transactions; persons who are not well informed often entertain the impression that it is much larger than it really is. As a matter of fact considerably more than 90 per cent. of the business of the banks is done through the Clearing House, an institution designed, as every one knows, to minimize the transfer of actual cash and to simplify the payment of balances. If these clearings seem large—they are, in fact, twice as large in New York as in all the other cities of the Union added together—it is not alone because more speculation in securities takes place in New York, but because this happens to be the centre where many other cities balance their claims against each other.
Furthermore, when critics who do not understand the subject look askance at the volume of loans of the New York banks, they must remember that the lending power of such institutions is always four times greater than the supply of money in its vaults. The reserve of 25 per cent. which the banks are required to maintain means that every million dollars of actual cash added to their funds renders possible an expansion of four million in loans, and every withdrawal of funds involves a proportionate reduction of these loans. These matters are self-evident. The point to bear in mind is that through this expansion and contraction of loans stock-market operations are increased or diminished by almost automatic processes. “Money talks” is an old aphorism. In this case it is not money that talks, but credit, and the credit extended to stockbrokers by the banks is always wisely regulated to meet conditions as they arise.
The customer of a brokerage house buys, let us say, 1000 shares of St. Paul at 120, on which he deposits a partial payment or margin of $15,000. The bank will loan to the broker 80 per cent. of the market value of the stock, or $96,000, which, added to the $15,000 deposited by the customer, leaves $9000 which the broker supplies from his firm’s capital. The broker gives to the bank, with the securities, a note on one of the bank’s printed forms, which gives the bank absolute authority to sell the collateral whenever the margin shall have declined to less than 20 per cent. This note is so sweeping in its terms, and gives the bank such complete power, that a reproduction of it, in small type, would fill two pages of this book.
It empowers the bank to sell as it pleases—if the broker fails to pay the loan on demand, or to keep the margin at 20 per cent.—all the securities in the loan; it authorizes the bank to seize any deposit the broker may have in the institution; the bank may itself purchase all or any part of the securities thus sold, and all right of redemption by the broker is waived and released. This instrument would seem, per se, a pretty strong hold on the broker, but the bank’s security does not end there. In making the loan the bank knows that the borrower is a member of the New York Stock Exchange, and that presupposes capital, with at least one Stock Exchange membership, worth to-day about $60,000. It knows, too, that a fundamental rule of all Stock Exchange brokers is to protect the bank at all hazards, not merely because the personal honor of the broker is involved, but because the business could not be conducted otherwise.
It is apparent from a consideration of all these elaborate precautions that the lending of funds to stockbrokers is a safe business, indeed in all the criticism directed against Wall Street methods I have not yet heard it questioned. The department of the bank entrusted with such matters watches