Banking Part 7

In details these laws differ widely from one another, but they are alike in that they impose upon some branch of the state government the obligation of supervising both companies which issue securities and those which offer securities for sale. The Kansas law, the first of this kind pa.s.sed in the United States, has been considered too drastic by most of the companies that have attempted to operate under it, but the Wisconsin law, which went into effect October 1, 1913, is looked upon with more favor.

In formulating these and other laws for the proper regulation of these concerns, it has been found difficult to provide adequate protection to the investing public without unduly hampering the issue and negotiation of securities, but this difficulty should, and in time doubtless will, be overcome. A free and open market for bonds, stocks, and other evidences of indebtedness is essential to freedom of enterprise and mobility of capital, which are in turn essential to the economic prosperity of any country. On the other hand, investors undoubtedly need and deserve the protection of the state against misrepresentation and fraud. It is practically impossible for them in many, perhaps in most, cases to obtain the information necessary for self-protection. The matters and conditions to be dealt with in such legislation are so complex and subject to such frequent change that laws are apt to be imperfect, inefficient, or obstructive. It seems probable that those which do not attempt to be specific and detailed, but give wide powers and discretion to administrative boards or commissions, are most likely to be successful.

_4. Land Banks_

In Europe an important group of inst.i.tutions has developed for the supplying of agriculture and the building industries with the capital needed in their operations. The greatest number and variety of these are in Germany, in which their development has been continuous since the days of Frederick the Great.

In order to a.s.sist in the recuperation of his kingdom from the devastation caused by the Seven Years' War, Frederick caused the land owners of certain provinces to be organized into a.s.sociations called Landschaften, which were authorized to issue mortgage bonds on the joint security of the lands of all the members of the a.s.sociation in exchange for mortgages on the lands of individual members who needed funds for the improvement of their estates. These mortgages were made payable to the a.s.sociation in the form of small annuities, to which were added the interest paid on the bonds and an increment for the payment of the expenses of the a.s.sociation.

These a.s.sociations were governed by the members through a general a.s.sembly, representative boards, and elected officers, and were supervised by the state and carefully regulated by law. Regulations were carefully worked out pertaining to the ratio that the loan should bear to the value of the estate mortgaged, methods of valuation, ways and means of maintaining an equilibrium between the bonds issued and the mortgages held, the treatment of defaulting members, etc., etc.

Machinery for the sale of the mortgage bonds delivered to members was also created, and in some cases later on these sales were made directly by the a.s.sociations themselves, and cash paid to the maker of the mortgages.

Five of these original Landschaften have continued to the present day, and others modeled after them were subsequently established. In 1909 in all Germany twenty-five were in operation, of which eighteen were in Prussia. The newer ones have not in all respects followed their models. Unlike the original five, membership in them is not limited to the n.o.bility and is not compulsory; the liability of the members for the payment of the bonds issued has in some cases been limited to a percentage of the total; the loans are usually paid in cash; and the bonds are sold directly by the a.s.sociations; but the principles of mutual liability and mutual control which were basic in the old organizations have not been violated in any case. Both old and new are organized in the interests of borrowers on real estate mortgage security, and aim to secure funds for these on the lowest possible terms and for long periods of time, by making the security offered the lenders greater than any single borrower could supply.

The degree of their success is indicated by the fact that in 1909 the amount of their outstanding mortgage loans amounted to nearly a billion dollars, and that their mortgage bonds rank on the exchanges with Prussian state bonds and have at times outranked them.

Another type of land bank appeared in the early part of the nineteenth century as a result of the movement for the freeing of the serfs and their transformation into freehold peasants. The lands of these cultivators were burdened with a variety of feudal dues and charges which had to be commuted before they could become freeholds.

In order to facilitate this process banks were established which a.s.sumed the obligations of a peasant towards his feudal superior in return for a mortgage on his holding, repayable with interest in the form of an annuity, and in amount equal to the sum to be paid to the feudal superior for the total extinguishment of all feudal obligations.

Some of these banks were established and administered by states, provinces, and communes, and some by private parties. The public ones obtained the funds they needed partly from subsidies and partly from the sale of guaranteed mortgage bonds and the private ones wholly from the sale of mortgage bonds.

The completion of the work for which these banks were originally established put an end to their development about 1883, but similar inst.i.tutions have since been established in Prussia to a.s.sist colonists in the purchase and equipment of their farms, and in central and western Germany to promote general agricultural and urban real estate operations. The colonists sent into Poland for the Germanization of that province were in this way a.s.sisted by the Prussian government, and in some parts of Germany the same means have been employed for the purpose of aiding in the process of breaking up large estates into small holdings, in the construction of dikes, roads, and reservoirs, and in changing the courses of streams.

Next to the Landschaften the most important intermediaries between capitalists and investors in real estate in Germany are the so-called Hypothekenaktienbanken, or joint-stock mortgage banks. These are private corporations, capitalized by the sale of stock shares to the general public, and controlled by their stockholders through directorates, like industrial corporations the world over. Their business is the making of long-period loans on real estate security, and the funds thus employed are obtained by the sale of mortgage bonds secured by the real estate mortgages in which the proceeds are invested and by their own capital, surplus, and other funds.

They differ from the Landschaften in that they are not cooperative or mutual inst.i.tutions, but strictly business enterprises run in the interests of their stockholders. Their primary aim is to earn dividends rather than to secure the lowest possible loan rates and other favorable terms for borrowers. As a matter of fact they are forced by compet.i.tion and by the principles of good business to make loans at reasonable rates and on favorable terms regarding repayment and other matters, and they successfully compete with the Landschaften and other cooperative credit inst.i.tutions of Germany. Their mortgage loans are usually made repayable on the annuity plan, one-half per cent each year being the common rate of payment, and they loan about the same percentage of the value of the lands mortgaged, as do the Landschaften and other land banks, and the rate of interest charged is the market rate, into the determination of which, of course, the compet.i.tion of all other inst.i.tutions enter.

While these inst.i.tutions loan in the aggregate enormous sums on farm property, their chief field of operations is urban real estate, and particularly the industry of residence, or as we would call it in this country, apartment-house construction. It is on this account that the period of their most rapid development coincides with that of the recent rapid industrial and commercial development of Germany, which dates back only to the establishment of the Empire in 1870. Most of them began operations in the decade 1862-1872, but the most rapid growth in the magnitude and scope of their business operations has come in recent years.

In 1899 there were forty inst.i.tutions of this kind in operation in the German Empire. The number at the present time is probably considerably greater, since for obvious reasons combinations among them are not promoted by the same kind of economic pressure that in recent years has operated so efficiently in Germany in the field of commercial banking.

Two other groups of German inst.i.tutions merit attention in this connection, namely, the so-called Schulze-Delitzsch and the Raiffeisen Credit a.s.sociations.

The Schulze-Delitzsch societies were the direct outcome of the period of dearth and famine through which Germany pa.s.sed in the years immediately preceding the revolution of 1848. The first one was not a credit a.s.sociation, but a cooperative buying society, organized by a local judge named Schulze for the aid of his needy neighbors of the small trading cla.s.s in the town of Delitzsch. In 1850 a credit a.s.sociation on the same plan was organized. Others followed, in rapid succession in and after the seventies, until at the present time they are numbered by the thousands and their members by millions, and they are scattered throughout the entire empire.

The principle of their organization is the a.s.sociation of a comparatively small group of neighbors, or of people who know one another well, or who may easily come to know one another well, by each making a contribution to a common fund to be loaned out to individuals on personal security chiefly, and which, together with the credit of the entire group, may be made the basis of security for larger funds to be borrowed on the open market. They are carefully organized on the cooperative principle, each member having an equal voice in a general a.s.sembly which chooses a board of directors and a small administrative board, to which is intrusted the actual management and administration of the affairs of the society.

Loans are made to members only, usually for short periods of time, on the personal security of the borrower and of others who are willing to vouch for him, and on the unusually favorable terms which the credit of the entire organization and very low costs of administration render possible. The knowledge which each member has of the character and business methods of his fellow members who borrow, and of the use to which borrowed funds are put, and the stake which each one has in the financial stability and success of the organization, bring the percentage of losses to a very low figure, and make it possible for these societies to grant their members maximum accommodations at minimum prices.

To the funds acc.u.mulated from initiation fees, membership dues and the sale of the a.s.sociations' credit have been added, in constantly increasing amounts in recent years, the savings of the members themselves. Many societies have such an amount of funds intrusted to them in this way that they are not only entirely freed from the necessity of borrowing, but are obliged to seek opportunities for investment outside their own group.

This condition of affairs, in addition to many other common interests, led to the federation of the Schulze-Delitzsch societies into larger groups, and these in turn into state and national a.s.sociations, through which surplus funds in one could be made to serve the needs of others inadequately supplied, and through which all the societies could be brought into efficient connection with the general money market of the country. For a number of years these federated societies conducted a large central inst.i.tution, first in Frankfurt and afterwards in Berlin, known as the Deutsche Genossenschaftsbank.

In 1904, however, this inst.i.tution was absorbed by the Dresdener Bank, one of the eight great private banking corporations of Germany, which now serves as the central agency for all these societies.

The membership of these a.s.sociations is not restricted to any cla.s.s of persons, and they actually include a very large number of small farmers. An inquiry made in 1885 showed that in 545 of them, with a total membership of 270,808, there were 72,994 farmers, and that one-fifth of the total loans of these a.s.sociations were made to this cla.s.s of their members. They must, therefore, be numbered among the land banks of the Empire, or at least among the inst.i.tutions which are helping to solve the credit problem for the agricultural cla.s.ses.

The Raiffeisen societies resemble the Schulze-Delitzsch in many particulars and differ from them in others. Like them they are strictly cooperative in character, and, when organized for credit purposes, designed to supply members with loans on the most favorable possible terms. Their development was also due to the hard economic conditions of the period immediately succeeding the revolution in 1848.

They differ from the Schulze-Delitzsch societies chiefly in the following particulars: They charge no initiation fees and do not rely to the same extent on the proceeds of the sale of shares, the amount of which they place at a very low figure, often the lowest permitted by law; they make long-period as well as short-period loans, indeed the former chiefly; they do not pay dividends on their share capital, but instead put all profits into reserve funds or prevent their acc.u.mulation by keeping the loan rates low; they exercise more care than do the Schulze-Delitzsch a.s.sociations to keep their societies small, laying great emphasis upon the importance of personal acquaintance between members and thus upon mutual watchfulness; and, in their origin, they were peasant organizations pure and simple, and hence more strictly land banks.

Their founder, F. W. Raiffeisen, Burgomeister of a small village in Westphalia, Prussia, wanted to rescue the poor peasants of his and other districts from the clutches of the usurers, into whose hands they had fallen and by whom they were being exploited in a most shameful manner. Since it was loans that these people needed and since their cash resources were always very low and in many cases nil, he felt that to require, as a condition of membership, entrance fees and the purchase of one or more shares of stock, however small, would be fatal to the success of his plans. He also firmly believed that in the integrity, industry, frugality, and agricultural skill of these people was the basis for sound credit and that cooperation was a means by which these elements of sound credit could be made available and attractive on the money market. At the beginning, therefore, no entrance fees or share subscriptions were required. Later Prussian law made share subscriptions compulsory and they were, of course, introduced, but they were made so low, and the acquisition of the money for their purchase so easy, that they have not been a serious obstacle.

From the beginning Raiffeisen invited to membership in his societies the well-to-do and substantial people as well as peasants. Of course these people did not require the society for the satisfaction of their own credit needs, but Raiffeisen saw that they would greatly strengthen the credit of the societies and he was able to appeal to them on philanthropic grounds. This cla.s.s of people have a leading part in the administration of the societies of which they are members and have contributed greatly to their success.

At the outset the Raiffeisen societies had to rely chiefly on borrowing for the acquisition of the capital needed, but with time and success savings deposits, surplus funds acc.u.mulated out of profits, and lastly the proceeds of the sale of shares have played an increasing role. At the present time many societies are not obliged to borrow at all, and not a few have surplus funds which are placed at the disposition of other societies which are still obliged to borrow.

Like the Schulze-Delitzsch societies the Raiffeisen a.s.sociations have federated. At present there are thirteen so-called unions, and at the head of all is a central bank with head office at Berlin and branches at Konigsberg, Danzig, Breslau, Ca.s.sel, Frankfurt, Coblenz, Brunzwick, Stra.s.sburg, Nuremberg, Posen, and Ludwigshafen. The central bank is a joint-stock company, organized on the principle of limited liability, the stock of which is owned by the local societies. It formerly had close relations with the Imperial Bank, but is now a.s.sociated with the so-called Centralgenossenschaftska.s.sa, endowed by the state of Prussia, in such a way that advances and discounts are extended to it on favorable terms.

The Raiffeisen societies rival the Schulze-Delitzsch in the rapidity of their growth and in the role they play in the economic life of modern Germany. In 1908 they numbered 5,047, of which 4,340 were credit a.s.sociations. The collective balance sheets of these societies in 1907 showed 490,734,834 marks a.s.sets, 489,234,357 marks liabilities, and a membership of 405,819.

While Germany was the pioneer in the establishment of land credit inst.i.tutions, and while such inst.i.tutions have attained a greater variety of form and a higher degree of perfection in that country than in any other, other countries have advanced along similar lines and now have inst.i.tutions and a fund of experience well worthy of study.

The inst.i.tutions of Germany have in most cases served as models in these other countries, the mortgage banks and the Schulze-Delitzsch and Raiffeisen societies having been most frequently copied. These models have been adapted to foreign conditions and modified in interesting and instructive ways as well as copied without essential change.

Among the mortgage banks developed outside of Germany the Credit Foncier of France is especially noteworthy. In its organization it was modeled after the Bank of France and is second only to that inst.i.tution in the magnitude of its operations and the scope of its influence. Its head office is in Paris and it has at least one branch in each department. Its capital stock owned by private parties amounts to about $40,000,000, its surplus to over $4,000,000, its loans secured by mortgage to over $400,000,000, and its total resources to about $1,000,000,000.

Like the German mortgage banks, it secures the greater part of its loan funds through the issue of mortgage bonds and a large percentage of its loans are made on mortgage security for long periods of time and are repayable on the annuity plan. However, it transacts a greater variety of business than does the typical mortgage bank of Germany. It loans on city and farm real estate and to communes, and it transacts a large commercial banking business, though this is distinctly a side issue, incorporated with its other business in order to give profitable employment to funds, sometimes large in amount, which are temporarily on hand awaiting investment.

At various times it has absorbed competing inst.i.tutions and at times it has established collateral inst.i.tutions to transact lines of business for which its own const.i.tution and legal limitations did not fit it. Among these the most important are the Credit Agricole and the Foncier Algierienne. It was obliged ultimately to absorb and liquidate the former, but the latter still flourishes in the colony of Algiers.

Mortgage banks have also gained a footing in most of the other countries of continental Europe. In Italy they pa.s.sed through a period of storm and stress, owing to their connection with the issue banks of that country and the consequent confusion between commercial and investment banking which resulted, but they have recently been established on an independent basis and are now developing along right lines and with apparent success.

The Schulze-Delitzsch and Raiffeisen societies have been imitated in Austria, Hungary, Belgium, Switzerland, and, to some extent, in France and India. The so-called "Banche Populari" and "Ca.s.se Rurali" of Italy are respectively modified forms of these two German types, and rank among the most important means employed in that country for the improvement of the condition of the peasants and small tradesmen.

State, provincial, and communal aid for these inst.i.tutions has been more frequently evoked and more extensively employed outside than inside of Germany, and other important modifications of the German prototypes have been made in Italy and elsewhere.

_5. Stock Exchanges_

An essential part of the machinery of investment banking is the stock exchange. This is a place where the buyers and sellers of securities or their agents regularly meet for the transaction of business. It may be a portion of a street or a market place or a room in a building. A fully equipped modern exchange contains a large room equipped with telegraphic and telephonic communication with the most important parts of the country in which it is located and of the world, with apparatus for registering prices and easily communicating information to its members, and with the offices needed for the accommodation of the clerks and other employees required. Either by posts or in some other manner the precise places in it in which each security or group of securities is to be dealt in is also usually indicated.

The purpose of the stock exchange is to facilitate and to regulate dealings in securities. It facilitates such dealings by providing as nearly perfect means as is possible for putting buyers and sellers into communication with each other, and for collecting and making available to them the information they need. To this end they provide for daily meetings at fixed hours; they make and publish lists of the securities dealt in; they speedily record and, through the telegraph and the telephone, communicate to all quarters of the globe the prices at which securities change hands; and through the meeting room equipped as before described they make it possible for buyers and sellers, no matter where located, to communicate with each other in a very short period to time. They regulate such dealings by establishing and rigidly enforcing rules and regulations for listing, transferring, clearing, and paying for securities and for other matters pertaining to the conduct of their members.

These inst.i.tutions serve investment banks as well as private investors, const.i.tuting the machinery which connects them all. They thus enlarge the area and scope of the markets for securities, and greatly increase the mobility of capital. Without them the surplus savings of one locality would only very slowly and with difficulty find their way to other localities where they are needed, with the result that capital would lie idle or be very inefficiently employed in some places while in others natural and human resources would be undeveloped or very inefficiently developed.

Existing stock exchanges differ considerably in the manner in which they are organized and managed, in methods of doing business, and in the scope of their operations. Some of them are incorporated and others unincorporated; some restrict their membership to a prescribed number, others admit as many as are able and willing to comply with the conditions imposed; some are local in their scope, some national, and others international. In this country all the exchanges deal in local securities chiefly, except the one in New York City, which is national in its scope. The London exchange does a larger business in international securities than any other, but the Paris and Berlin exchanges, as well as those located at the other important European capitals, and the one at New York share in it to a greater or less degree.

Stock exchanges have suffered in reputation, and their real functions and merits have been obscured by the abuses to which they have been subjected. Connected with their legitimate business of facilitating the investment of capital, various forms of speculation have developed which in some cases have degenerated into gambling pure and simple. The better managed ones have striven to rid themselves of these abuses, and in some countries, notably in Germany, legislative bodies have taken a hand. The results, however, have proved only partially successful.

Some forms of speculation are not only legitimate but necessary in modern business life, and these shade into the illegitimate, unnecessary, and positively harmful forms by such short and easy steps as to render it difficult, and perhaps impossible, to draw a line between the two which can serve as a guide for regulations of an administrative or legislative kind.

_6. Some Defects in Our Investment Banking Machinery_

A comparison of our investment banking machinery with that of European countries, especially Germany, reveals important differences. Among these the most notable are the wide use there and the almost complete absence here of the following: (a) the resort to cooperation as a means of revealing and making available the basis for credit of large numbers of people who lack capital but could use it to the advantage of themselves and of the nation; (b) the long-period mortgage loan repayable on the annuity plan and the mortgage bond as a means of acc.u.mulating capital for such loans; and (c) the cooperation of the state and other public bodies and of capitalists and philanthropically disposed persons in developing the credit possibilities of the ma.s.ses and in directing the flow of proper portions of the stream of capital in their direction.

In the development of investment banking inst.i.tutions in this country, individual initiative prompted by self-interest has been the chief, and except in the case of savings banks, the sole motive force. The result is that most of them have been organized in the interests of lenders rather than borrowers and serve best the purposes of big business and of persons already possessed of large credit by virtue of their wealth or their business reputations. Under these conditions, while enormous amounts of capital in the aggregate have been invested in agriculture and urban real estate, the former has suffered relatively in comparison with transportation, manufacturing, and speculation.

Contributory causes in the development of this situation have been the great need for capital for the development of our transportation system, the stimulation of manufactures by high protective duties, and the enormous area of our public domain which was given or sold to settlers on very easy terms. Inasmuch as our transportation system and our manufacturing industries have now attained a high degree of development, our public domain has been nearly exhausted, and land values and the cost of living are rapidly rising, the needs of agriculture are pushing themselves into the foreground, and we are beginning to look to European experience for suggestions regarding the best methods of diverting to that industry a larger part of our rapidly acc.u.mulating capital resources.