Investment banking

“ A large part of the business of investment banking in the United States is conducted by corporations and firms organized for the purpose of buying and selling investment securities, especially bonds and mortgages. ”

“ Furthermore, it is the investment banker’s access to other people’s money in controlled banks and trust companies which alone enables any individual banking concern to take so large part of the annual output of bonds and stocks. The banker’s own capital, however large, would soon be exhausted. And even the loanable21 funds of the banks would often be exhausted, but for the large deposits made in those banks by the life insurance, railroad, public service, and industrial corporations which the bankers also control. ”

“ Commercial banks rarely confine themselves exclusively to the conduct of exchanges. Most of them also conduct savings departments and invest the funds intrusted to them through such departments in agricultural, industrial, or [Pg 7] commercial enterprises or loan them to public corporations. Commercial banking, however, is their main concern, their other departments being side issues of greater or less importance according to circumstances. Investment banks also frequently carry on commercial banking as a side issue. ”

“ The bank might divert talent and resources from its commercial banking operation to the promotion of the fund. Moreover, because the bank would have a stake in a customer's making a particular investment decision-the decision to invest in the bank's investment fund-the customer might doubt the motivation behind the bank's recommendation that he make such an investment. If the fund investment should turn out badly there would be a danger that the bank would lose the good will of those customers who had invested in the fund. ”

“ The capital of every National Bank must be fully paid in, before it is allowed to open for business; and in most of the States, the banks, other than National, must have their entire capital paid up within a year from their beginning. The net profits of successful banks, located in cities with a population of one hundred thousand or over, average about six to ten per cent. The business man, when considering an investment in a mercantile or manufacturing enterprise, generally counts on double that amount of dividends. ”

“ Foreign legislators have approximated more closely than ours what is needed in the regulation of bank investments. In the case of their central banks, many of them, notably those of France and Germany, have recognized the fundamental distinction between commercial and investment paper, and have required them to hold the former against their demand obligations, especially their notes. ”

“ Vast amounts of capital are invested directly by the people to whom it belongs without the aid of middlemen and large amounts are also invested through brokers of one kind and another who can hardly be classed as bankers. The most important types of institutions which have been developed in connection with these functions are savings banks, trust companies, bond houses and investment companies, land banks, and stock exchanges. ”

“ These institutions serve investment banks as well as private investors, constituting 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 [Pg 165] 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. ”

“ Moneyed capital is brought into such competition where it is invested in shares of state banks or in private banking, and also where it is employed, substantially as in the loan and investment features of banking, in making investments, by way of loan, discount or otherwise, in notes, bonds or other securities with a view to sale or repayment and reinvestment. ”

“ Their holdings of investment securities are kept well within the limits set by their aggregate capital, surplus, and savings funds, and their method of handling commercial business, based as it is on accurate knowledge of their customer's operations and upon the lien upon produce heretofore described, prevents their acceptance, through ignorance, of investment securities under commercial disguise. ”

“ The accumulation of a nation's capital and its investment require the cooperation of numerous agencies of which banks are the chief. They collect the savings of the people, combine them into amounts of sufficient size for investment purposes, and invest them temporarily and sometimes permanently. Cooperating agencies in this work are insurance companies, societies of various kinds for the promotion of saving, stock exchanges, promoters, etc. ”

“ All these various forms of banking are distinct in character and economically the funds of each perform a peculiar function that must be recognized and observed or we shall make a great fundamental error in constructing what we hope will prove a sound financial and banking system. We must provide that the commercial function, the savings function, the trust function shall be kept apart by separating the funds arising from each, and keeping them completely segregated, in order that the country may always know just what its commercial fund is, as distinguished from its investment fund. ”

“ Under this view, if logically pursued, capital invested in businesses engaged in some, but not all, of the activities of national banks, as well as that employed by individuals in investment and reinvestment in securities, such as we have described, could not be considered in determining the question of competition. ”

“ These constitute the important intermediary which transforms stock exchange securities into the basis of bank-loans. The commercial banker buys, in general, not the stocks, but the note of the private banker, broker, speculator, or investor, with the stocks as collateral. If investment bankers, speculators and investors decide to support old ways of doing things, the banks lend on the securities of the old kinds of businesses; if investment bankers, speculators and investors turn to new things, the commercial banks follow suit. ”

“ But when railway shares and bonds, based upon lines of road which were constructed through the rich regions of the Union lying between the Atlantic and the Mississippi river, came upon the market in large amounts, affording ample security for investment and loans, the great banks of Wall Street were quick to appreciate the advantages of loans made upon such undoubted values, which were at all times convertible into cash on the stock exchange. In times of pressure, commercial paper is an inferior asset for a bank, all of whose obligations are payable on demand. ”

“ I think that joint stock banks are deficient in everything requisite for the conduct of the banking business except extended responsibility; the banking business requires peculiarly persons attentive to all its details, constantly, daily, and hourly watchful of every transaction, much more than mercantile or trading business. ”

“ It is argued that a bank investment fund simply makes available to the small investor the benefit of investment management by a bank trust department which would otherwise be available only to large investors, and that the operation of an investment fund creates no problems that are not present whenever a bank invests in securities for the account of customers. ”

“ The sum the stockholders must contribute to the establishment of a National bank varies according to the population and the business importance of the place in which the bank is to be located.
The capital must exist in a prescribed form.
Certain forms of investment are prohibited, as for instance the ownership of real estate, except under certain restrictions.
This is done that the National bank may be able to convert its securities into cash in the shortest order. ”

“ We have bankers enough who are "risk-bearers." But they are, on the whole, "private bankers," "investment bankers," and the like, who do not manufacture a great deal of deposit credit, but rather borrow heavily from the commercial banks, which are the great manufacturers of bank-credit. Under our system, the decisions which divert industry from old to new lines are more democratically made, by speculators [Pg 528] and investors under the leadership of private bankers, and sometimes without that leadership. ”

“ The opening of this new field would furnish a market, in some respects more desirable and certainly wider than that now reached by the bankers.
117 Neither do states or cities ordinarily need the services of the investment banker to carry their bonds pending distribution to the investor. Where there is immediate need for large funds, states and cities—at least the older communities—should be able to raise the money temporarily, quite as well as the bankers do now, while awaiting distribution of their bonds to the investor. Bankers carry the bonds with other people’s money, not with their own. ”

“ Commercial banks can and do discourage certain types of enterprises by refusing loans with their securities as collateral, or by requiring very heavy margins with such loans, but even these may be developed, and are with us on a large scale developed, on banking credit, advanced by the speculators and private bankers who borrowed it from the commercial banks with other securities as collateral. ”

“ But the massing of this power in a few vast, centralised units has been a development of the last ten or fifteen years only. That is, it has been coincident with the development of trusts and combinations. Big Business and Big Banking have gone hand in hand. Each has made the other possible. By law a bank cannot loan more than one-tenth of its capital and surplus to any one customer. But the customers have grown into behemoths. ”

“ By its means their reserves can be replenished and their lending power made responsive to the needs of their communities. A bankers' bank makes it possible for the money of the individual banks to do many times the work it would do if left in the separate institutions, and to do it far more effectively. It is the only ultimate safeguard, the only scientific deposit guarantee, the only sound basis of flexibility in any banking system. ”

“ Because of this necessary instability bankers watch most carefully the tendencies of the money market, and necessarily reduce their loans for safety when any anxious pressure begins. For the same reason legitimate banking is limited to short time loans—on demand, thirty, sixty, ninety days—the shorter being the safer. Laws sometimes prohibit a bank from dealing in any other business, where a stock of goods must tie up funds, or from speculation in real estate, which confines capital more certainly. ”

“ The unique powers of commercial banks to accept demand deposits, provide checking account services, and lend against fractional reserves permit the banking system as a whole to create a supply of 'money,' a function which is indispensable to the maintenance of the structure of our national economy. ”

“ As some philosopher once said of God—if such an institution did not already exist, people would certainly have to invent one, and, as we have no such institution permanently and legally established in America to-day, the prime essential of any sufficient banking plan is the equipment of our system in some way or other with the facilities of a bankers' bank. ”

“ The volume of new security issues was greatly increased by huge railroad consolidations, the development of the holding companies, and particularly by the formation of industrial trusts. The rapidly accumulating savings of our people sought investment. The field of operations for the dealer in securities was thus much enlarged. And, as the securities were new and untried, the services of the investment banker were in great demand, and his powers and profits increased accordingly. ”

“ Only by having banks which employ in loans a part of depositors' capital lodged with them, can the best interests of the whole people be served, even if this entails something less than an absolute certainty of power to liquidate deposits on demand. That banking system must then be best which combines equally the largest measure of each of two elements: the use in commerce of funds deposited, and the certainty of paying depositors in money on demand. ”

“ Benefit of banks to trade.—Second, the deserving merchant can manage with a smaller capital than formerly, because he can borrow more easily and to much better advantage. The reader must be content with a summary of the results of the development of banking in the course of the century, for there is no space in which to treat the details of its history. Banks have followed business throughout the world. They have attracted the unused capital of the community until they control now a fund of enormous dimensions, available for mercantile loans. ”

“ If, on the other hand, his business is unexpectedly large, giving opportunity to make bigger profits and creating the need for more capital, he will find the bank ready to increase his line of credit, provided the manager is satisfied that business conditions and prospects warrant expansion. Under no circumstances, however, must the customer of a bank seek to raise funds elsewhere unless he first gets the consent of his bank. If he sells his notes in the open market, he must do it with the [Pg 429] full knowledge of his bank or run the risk of being placed upon the "black list." ”