either out of his own capital or else borrow of the banks. Necessity compels him to go to the banks. He takes the 5,000 shares of the New York Central to the banks and offers them as collateral for a loan. If he is wise, he already has an agreement with his customers enabling him to do this. The banks lend him $440,000 on the collateral at the prevailing rate of interest. With the $55,000 from his customer and $440,000 from the banks the broker has $495,000, or $55,000 less than he must pay for the stock. This he would have to supply out of his own capital. What is the net result? The customer is nominally the owner of 5,000 shares of stock, which he has, however, never seen, and which is actually in the possession of banks whose very names he may not know. The interest of the banks in the stock represents 80 per cent of its value; the broker's, 10 percent; and the customer's, 10 per cent. It does not follow that every transaction is exactly of these proportions of risk. The broker, in fact, may be able to obtain from the banks loans large enough to enable him, in connection with his customer's margin, to carry a transaction without the employment of much, if any, of his own capital. This example has been based upon the general rule that the margin demanded by the broker of his customer is usually 10 per cent, and the margin demanded by the banks of the broker is usually 20 per cent, the percentages in both cases varying in accordance with the character of the securities. The example serves to illustrate clearly the close intimacy existing between the money-market and the stock-market. The money-lenders are, in fact, the actual holders of the securities dealt in, and they have the largest interest at stake in the maintenance of values. But this is not the only connection between the banks and the stock-brokers. Let us return to the example already given. The broker has bought stock for which, on delivery, he must pay $550,000. Now, before he can get any loans from the banks on this stock he must have the stock in his possession, so as to be able to use it as collateral for the loans. Before he can get it in his possession he must pay for it. His balance in the bank may not be more than $50,000. What is he to do? Right here enters the new alliance between the banks and the brokers. It goes by the name of certification. The broker, in the case instanced, draws a check for $550,000 in payment for the stock. The check is sent to the bank where the broker keeps his account for certification. The cashier or paying teller indorses the check across its face, thus certifying, not only that the signature is correct, but that the bank will pay the amount of the check on presentation and identification, or when it comes to it through the operations of the clearinghouse. But it has been said that the broker has a balance of only $50,000, and here the bank is certifying to his check for $550,000. That is what is called "overcertification," and it is another form of a great system of credits on which the transactions of Wall Street stand. Overcertification is in effect a temporary loan, and as employed in stock exchange transactions involves little risk. There are a number of Wall Street banks-not all-that do a regular business of certifying brokers' checks, but a large proportion of this business is done by the trust companies. A broker enters into a definite arrangement with one of the institutions on a basis something like this: The broker agrees to keep a daily cash balance at the bank of, say, $50,000; in return the bank agrees to certify his checks to an amount, say, of $1,000,000. While this seems startling, the practice is in reality not dangerous. The banking institutions are very conservative in transactions of this kind. They must know all about the broker, his character, good judgment, and business methods and standing. In other words, personal character is a valuable asset in Wall Street. A man's credit in the Exchange and in the banks depends largely upon it. Then the bank stipulates, in entering upon an agreement of this kind with the broker, that, while it will certify, say, to an amount of $1,000,000 on a net daily balance of $50,000, the broker must not frequently reach that limit. Moreover, he must make his deposits at the bank as frequently as he receives checks for payment for securities delivered. He cannot wait until nearly 3:00 o'clock and then make one deposit for the day, but must deposit, it may be, six or seven times a day. The result is that while the broker is receiving the benefit of large certifications in excess of his balance, at the same time he is at frequent intervals depositing other certified checks. Deposits and certifications thus go on simultaneously. In making these loans the banks scrutinize the collateral closely. The securities must be strictly good delivery according to the rules. of the Exchange. Stocks and bonds for which there is not a constant market are generally not acceptable. The bank's protection consists in its actual holding of the collateral, and either in a note signed by the borrower in each transaction or in a continuing agreement, which its customer signs, enabling the bank to sell the securities, without notice, in case the borrower neglects to respond to the call for payment of the loan. This agreement obviates the necessity of a new note each time a new loan is made. The violation of the national bank law against overcertification is in most cases more technical than actual; for as soon as the broker gets his stock and arranges his loan he is able to make every check good, and by his arrangement with the bank he is bound to maintain his average daily balance of $50,000, or whatever other amount may be agreed upon. The larger the average balance the larger the certification. But even the appearance of violation of law may be open to criticism, and therefore the national banks are gradually withdrawing from this business and other institutions are taking their place. The institutions also are beginning to adopt other systems, which have the merit of simplicity and freedom from possible illegality. Many of them are making morning loans to brokers of an amount that will cover their probable certification for the day. These loans are based on the "single-name paper" of the broker-that is to say, his individual, unindorsed note. With such a loan the broker has to his credit a deposit at the bank sufficient for the day's probable business, and technical overcertification is avoided. The practical result is the same under either system. The latter has the merit of avoiding the appearance of evil. The amount of certification required in the operations of the stockmarket is stupendous. On the deliveries made in the Stock ClearingHouse transactions the certification actually required in 1901 was nearly $11,000,000,000. The Stock Clearing-House clears about 85 per cent of all the sales of stocks. The remaining 15 per cent, as well as transactions in bonds, must therefore be taken into account in any estimate of total certification required. The bonds alone added at least another billion, and it is safe to say that the business of the New York Stock Exchange exclusively, in 1901, required a certification of $14,000,000,000, or an average of about $45,000,000 daily. This was over one-fifth the average daily clearances of the Bank Clearing-House. It may be asked, What does a bank make by certifying brokers' checks? In the example given the bank gains the use of $50,000, the required daily balance of the broker. But as the national bank is, by law, required to keep a reserve of 25 per cent, its net gain by this operation is the use of $37,500. Its profit is the interest it earns by the loaning of that amount. If it were not profitable the bank would not engage in the business. While the great mass of these stock exchange loans are on call, most brokers seek to secure a certain proportion of their required line of credit on time. Formerly time loans were made by months, but now by days. Thus there are thirty-day, sixty-day, and ninetyday loans. The rates for time loans are generally higher than for call, except in times of severe stringency in the money-market, and banks are commonly very conservative in making such loans for long periods. The bank's deposits being subject to withdrawal on demand, it follows that it can lock up only a comparatively small part of its resources in the form of time loans. The stock-broker, though paying more for his credit than he would on his call-loan basis, escapes the liability of having all his loans called at one time. .after date for value received the undersigned promise to pay to the order of THE NATIONAL CITY BANK OF CHICAGO Dollars at its banking house in Chicago, Illinois, with interest AFTER MATURITY at the rate of seven per cent per annum until paid and with costs of collection and SIGN HERE AND The undersigned jointly and severally hereby deposit with and pledge to THE NATIONAL CITY BANK OF CHICAGO as collateral security for the pay- At any time said bank or legal holder of said note may call for additional security satisfactory to the said bank or legal holder of said note, and failure to Business Address: SIGN HERE AND |