This section is from the "Practical Banking" book, by Albert S. Bolles.
Once when notes were for a longer period, and notes were almost universally given for purchases, they were generally drawn to the maker's order, and read for value received "from A B & Co.," or whoever the seller might be. Indeed, some houses were so careful lest the paper might be thought to be made paper that they inserted the name of the seller of the merchandise in full. This paper was sold largely in the "street" to banks and others, who bought it with confidence because it represented an actual business transaction. It suited commission houses and importers, because if not willing to hold the paper until maturity, they could realize upon it without the responsibility of endorsing it, and thus go on and sell to a house (whatever their own private opinion of its soundness might be) so long as the paper would sell at a rate of discount not interfering too much with the profit on the goods or the rate of commission. This, of course, was legitimate dealing, representing actual merchandise transactions. So, indeed, is the making and openly selling of one's paper in the market, and the using of the proceeds in "cashing" bills, legitimate, but it is dangerous and liable to abuses. Funds so obtained can be used for any purpose, and the developments in some recent failures have shown that the money was often used for operations entirely outside of the regular business of the maker, or for purely speculative purposes.
As merchants often sell their paper at six or seven per cent, interest, and discount their own bills at seven to nine per cent., of course they make two or three per cent, by borrowing the money for thus paying their bills in advance of their maturity. The broker gets a commission for negotiating the merchants' paper, which must be deducted from the profit of the transaction. After deducting this brokerage, however, there is a considerable profit from borrowing money as just described, and the business has become a very large one.
In some parts of the country, Hartford, Connecticut, for example, the banking capital is much larger than can be profitably employed locally. Providence is another place of the kind. The banks of those cities consequently invest large sums through note-brokers.
The following is the method of conducting the business in the largest cities. A printed or lithographed list of notes is sent to a bank. It may contain a description of a hundred pieces of paper and is marked "This is for bankers' use only." Each piece is numbered. If a bank wishes to see any of the pieces therein described, they are sent on application. There is another way, however, of negotiating such paper, which may be explained here. If a note-broker were selling all the paper given by a certain merchant, the broker would be very careful in offering it for sale. If a banker has twenty thousand dollars of it, for example, and the broker knows that he cannot increase the amount, he will be careful not to offer more. The broker would be equally careful not to put such paper on a printed list through fear that the banker would see it, and concluding that the merchant was giving a large amount of paper, would determine to buy no more. The banker, in other words, might conclude that the merchant was issuing more paper than he ought to issue if his name appeared very frequently on printed lists.
Sometimes the broker has the notes in his possession for sale; in other cases he has simply a memorandum of them. In the latter case he has a printed form, containing the name of the maker, amount, when and where payable, indorser, and other particulars. A list is sent to a bank containing such a description of notes, or a broker, or agent for him, may visit a bank personally and exhibit such a list, or the paper itself, which he wishes to negotiate. Many banks are visited several times a day by these brokers offering the notes of persons for sale.
It may be further added that brokers do not always get possession of the notes until they have paid for them. Several practices exist in this regard. One practice is for a merchant to make notes and then deliver them to a note-broker for sale. The latter may give a receipt or acknowledgment, or he may not. In such a case the merchant has entire confidence in the broker, otherwise he would not give him notes without adequate security. There are some very good reasons for thus leaving notes with a broker when perfect confidence is reposed in him. Very likely he has a class of customers, retired merchants, perhaps, who buy paper occasionally. They frequent his office, and, if he has notes which they can examine, may be led to purchase, whereas they would not do so if the broker had only a memorandum of the paper, and was obliged to send for it before he could sell it and get the money therefor. For this reason, therefore, sales are facilitated by entrusting the broker—and, in truth, vast amounts are left for sale. When Alonzo Follet, of New York, failed a few years since, he had in his office nearly $10,000,000 of notes, and the amount of paper that he had sold annually was about $100,000,000.
Another way is for merchants to leave their paper with a note-broker and get immediately from him a certain amount thereon. A merchant, for example, may leave $25,000 of paper and ask for $10,000, expecting the balance when the paper is sold. The note-broker pays him this advance on account, and after selling the paper and deducting his commission sends the balance.
Another way is for the note-broker to buy the paper, paying therefor at the time of the purchase. A note-broker will go to a merchant and say, "I will take so much of your paper at such a rate." If the rate be acceptable, the merchant will sell it to him and get his money. In these cases the broker expects to sell the paper at a lower rate, and to make more than he would if charging the ordinary commission. Many brokers do wholly a business of this kind—buying paper and selling it at the best rate they can obtain for it.
The broker's commission in the large cities is one-eighth of one per cent.; but for negotiating leather paper, as it is called, one-quarter of one per cent, is paid, and the same rate is paid on dry-goods and on tea paper. The rate first named, however, is the most general one for negotiating notes.