9. Mode Of Buying Paper

Let us now turn to the purchasing of paper by banking institutions. This is done when they can not lend all their money to ordinary applicants. From whom is the paper obtained? From note brokers or bill brokers, who get it from merchants and others who wish to borrow money. They make a quantity of notes and give them to bill brokers to sell. It is a frequent practice for two men to act together in making and indorsing notes for each other. A makes a series of notes which are given to B and indorsed by him, and then delivered to a note broker to sell ; B makes another series which are given to A, and are treated by him in the same manner.

1 Country Banker, page 15

2 See a valuable paper in 66 American Banker,page 922, by J. B. Forgan, president of the First National Bank of Chigago, entitled," How to Reach a Decision Regard to the Desirability of Notes Offered for Discount"

Besides his own notes A may deliver into the hands of a note broker notes that he has taken from others in payment of merchandise. These are often regarded as of higher worth than his own, because, besides his own indorsement, they represent sales, actual property received by the makers, and from the sale of which they expect to obtain the means to discharge their obligations.

Sometimes the notes are not given to note brokers to sell, but only copies or memoranda of them. Again, note brokers may have the actual notes, but send only copies to banks for their examination and purchase. In other words, the note broker has enough knowledge of the notes to give any inquirer wishing to purchase all the information he seeks, the names of the maker, indorsers, date, and length of life and securities.

Note brokers sometimes indorse the notes they negotiate. This is not a common practice, though it was once. Of course, his indorsement is an additional security ; besides, it is a kind of guaranty that he has confidence in the note.

A note broker is responsible in any event for the genuineness of the paper sold by him. There is a general principle of law of wide application that every vendor or seller of personal property warrants the title; that is, whether he says so or not, he is declared by law to be the owner. In like manner when a note broker takes a note to a bank for sale, the law implies that the note is made by the man whose name is attached thereto, and if it should prove to be a forgery, the broker would be obliged to make up the loss. Several years ago the confidential clerk of a merchant brought the notes of his employer to a broker for sale. He had been long employed and was supposed to possess the highest integrity. In an evil hour he forged the name of his employer to a large number of notes, mingled them with genuine notes, and took all to the note broker. The broker made advances on them, as he had done on other notes, and the clerk fled as soon as he obtained the money. The broker was obliged to pay the holders. It was at one time questioned whether a national hank had a right to buy paper, but the question was soon answered by the courts in favor of the exercise of this authority.

In selling notes the operation is a very simple one. A broker, or one of his agents, takes one or more packages of notes to a bank and submits them to the examination of the president. Such an official once told the writer that his method of making selections was the following: Sup pose he had $ 100,000 to lend. He examined all the paper a broker had to sell, and drew out and laid aside from the several packages all of the most desirable notes. Suppose the aggregate amount was $200,000 Then began the work of exclusion. He continued to go over the notes selected, throwing out the least desirable until the amount corresponded with his loanable fund.

Let us, however, inquire by what principle was he guided in unking his selections. One was paper of which he had knowledge from previous purchases and payments.

Suppose he sees the note of John Smith. He inquires of the broker who John Smith is and is given a highly satisfactory answer. The note is purchased, and at maturity is promptly paid. At a later period he sees another note by the same maker and, remembering his former experience, this is purchased. Thus confidence is strengthened by performance, and in buying paper the president looks sharply after familiar names who have won his good opinion by the punctual fulfillment of their promises.

If he can not find such names, or not enough, then he must take the somewhat uncomfortable step of purchasing paper made by men of whom he has perhaps little or no knowledge. We have said that the new and better method is to make careful inquiry before purchasing, obtain a statement from the maker, and thus learn much concerning his condition; but this is done by only a few banks that purchase paper. In truth, most of them are still pursuing the old way of buying paper first, largely on the statement of the note broker, the rating of the maker and indorsees in the credit books, and of making their own independent inquiries afterward.

One of the serious difficulties in purchasing paper is the ease with which the makers can cover up the quantity they offer for sale. Suppose a concern wished to borrow $250,000. It would probably make fifty notes and give them to a note broker, who would not put them all in one package and present them to a bank. Perhaps he would put in five or six, possibly ten, and as soon as these were sold he would put more notes into his packages, and in this manner would work them off without any bank knowing how many notes other banks had purchased. A few years ago a great tannery having its principal house in Boston failed for several million dollars, and hundreds of banks in the United States and Canada had its notes. They had been distributed everywhere through the agency of note brokers. The banks were amazed when they learned the truth. They knew that the concern transacted an enormous business and borrowed large sums of money, but they never imagined that its indebtedness ran into so many millions. For a time the banks thought of suing one of the credit agencies for misleading them until they learned that it had spent a very considerable sum in making a special investigation into the affairs of the concern and had been badly deceived. Had this concern raised the capital needed in the way of ordinary discounts from one or a few banks, it would have been quite impossible to extend its credit to such a length. The limited number of discount banks would have had a much better knowledge of its indebtedness, and knowing this would not have dared to lend so much.

This risk is well understood by bankers, but there is no way perhaps of guarding effectively against such an occurrence. Much might be done by banks in the way of cooperation. Suppose an applicant should make a statement to the Arctic National Bank of New York, for example, that he had $50,000 of paper outstanding, consisting of ten notes of $5,000 each, and that they were held by banks in various specified places Suppose the Arctic Bank, without saying anything to him concerning its purpose, should write to those banks and find out whether his statement were true, or still further, suppose they were requested to inquire of other banks whether they held any paper made by this applicant. if this practice were adopted, borrowers not knowing how many banks were thus associated, or how far their relations extended, and knowing also of the danger to their credit of making wrong statements, would be less inclined to deceive those to whom applications for money were made. It is true they might borrow from sources that were never likely to be disclosed, of their brothers and sisters and other individuals; but we think our remark will be understood that it is feasible enough for banks to adopt such a practice, and the more general it became, the more completely would applicants be cut off from their old-fashioned methods of deception. Would it not be a comparatively easy thing for a bank to establish such a relation with many of its correspondents; to have lists of the paper discounted by a bank in Chicago or persons living in New York sent regularly to its corresponding bank in that city? In like manner the New York bank could send to its Chicago correspondent a list of paper held by it made by persons living in Chicago. Again, some if not all the banks in Chicago might, as occasion required, make inquiries of one another and determine to whom they would lend, and in this way greatly assist one another.

"But it will be said that competition, rivalry, distrust, would forbid banks from doing these things. To some degree this objection is true. Ranks must judge for themselves which of their number they can trust, whether they are likely to be deceived or not by putting the system in operation. Nevertheless, the suggestion is worthy of consideration, and might prove helpful to banks in lessening the losses that are now so common, and so greatly diminish their profits. There are two reasons that work against the practice of making requests for statements, - the abundance of loanable capital held by the banks and by borrowers themselves. The great increase in deposits and in shareholders' capital stimulates competition among lenders to put out their resources, and to that end to make fewer inquiries of borrowers. If it had the effect of lessening the rate of interest, no harm would be done, but the consequences are calamitous when capital becomes so abundant that it is lent carelessly on insufficient security, to illegitimate speculations; in short, in other ways than in production and exchange, without making proper inquiry into the ability of borrowers to repay." 1

One object of selling paper through note brokers is to prevent the banks from acquiring too much knowledge of the borrower's business. It is more perfectly hidden by such a disposition of his paper. The method, though, has its disadvantages to the borrower, which have been already explained.2

Often the broker advances a large sum on the notes left with him for sale before disposing of them. He may give seventy-five or eighty per cent of their value or even more, He has a lien on the notes for his advances, and, when he has sold them, reimburses himself and pays over the balance less his commission. This varies from one eighth of one per cent to five or six per cent or even more.

Brokers and bankers not infrequently sell bonds on commission, advancing large sums prior to their sale. In other cases they buy large quantities with the intention of reselling them at a higher juice and gaining a profit by the operation.

Sometimes bills of merchandise are attached to com-mercial notes to show for what purpose they were given.

A few years ago an English concern suceeded in getting large sums from banks in London by making false bills of merchandise and attaching them to their notes. The buyers were thus led to believe that the makers possessed a large amount of property for which they had given their notes which, in truth, they did not have. The scheme worked well for the note makers, and about the only satisfaction accruing to the banks that bought them was in punishing the offenders as criminals.

1 Bolles, Practical Banking 11th edition, page l06,

2 See Page 96.

One remark more will complete this part of the subject. While the president of a bank often buys such paper in the same manner as he discounts notes, on his authority, he may submit the paper thus offered to the board before purchasing. This is done whenever he is unwilling to assume the sole responsibility.

10. Rediscounts

It is not uncommon for a bank to rediscount some of its loans. This is especially true of banks in the South and far West in some seasons of the year. They have not funds enough to supply all their customers, but they lend to them, on the condition perhaps that the proceeds shall not be checked out for a week or ten days, and in the meantime the lenders send the notes thus taken to banks in New York or elsewhere with their additional indorsement to be rediscounted. These are usually obtained without difficulty, for, with the indorsement of the borrowing bank as additional security, such paper is deemed as safe as any a bank can take.