It has been estimated that from 60 to 70 per cent of the reserve money carried by big banks in New York and Chicago has been loaned to brokers on stocks and bonds. A typical illustration will serve to show how collateral loans are made in Wall Street. A speculator goes to a stock broker and asks him to buy for him 100 shares of New York Central stock at par. The broker agrees to execute this order on a ten per cent margin, that is, the customer puts up only $1,000 and the broker provides the balance, $9,000. Now the broker may not have this much money, so he must borrow it from the bank, depositing the stock as security. On such security the bank will advance about 80 per cent of the market price of the stock, that is, $7,200. But to use the stock as collateral he must first buy it and pay the purchase price. How does he get the money? The broker has a balance at the bank of, say, $2,000, but he must have the use of $9,000 Tor a short time. He draws his check for $9,000 in payment of the stock and sends it to the bank to be certified. Evidently the bank has over-certified to the extent of several thousand dollars and has in effect granted the broker a temporary loan, which, however, usually lasts just for the day.
Many Wall Street banks, especially trust companies, make a regular practice of certifying brokers' checks. Pratt, in his "Work of Wall Street," says: "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 three o'clock and then make one deposit for the day, but must deposit maybe 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."1
Over-certification is distinctly forbidden by the national banking act, but most cases of violation are more technical than actual. As soon as the broker gets his stock and arranges his loan he is able to meet every check he draws, and he is bound to maintain his average daily balance according to agreement with the bank. Pratt notes that, to avoid even the appearance of violating the law, the national banks and even the trust companies are withdrawing from this practice. Many of them make morning loans to brokers sufficient to meet their probable certifications for the day, taking the broker's single-name note. The Wall Street banks do not require from regular borrowers a new note every time a call loan is made. The broker signs a "general loan and collateral agreement" which covers new as well as existing call loans. This agreement gives the bank the right to sell the collateral in case the borrower fails to pay on call or to deposit additional collateral.
When a broker wants to make a call loan he sends his securities to the bank in an envelope, called the "loan envelope. "On the outside is written the borrower's name, the date, the rate, and an itemized list of the securities with their market prices on that day. If the bank approves of the securities, the cashier issues a check to the person bringing the envelope. The loan envelope is placed in a larger bank envelope on which is written the name of the borrower, the amount of the loan, and the rate. The collateral loan clerk makes out a loan card containing a full record of the loan with a list of the securities thus pledged. In the great Wall Street banks the loan clerk holds a very responsible position requiring keen and constant vigilance. He follows the fluctuations of the stock market closely by means of a ticker installed in a special room reserved for this use. He must see that the loans are properly protected by a fair margin, he must call loans when it is necessary, and attend to the disposing of the collateral if the broker fails to pay his loan.
1 Pratt: Work of Wall Street, p. 270.