Credit may be classified in a variety of ways. A common and serviceable classification divides credit into five kinds: personal, commercial, banking, public and investment credit.3 In a broad sense all credit is financial since it involves the payment of money or money's worth, but the foregoing classification will be helpful in illustrating the different kinds of credit instruments to which each class of credit gives rise. Though in this book we are concerned primarily with banking and commercial credit it will be well to discuss the other kinds briefly to show their relation to these two.
1 Ibid., p. 15.
2 Johnson, p. 36.
3 Hagerty, p. 37; Prendorgast, Pt. II.
Public credit is the power of a government, nation, state, county, or city, to secure funds in exchange for its promise to pay in the future. This promise takes the form,ordinarily of bonds which are sold to bankers, investment houses and individuals. Government or municipal bonds, which are simply promises to pay money, are usually not protected by the pledge or deposit of any specified property; the purchaser rests upon faith in the government to pay its debts. Sometimes, however, the credit of a government becomes so weakened because of heavy expenditures for war or other purposes that it finds it necessary to pledge certain property or income as a guarantee that it will meet its obligations. Thus, for example, the Japanese government was compelled to borrow vast sums of money during the war with Russia in 1905, and one of its loans was secured by a charge on the revenues of the tobacco monopoly. The rate of interest on government bonds is a general index of the government's credit. Government and municipal bonds are frequently used by the owners as collateral to strengthen their individual credit when they wish to borrow funds at the bank.
National governments use their credit also by the issue of government notes or paper money, as in the case of our greenbacks. Many governments have abused their credit by issuing great quantities of irredeemable paper currency and, generally, humiliating results have followed.
Investment or capital credit is represented by bonds and stocks of incorporated businesses and by real-estate mortgages and bonds. Real-estate mortgages have always been a favorite form of investment. Vast amounts of money are thus invested by savings banks, trust companies, insurance companies, building and loan associations, and other organizations which act in the capacity of trustee or custodian of funds. Agricultural credit instruments take the form of notes accompanied by mortgages on the land, farm implements, or the crops. Most European countries have long had mortgage banks and systems of agricultural credit which have provided the farming classes with fair credit facilities. Until recently scant attention has been given to agricultural credit in the United States, but plans are being made to provide the farmer with credit facilities comparable with those enjoyed by the manufacturer and the merchant.
In the modern business world the corporation has proved to be the most advantageous form of business organization for large undertakings. Railroad and public utility companies, manufacturing concerns, mercantile enterprises, banking and insurance companies - these and many other types of business organizations operate under the corporate form. These corporations get a large proportion of their capital through the sale of stocks and bonds to individual investors. Bondholders have a preferred claim to the earnings and assets of the company, and, usually, their investments are protected by a mortgage upon the property of the corporation. A stockholder is virtually a partner in the corporation sharing its gains and its losses, and having a voice in its management. A corporation is able to get capital credit from a great variety of investors through the sale of its shares of stock the par value of which is usually $100. In most types of corporations stockholders are responsible for the debts of the company only to the amount of their holdings. Then, again, they are free to leave the corporation at any time simply by selling their stock to someone else. Because of these and other advantages, the corporation attracts capital funds from many sources.
Corporation bonds are issued usually for long periods, varying from five to fifty years or longer. Sometimes, however, when money rates are high, corporations which are in urgent need of funds issue "short-term notes" running from one to three or five years, rather than contract to pay the high rates for a long period of years which would be the case if they issued bonds. When a corporation issues these short-term notes instead of bonds it is with the 8 expectation, usually, that before the notes mature it will be possible to sell bonds at a lower rate of interest or at a better price than when the notes were issued. As already noted, corporation bonds are generally issued against a mortgage which gives the bondholders title to some property. Short-term notes, however, have no such protection, but are issued on the general credit of the corporation.