Objections to Open-Market Borrowing Borrowing in open-market through note-brokers is not un attended with danger. The borrower who uses brokers in prefer ence to establishing ample relations with banks for the full re quirements of his business runs the risk of being caught in a tight money market; the experiences during the panic of 1907 have brought many men to realize the importance of making broader banking connections to provide against emergency and not to rely too exclusively upon note-brokers.
As a rule, banks do not make loans for a longer period than 6 months; but the practice of making longer term loans has de veloped in some banks by concerns selling their paper through note-brokers, which paper sometimes runs for 8 or 9 months. Some banks regard this as unsound banking. The lengthening of time of such paper is due to the fact that the broker charges a straight commission on the face of the paper, no matter what the period. The longer the note runs, therefore, the less rate of in terest per annum the borrower pays to the broker as commission.
The constant renewal of paper is highly objectionable. It usually shows that the funds arc being used as permanent capital, which practice good banking principles dictate should be spar ingly used and which likely denotes a weak financial condition on the part of the borrower. A common criticism against brokers' single-name paper is that it is to the brokers' interests to keep as much of this paper out as possible; at maturity of one batch another is offered, and the constant stream of notes represents fixed investments. The broker holds the paper a very short time, is limited by no reserve requirement, and his earnings vary with the volume of paper placed; therefore, he may be a factor in en couraging expansion beyond the rules of prudence. The borrower is prone to think of frequently renewed borrowings as permanent capital and not make provision for meeting them at maturity. The banker cannot test the solvency of the borrower by requiring a yearly "clean up," for the broker will simply shift his borrow ings to other areas or banks.
Probably the most serious objection by banks to the note broker has been the competition to which he has subjected them. He gathers idle funds from all parts of the country where interest rates are low, and gives them to borrowers who would otherwise have to pay high local rates. In times and places of easy money the competition between brokers and banks becomes very keen.
The brokers also compete keenly against each other to get and maintain customers. They may offer some paper at very low prices in order to dispose of other less desirable paper along with it. A demoralization of rates follows. Since brokers have bought the paper outright, any fall in discount rates adds to their profits; accordingly their efforts are bent constantly to lower those rates. They probably tend to make the rates more sensitive and fluc tuating. In times and places of high money they absent them selves and let the local banks withstand the situation alone. The brokers not only tend to rob the local banks of customers, but those banks are called upon by the brokers to testify as to the credit title of the customers they are seeking to wean away.
Volume of Open-Market Borrowing According to the Bank Service Department of the National Credit Office, 3,676 concerns, each with a capital in excess of $25o,000, sold notes in the open market between January 1, 1920, and July 1, 1921. These concerns are among the most widely known traders and manufacturers in the United States, in every industry. The classification according to trades of these open-market names is as follows: dry goods, 31.5 per cent; foodstuffs, 22.3 per cent; rubber tires and leather shoes, 8.8 per cent; lumber, furniture, and paper, 6.2 per cent; hardware and automobiles, 17 per cent. The total amount of open-market paper sold during this period by note-brokers was approximately $4,000,000,000, and of this, $3,896,000,000 was liquidated at par without effort on the part of the holding banker. The net loss to the banking community on the total purchases is estimated at .0047 per cent.
The Registration of Paper Sold in Open Market If several brokers are employed by the same concern there can be no effective check on the amount of paper issued, and credit inflation is facilitated. As a safeguard, the registration of all paper sold in open market has been proposed. Registration will certify the authenticity of the paper and the regularity of the issue; this certification is fairly well done now by note-brokers, but registration would make it invariable. Registration will also check and make it possible to know definitely the amount out standing. The need of such information was demonstrated by the famous Claflin failure and the default of its receivables. Registration in this case would have apprized the banks of the amount issued and the danger incurred.