We can now take up directly the state ments of those who criticize the size of bank ers' profits and who declare that they are an unwarranted charge on the community. Usually the critic accompanies his criticism with the advice that the corporations should seek their capital directly from the capitalist and cut out the banking-house middleman and its profits. We have already mentioned several reasons why the corporations are not successful when they attempt to do this, and have shown under what circumstances a corporation can, on appealing to its stock holders, get directly to the capitalist. Let us examine this charge of undue profits to the investment banker.
Such critics charge investment bankers with making a profit of two and a half per cent and sometimes as much as five or ten per cent. It is true that the difference be tween the price the banker pays for the se curities and the price at which he expects to sell them does range from about one per cent to the higher figure charged against them. The banking house bases its purchase price on its estimate of what it can sell the securities for. When the banker has decided on what price he can probably get for the se curities, he offers the issuer a price of one point or more below this. The amount of dif ference he makes between his anticipated sell ing price and the price he offers to the issuer, he bases on the length of time the securities have to run, market conditions, and the probable amount of expense and labor in volved in selling them. He can afford to make a smaller gross profit on short-time securities, not only because ordinarily they are easier to sell, but also because when they fall due he may have a chance to reinvest the fund and make another profit. Market conditions will influence him because, if they are stable, the transaction does not involve as much risk as when they are unstable; there is less chance that changing financial conditions will force him to sell at a lower price than he paid. If current interest rates are high, he will also have to take into con sideration the possibility of loss on the in terest account. Most of all, the probable difficulty of selling the securities will influ ence him. If they are of the kind which, how ever secure, will require a large amount of personal effort and consequently, under the most favorable conditions, can be disposed of only from day to day over a considerable period of time, the banker will have to esti mate a charge for the cost of selling, includ ing the tying-up of his capital, and also for the risk of change in market conditions in volved in the length of time necessary to complete the transaction.
Let us compare the profit the investment banker hopes to make with charges for serv ice in other forms of financial work. Brokers in real estate mortgages make a minimum charge of one per cent for negotiating the highest grade of real estate mortgages on New York City property. Such mortgages as they will handle on a one per cent com mission are a legal investment for New York savings banks.
When dealing in bonds that are a legal savings bank investment, the investment banker, acting only as a broker in the trans action, often charges as little as one six teenth of one per cent and sometimes only one thirty-second of one per cent. The us ual commission for selling securities of this character is one eighth of one per cent, or $1.25 per $1000 bond.
If a mortgage on improved property in New York City exceeds in the slightest de gree three fifths of the appraised value of the property, it is not a legal investment for the savings banks. For mortgages which do not fall within the savings bank class the broker immediately advances his rate of commission to two per cent or more. His risk is not increased, for he assumes no risk or responsibility. He does not buy the se curity as does an investment banker the securities he deals in. The mortgage broker charges the increased commission because he finds it harder work to locate a buyer for a mortgage which does not fall within the legal limitations of a savings bank invest ment. There is a broad market for invest ments within the savings bank class and it is not difficult to convince an investor of the merits of such a security.
The difference between these two rates of commission does not express the full situa tion. The mortgage may run for only three years, the bond for thirty years. When the mortgage falls due, it may be paid off. Then the broker will have another chance to make a commission on selling the investor a new mortgage. But the bond broker may not for thirty years have an opportunity to re invest for his client the capital placed in bonds. Investment bankers are fully aware of the value to them of more frequent periods in the investment of capital and are glad to handle short-term securities, one maturing, say, in three or five years, on a smaller anti cipation of profit than that sought for han dling a long-term bond.