3. Effect of world war on market.—The market for such obligations has been limited, tho corporate notes have been growing rapidly in popularity since the outbreak of the European war. They have been purchased in the past mainly by investment bankers and certain large private investors, who have funds temporarily idle and who are glad, pending other permanent investment, to receive the five or six per cent interest which such notes bear instead of the lower rate obtainable from the bank deposits or bonds. During the war, yields on such loans have ruled be tween six and eight per cent.
Since the outbreak of the European war, financing in this form has become quite general, both in the United States and Canada, altho of very recent adop tion in the latter country. Government issues of long-term notes, known as treasury notes or treasury bills, have long been issued by various nations, includ ing the United States. Many commercial banks have, within the past few years, invested for the first time in such obligations, because the interest rate on prime commercial paper was low, money plentiful and the bond market uncertain during the first two years of war. During this period, bond prices were low, due largely to the tremendous new issues of foreign gov ernment bonds at high interest rates. When the United States finally began hostilities after nearly three years of forbearance, money rates rose rapidly, owing to the vast demands of government financing; and the market for corporation notes suffered curtail ment along with all other private issues. The educa tion of investors in the purchase of corporation notes will be a valuable help to future corporation financing, but contains elements of danger that will presently be pointed out.
Altho corporation notes have been sold by note brokers in the same manner as the sixty and ninety day obligations of large corporations are sold to out side banks, they are at the present time mainly mar keted thru large investment bankers, who underwrite the issues or undertake their sale in much the same manner as bonds are underwritten and sold. The principal business of the note broker is to sell the thirty, sixty or ninety-day paper of commercial or ganizations to banks and to some few private inves tors, who prefer to invest their surplus funds in the more liquid form of commercial paper than in bonds.
4. Operations of note brokers.—Perhaps an ac count of the operation of note brokers should have been included in the chapter dealing with bank loans. In brief, it may be stated that they either purchase outright and sell at a profit, without indorsement, the commercial paper of large companies, or else market this paper upon a commission basis. Their clients consist mainly of bankers, who, thru the constant in vestment of surplus funds, become acquainted with the credit of these large companies, altho having no direct banking connection with them. Such commer cial paper is usually not secured by collateral and bears the current rate of interest on accommodation loans. The sales usually are made by personal call by the broker or his representative upon the banker, the broker displaying his collection of paper, or dupli cates thereof, for the inspection of the banker, who selects the pieces which he desires to buy. Settlement is made then and there, or upon receipt of the original, if the banker has purchased from a duplicate.
The operation of note brokers, while conferring certain benefits by the more active distribution of idle funds, has not been altogether advantageous. By scattering notes broadcast instead of selling them thru their own direct bank connections, some corporations have been able to obtain current credit out of all pro portion to the amount they are entitled to receive. One concern in Boston which failed a few years ago, was found to have notes outstanding aggregating sev eral times its entire assets, these notes having been dis tributed by brokers as far West as St. Louis and even thruout Canada.
It is probable that the active use of the credit files of the Federal Reserve system, in cooperation with state bank examiners and clearing house associations, will minimize the dangers of the practice of distribut ing commercial paper thru note brokers, at the same time retaining the benefits accruing therefrom. It should be noted that the evils of this practice arise entirely from the discount of accommodation paper, and would not be possible if the discounts were in the nature of trade acceptances or the notes of customers rediscounted in the open market.