Adjusting the Pendulum

by JONATHAN C. ROYLE

THE swing of the speculative pendulum must be regulated. That is as obvious to financiers, business men, and economists as the fact that the swing of a clock pendulum too far one way or the other must wreck the mechanism of a timepiece. The movement of speculation from the high point of 1929 to the equally unnatural low point of 1932 is likely to be repeated with even more disastrous results unless it is controlled.

The banks are the natural regulators of such movements. To them the country must look for protection against this potential speculative danger. All who are concerned with the financial condition of this country agree that the banks can and should furnish this protection. Senator Carter Glass declares that the depression from 1929 to 1932 can be laid at the door of ’unsound credit and banking conditions. He traces the history of the movement through a steady increase in bank security loans and investments, increasing security demand, rising prices, growth of the volume of stock-exchange transactions, and multiplicity of new issues, to the violent fluctuations which caused the Collapse of the bull movement of its own weight.

The Virginia Senator believes that bank protection should be assured by regulatory laws. Other financiers, agreeing as to the necessity for safety, believe the bankers have learned enough from the events of the last three years to be willing and able to restrain speculation voluntarily.

How are they going to control this danger? They cannot or will not control the prices of stocks in the open market. They have shown that, But they can control the volume of trading by curbing the amount of money provided for what they know to be speculative purposes. Even this will not be possible unless some of them revise their own policies and clean their own houses. The directors of banks undoubtedly will take a more active and conscientious part in the affairs of their institutions than ever before. Hanking styles will change back to those of a simpler period, and the ‘big profit’ executives will be gently but firmly repressed, in many instances being kicked upstairs on to high executive seats where they will have few possibilities for action. For the banks were bitten by the easy-money bug just as surely as was the public.

The first thing for the banks to do is to take measures to regain some of the confidence and good will of the public which unquestionably they havelost.

The period prior to the big stock-market advance marked the entry of many banks into side lines. They bought theatre tickets for customers, put their children in school and paid them pocket money, provided mourners at funerals, bought circuses and side shows for customers on the other side of the world, and added merchandise like a chain drug store. Once the business of the commercial banker consisted largely of taking the money deposited by clients and lending it safely on sound security at a legal rate of interest. This basic function became almost a side line with some.

No small part of the blame for the depression is laid at the door of ’banking affiliates.’ It is declared that they were factors in overdevelopment of security loans and were utilized at times for the making of speculative profits and the incurring of hazardous risks. The opponents of the affiliate system explain it in this way. Bank presidents, they say, were anxious to make big profits to impress their directors and stockholders. The sound old 6 per cent looked small and unattractive. The 10, 12, 14, and 16 per cent rates on call money beckoned, and the bankers responded. They lent money — millions of it — on stocks on the basis of unwarranted high prices for the securities. So great became the volume of business that the old stock list did not provide a broad enough field, and new companies were formed, sponsored, and their securities underwritten and sold. In other words, the banks went into the investment banking field instead of sticking to commercial business. When the break came, many banks were left holding a hot potato which burned their fingers badly, but -which they were afraid immediately to drop.

Bank directors are human even if some borrowers refuse to believe it, and it was natural that a goodly number should accept the big profits without worrying greatly about how they grew. But, when great losses loomed, their indifference fell away. Bank presidents were called on the carpet so often that they wore out the rugs in directors rooms. ’What kind of banking is this?' demanded directors, and presidents departed, walking very, very softly. Many who had recently reached forward for profits now began to stand so straight in conservatism that they leaned backward.

It has always been the assertion of the banks that they had ample money to lend on prime commercial paper, specifying that it must bear ‘good names,’ but many would-be borrowers found it difficult if not impossible to get it. Concerns to which bank’s were willing and anxious to lend money did not have to borrow. As a result, Senator Glass, a former Secretary of the Treasury, declared that, of the $10,261,648,000 hoarded in February 1932, $8,561,648,000 was hoarded by the banks.

As the depression continued to grow more severe, liquidity became the motto and war cry of the banking institutions. Stocks were thrown on the market, loans were called on every side, and in a majority of cases the money realized was put into short-term government securities. The banks, with the exception of some of the smaller units, improved their liquidity, but economists are still disputing bitterly as to whether they did not weaken their own positions in so doing. As one economist pointed out, it was possible for a bank’s assets to be made liquid, but it was totally impossible for all banks to liquidate at the same time, however much they might desire to do so. In other words, no security, not even those of the United States Government, is liquid unless there is a purchaser for it, and if the volume of securities exceeds the purchasing power or desire of the public, those securities cease to be liquid except at a drop in price which will provide more buyers.

Liquidity was carried to extremes, according to many authorities. For example, one New York bank has deposits of $240,000,000. One of its executives asserts that the institution could pay $205,000,000 in cash within thirty-six hours. It is a physical impossibility for that sum, in accounts of various sizes ranging from a few hundred dollars up, to be paid out in such a brief space of time, and the precautions were, to that extent at least, unnecessary. There has never been a bank run yet where payment of more than 25 per cent of the deposits was demanded immediately.

The calling of loans, whether necessary and wise or not, lost the banks both customers and good will. The following will show how this worked in some cases. There is a department store in New York in an extremely strong financial position, and its bankers had been urging the concern to borrow money from them. In the meantime, the bank had called a loan for a few thousand dollars on a florist who had rented a department in the big store and who had given as security Long Island property valued at $500,000. The florist was about to go to the wall when the department store decided to borrow from the bank. It immediately lent the amount necessary to the florist, who is back on his feet again. Thus the department store went profitably into the banking business.

Some firms, disgruntled at the policies of the banks, are doing their own banking just as some underwrite their own insurance. Considerable sums have flowed over the border for deposit in Canadian banks. It is worthy of note that there has not been a bank failure in Canada in two decades, while there has been but one week without a failure in the United States since the fall of 1929. Hoarding has now been pretty well checked, but, owing to resentment, a good part of the released cash has not found its way back to the bank vaults.

These conditions are already in process of correction. Even the bank presidents are being blamed somewhat unjustly. If they lent money on stocks, at least the stocks had a market, and could be realized upon at a moment’s notice when some other assets could not be liquidated at any price. The tendency to lean backward is gradually passing, for executives know that they owe it to their stockholders to make a profit, and there is no profit in hoarding. At the moment they know that if their loan policies turn out right it will be declared ‘business foresight,’ but if they turn out wrong it will be dubbed ‘overexpansion.’ But they are looking forward to the verdict of ‘business foresight’ with a brighter eye.

More responsibility is being placed daily on the directors, and individual directors are being made responsible for decisions upon matters with which they are most familiar. Finally, business getters are being shunted to one side and business keepers are at a premium. Many bankers will welcome gladly a return to the old commercial banking policies. They went into side lines and the; investment banking field because they were forced into them by competition. Most of them regarded it as ‘window dressing’ at best. As one executive of a huge institution in New York said: ’A bank is just like a drug store. Competition is keen. There are too many banks. If your competitor has an attractive window display, you must have something to meet it.’

The banks, if they are to curb further speculative frenzy, must regain the confidence of their customers, No depositor seriously doubts the absolute honesty of his banker. If he did, he would take his money elsewhere. But in the last three years he has seen his banker make what be thinks are grave mistakes, and the advice of the financier is therefore at a discount. Bankers know this and are extremely reticent. If a customer came into the ordinary bank to-day and asked the time, the banker would hesitate to tell him for fear the Naval Observatory clock might be wrong. That, however, is only a passing phase, and its passage will be materially aided by the certified public accountants who are tightening the lines appreciably in an effort to give the public a true picture of corporate positions.

The Class A accounting houses will brook no compromise in their effort to give accurate reports of conditions to the public. The following example may serve as an illustration. A famous accounting house was engaged to prepare the semiannual statement of a great corporation. As is usual, the accountants made a rough draft, which was submitted to the executive committee of the board of the corporation before the final report was written. In effect, this is to show those facts which can be expressed in the certified statement in only one way and those which can be expressed in either of two ways with equal honesty.

Argument arose as to whether a larger sum should be included under expense or capital investment. Much was said on each side, and finally the corporation executive lost his temper and said that if the firm would not write and certify the statement as he wanted it the corporation would dispense with the services of the accountants and would not pay them one cent. The accountants reached for their hats, declaring they would take their staff off the work and would not try to collect a cent of the $25,000 due them; but that if they did so no other Class A accounting firm would sign one of the corporation’s statements ’this year, next year, or evermore.’ They received an apology and did not walk off the job.