About this time the 'popular sales' of Baltimore
and Philadelphia attracted my attention.
and Philadelphia attracted my attention.
Louis Brandeis - 1914 - Other People's Money, and How Bankers Use It
handle.
net/2027/uc1.
32106000978228 Public Domain, Google-digitized / http://www.
hathitrust.
org/access_use#pd-google
? 110 OTHER PEOPLE'S MONEY
municipalities pay toll to the banker on all
bonds sold. Why should they? It is not be-
cause the banker is always needed. It is because
the banker controls the only avenue through
which the investor in bonds and stocks can or-
dinarily be reached. The banker has become the
universal tax gatherer. True, the pro rata
of taxes levied by him upon our state and city
governments is less than that levied by him upon
the corporations. But few states or cities escape
payment of some such tax to the banker on every
loan it makes. Even where the new issues of
bonds are sold at public auction, or to the highest
bidder on sealed proposals, the bankers' syndicates
usually secure large blocks of the bonds which
are sold to the people at a considerable profit.
The middleman, even though unnecessary, col-
lects his tribute.
There is a legitimate field for dealers in state
and municipal bonds, as for other merchants.
Investors already owning such bonds must have
a medium through which they can sell their
holdings. And those states or municipalities
which lack an established reputation among
investors, or which must seek more distant
markets, need the banker to distribute new issues.
But there are many states and cities which have
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? SUPERFLUOUS BANKERS 111
an established reputation and have a home
market at hand. These should sell their bonds
direct to investors without the intervention of a
middleman. And as like conditions prevail with
some corporations, their bonds and stocks should
also be sold direct to the investor. Both financial
efficiency and industrial liberty demand that the
bankers' toll be abolished, where that is possible.
The business of the investment banker must
not be confused with that of the bond and stock
broker. The two are often combined; but the
functions are essentially different. The broker
performs a very limited service. He has properly
nothing to do with the original issue of securities,
nor with^their introduction into the market. He
merely negotiates a purchase or sale as agent for
another under specific orders. He exercises no
discretion, except in the method of bringing
buyer and seller together, or of executing orders.
For his humble service he receives a moderate
compensation, a commission, usually one-eighth
of one per cent. (12 1/2 cents for each $100) on
the par value of the security sold. The invest-
ment banker also is a mere middleman. But he
is a principal, not an agent. He is also a merchant
BANKER AND BBOKEB
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? 112 OTHER PEOPLE'S MONEY
in bonds and stocks. The compensation received
for his part in the transaction is in many cases
more accurately described as profit than as com-
mission. So far as concerns new issues of
government, state and municipal bonds, espe-
cially, he acts as merchant, buying and selling
securities on his own behalf; buying commonly
at wholesale from the maker and selling at retail
to the investors; taking the merchant's risk and
the merchant's profits. On purchases of corpo-
rate securities the profits are often very large;
but even a large profit may be entirely proper;
for when the banker's services are needed and
are properly performed, they are of great value.
On purchases of government, state and munic-
ipal securities the profit is usually smaller; but
even a very small profit cannot be justified, if
unnecessary.
HOW THE BANKER CAN SERVE
The banker's services include three distinct
functions, and only three:
First: Specifically as expert. The investment
banker has the responsibility of the ordinary
retailer to sell only that merchandise which is
good of its kind. But his responsibility in this
respect is unusually heavy, because he deals in an
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? SUPERFLUOUS BANKERS 118
article on which a great majority of his customers
are unable, themselves, to pass intelligent judg-
ment without aid. The purchase by the investor
of most corporate securities is little better than a
gamble, where he fails to get the advice of some
one who has investigated the security thoroughly
as the banker should. For few investors have the
time, the facilities, or the ability to investigate
properly the value of corporate securities.
Second: Specifically as distributor. The banker
performs an all-important service in providing
an outlet for securities. His connections enable
him to reach possible buyers quickly. And good-
will--that is, possession of the confidence of regu-
lar customers--enables him to effect sales where
the maker of the security might utterly fail to
find a market.
Third: Specifically as jobber or retailer. The
investment banker, like other merchants, carries
his stock in trade until it can be marketed. In
this he performs a service which is often of great
value to the maker. Needed cash is obtained
immediately, because the whole issue of securities
can thus be disposed of by a single transaction.
And even where there is not immediate payment,
the knowledge that the money will be provided
when needed is often of paramount importance.
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? 114 OTHER PEOPLE'S MONEY
By carrying securities in stock, the banker per-
forms a service also to investors, who are thereby
enabled to buy securities at such times as they
desire.
Whenever makers of securities or investors
require all or any of these three services, the
investment banker is needed, and payment of
compensation to him is proper. Where there is
no such need, the banker is clearly superfluous.
And in respect to the original issue of many of our
state and municipal bonds, and of some corporate
securities, no such need exists.
It needs no banker experts in value to tell us
that bonds of Massachusetts or New York, of
Boston, Philadelphia or Baltimore and of scores
of lesser American cities, are safe investments.
The basic financial facts in regard to such bonds
are a part of the common knowledge of many
American investors; and, certainly, of most pos-
sible investors who reside in the particular state
or city whose bonds are in question. Where the
financial facts are not generally known, they are
so simple, that they can be easily summarized and
understood by any prospective investor without
interpretation by an expert. Bankers often
WHEEE THE BANKER SERVES NOT
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? SUPERFLUOUS BANKERS 11&
employ, before purchasing securities, their own.
accountants to verify the statements supplied by
the makers of the security, and use these account-
ants' certificates as an aid in selling. States and
municipalities, the makers of the securities,
might for the same purpose employ independent
public accountants of high reputation, who would
give their certificates for use in marketing the
securities. Investors could also be assured with-
out banker-aid that the basic legal conditions are
sound. Bankers, before purchasing an issue of
securities, customarily obtain from their own
counsel an opinion as to its legality, which inves-
tors are invited to examine. It would answer
the same purpose, if states and municipalities
should supplement the opinion of their legal
representatives by that of independent counsel
of recognized professional standing, who would
certify to the legality of the issue.
Neither should an investment banker be needed
to find investors willing to take up, in small lots,
a new issue of bonds of New York or Massa-
chusetts, of Boston, Philadelphia or Baltimore, or
a hundred other American cities. A state or
municipality seeking to market direct to the
investor its own bonds would naturally experi-
ence, at the outset, some difficulty in marketing a
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? 116 OTHER PEOPLE'S MONEY
large issue. And in a newer community, where
there is little accumulation of unemployed capital,
it might be impossible to find buyers for any large
issue. Investors are apt to be conservative;
and they have been trained to regard the inter-
vention of the banker as necessary. The bankers
would naturally discourage any attempt of states
and cities to dispense with their services. En-
trance upon a market, hitherto monopolized by
them, would usually have to be struggled for.
But banker-fed investors, as well as others could,
in time, be brought to realize the advantage of
avoiding the middleman and dealing directly with
responsible borrowers. Governments, like private
concerns, would have to do educational work; but
this publicity would be much less expensive and
much more productive than that undertaken by
the bankers. Many investors are already impa-
tient of banker exactions; and eager to deal
directly with governmental agencies in whom they
have more confidence. And a great demand Cv. old,
at once, be developed among smaller investor*
whom the bankers have been unable to interest,
and who now never buy state or municipal bonds.
The opening of this new field would furnish a mar-
ket, in some respects more desirable and certainty
wider than that now reached by the bankers.
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? SUPERFLUOUS BANKERS 117
Neither do states or cities ordinarily need the
services of the investment banker to carry their
bonds pending distribution to the investor.
Where there is immediate need for large funds,
states and cities--at least the older communities
--should be able to raise the money temporarily,
quite as well as the bankers do now, while await-
ing distribution of their bonds to the investor.
Bankers carry the bonds with other people's
money, not with their own. Why should not
cities get the temporary use of other people's
money as well? Bankers have the preferential
use of the deposits in the banks, often because
they control the banks. Free these institutions
from banker-control, and no applicant to borrow
the people's money will be received with greater
favor than our large cities. Boston, with its
$1,500,000,000 of assessed valuation and $78,033,-
128 net debt, is certainly as good a risk as even
Lee, Higginson & Co. or Kidder, Peabody & Co.
But ordinarily cities do not, or should not,
require large sums of money at any one time.
Such need of large sums does not arise except
from time to time where maturing loans are to be
met, or when some existing public utility plant
is to be taken over from private owners. Large
issues of bonds for any other purpose are usually
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? 118 OTHER PEOPLE'S MONEY
made in anticipation of future needs, rather than
to meet present necessities. Modern efficient
public financiering, through substituting serial
bonds for the long term issues (which in Massa-
chusetts has been made obligatory) will, in time,
remove the need of large sums at one time for
paying maturing debts, since each year's maturi-
ties will be paid from the year's taxes. Purchases
of existing public utility plants are of rare occur-
rence, and are apt to be preceded by long periods
of negotiation. When they occur they can, if
foresight be exercised, usually be financed without
full cash payment at one time.
Today, when a large issue of bonds is made, the
banker, while ostensibly paying his own money to
the city, actually pays to the city other people's
money which he has borrowed from the banks.
Then the banks get back, through the city's de-
posits, a large part of the money so received. And
when the money is returned to the bank, the
banker has the opportunity of borrowing it again
for other operations. The process results in
double loss to the city. The city loses by not
getting from the banks as much for its bonds as
investors would pay. And then it loses interest
on the money raised before it is needed. For the
bankers receive from the city bonds bearing rarely
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? SUPERFLUOUS BANKERS 119
less than 4 per cent. interest; while the proceeds
are deposited in the banks which rarely allow
more than 2 per cent. interest on the daily
balances.
CITIES THAT HELPED THEMSELVES
In the present year some cities have been led by
necessity to help themselves. The bond market
was poor. Business was uncertain, money tight
and the ordinary investor reluctant. Bankers
were loth to take new bond issues. Municipali-
ties were unwilling to pay the high rates de-
manded of them. And many cities were prohib-
ited by law or ordinance from paying more than
4 per cent. interest; while good municipal bonds
were then selling on a 4 1/2 to 5 per cent. basis.
But money had to be raised, and the attempt was
made to borrow it direct from the lenders instead
of from the banker-middleman. Among the
cities which raised money in this way were Phila-
delphia, Baltimore, St. Paul, and Utica, New
York.
Philadelphia, under Mayor Blankenburg's
inspiration, sold nearly $4,175,000 in about two
days on a 4 per cent. basis and another "over-the-
counter" sale has been made since. In Balti-
more, with the assistance of the Sun, $4,766,000
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? 120 OTHER PEOPLE'S MONEY
were sold "over the counter" on a 4 1/2 per cent.
basis. Utica's two "popular sales" of 41/2
per cent. bonds were largely "over-subscribed. "
And since then other cities large and small
have had their "over-the-counter" bond sales.
The experience of Utica, as stated by its Control-
ler, Fred G. Reusswig, must prove of general
interest:
"In June of the present year I advertised for
sale two issues, one of $100,000, and the other of
$19,000, bearing interest at 4 1/2 per cent. The
latter issue was purchased at par by a local bidder
and of the former we purchased $10,000 for our
sinking funds. That left $90,000 unsold, for
which there were no bidders, which was the first
time that I had been unable to sell our bonds.
About this time the 'popular sales' of Baltimore
and Philadelphia attracted my attention. The
laws in effect in those cities did not restrict the
officials as does our law and I could not copy their
methods. I realized that there was plenty of
money in this immediate vicinity and if I could
devise a plan conforming with our laws under
which I could make the sale attractive to small
investors it would undoubtedly prove successful.
I had found, in previous efforts to interest people
of small means, that they did not understand the
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? SUPERFLUOUS BANKERS 121
meaning of premium and would rather not buy
than bid above par. They also objected to mak-
ing a deposit with their bids. In arranging for
the 'popular sales' I announced in the papers
that, while I must award to the highest bidder, it
was my opinion that a par bid would be the highest
bid. I also announced that we would issue bonds
in denominations as low as $100 and that we
would not require a deposit except where the bid
was $5,000 or over. Then I succeeded in getting
the local papers to print editorials and local
notices upon the subject of municipal bonds, with
particular reference to those of Utica and the
forthcoming sale. All the prospective purchaser
had to do was to fill in the amount desired,
sign his name, seal the bid and await the day
for the award. I did not have many bidders for
very small amounts. There was only one for
$100 at the first sale and one for $100 at the
second sale and not more than ten who wanted
less than $500. Most of the bidders were looking
for from $1,000 to $5,000, but nearly all were peo-
ple of comparatively small means, and with some
the investment represented all their savings. In
awarding the bonds I gave preference to residents
of Utica and I had no difficulty in apportioning
the various maturities in a satisfactory way.
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? 122 OTHER PEOPLE'S MONEY
"I believe that there are a large number of per-
sons in every city who would buy their own bonds
if the way were made easier by law. Syracuse
and the neighboring village of Ilion, both of which
had been unable to sell in the usual way, came to
me for a program of procedure and both have
since had successful sales along similar lines.
We have been able by this means to keep the
interest rate on our bonds at 4 1/2 per cent. , while
cities which have followed the old plan of relying
upon bond houses have had to increase the rate
to 5 per cent. I am in favor of amending the law
in such a manner that the Common Council,
approved by the Board of Estimate and Appor-
tionment, may fix the prices at which bonds shall
be sold, instead of calling for competitive bids.
Then place the bonds on sale at the Controller's
office to any one who will pay the price. The
prices upon each issue should be graded according
to the different values of different maturities.
Under the present law, as we have it, conditions
are too complies <<k! to make a sale practicable
except upon a basis of par bids. "
THE ST. PAUL EXPERIMENT
St. Paul wisely introduced into its experiment a
more democratic feature, which Tom L. Johnson,
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? SUPERFLUOUS BANKERS 12S
Cleveland's great mayor, thought out (but did not
utilize), and which his friend W. B. Colver, now
Editor-in-Chief of the Daily News, brought to the
attention of the St. Paul officials. Mayor John-
son had recognized the importance of reaching the
small savings of the people; and concluded that
it was necessary not only to issue the bonds in
very small denominations, but also to make them
redeemable at par. He sought to combine
practically, bond investment with the savings
bank privilege. The fact that municipal bonds
are issuable ordinarily only in large denomina-
tions, say, $1,000, presented an obstacle to be
overcome. Mayor Johnson's plan was to have
the sinking fund commissioners take large blocks
of the bonds, issue against them certificates in
denominations of $10, and have the commis-
sioners agree (under their power to purchase
securities) to buy the certificates back at par and
interest. Savings bank experience, he insisted,
showed that the redemption feature would not
prove an embarrassment; as the percentage of
those wishing to withdraw their money is small;
and deposits are nearly always far in excess of
withdrawals.
The St. Paul sinking fund commissioners and
City Attorney O'Neill approved the Johnson
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? 124 OTHER PEOPLE'S MONEY
plan; and in the face of high money rates, sold on
a 4 per cent. basis, during July, certificates to the
net amount of $502,300; during August, $147,-
000; and during September, over $150,000, the
average net sales being about $5,700 a day.
Mr. Colver, reporting on the St. Paul experience,
said:
"There have been about 2,000 individual pur-
chasers making the average deposit about $350
or $360. There have been no certificates sold
to banks. During the first month the deposits
averaged considerably higher and for this reason:
in very many cases people who had savings which
represented the accumulation of considerable
time, withdrew their money from the postal sav-
ings banks, from the regular banks, from various
hiding places and deposited them with the citv.
Now these same people are coming once or fa ice
a month and making deposits of ten or twenty
dollars, so that the average of the individual
deposit has fallen very rapidly during September
and every indication is that the number of small
deposits will continue to increase and the rela-
tively large deposits become less frequent as
time goes on.
As a matter of fact, these certificate deposits
are stable, far more than the deposits and invest-
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? SUPERFLUOUS BANKERS 125
ments of richer people who watch for advanta-
geous reinvestments and who shift their money
about rather freely. The man with three or
four hundred dollars savings will suffer almost
anything before he will disturb that fund. We
believe that the deposits every day here, day in
and day out, will continue to take care of all the
withdrawals and still leave a net gain for the day,
that net figure at present being about $5,700 a
day. "
Many cities are now prevented from selling
bonds direct to the small investors, through laws
which compel bonds to be issued in large denomi-
nations or which require the issue to be offered
to the highest bidder. These legislative limita-
tions should be promptly removed.
SALESMANSHIP AND EDUCATION
Such success as has already been attained is
largely due to the unpaid educational work of
leading progressive newspapers. But the educa-
tional work to be done must not be confined to
teaching "the people"--the buyers of the bonds.
Municipal officials and legislators have quite as
much to learn. They must, first of all, study
salesmanship. Selling bonds to the people is a
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? 126 OTHER PEOPLE'S MONEY
new art, still undeveloped. The general problems
have not yet been worked out. And besides
these problems common to all states and cities,
there will be, in nearly every community, local
problems which must be solved, and local difficul-
ties which must be overcome. The proper solu-
tion even of the general problems must take con-
siderable time. There will have to be many ex-
periments made; and doubtless there will be many
failures. Every great distributor of merchandise
knows the obstacles which he had to overcome
before success was attained; and the large sums
that had to be invested in opening and preparing
a market. Individual concerns have spent mil-
lions in wise publicity; and have ultimately reaped
immense profits when the market was won.
Cities must take their lessons from these great
distributors. Cities must be ready to study the
problems and to spend prudently for proper pub-
licity work. It might, in the end, prove an econ-
omy, even to allow, on particular issues, where nec-
essary, a somewhat higher interest rate than bank-
ers would exact, if thereby a direct market for
bonds could be secured. Future operations would
yield large economies. And the obtaining of a
direct market for city bonds is growing ever more
important, because of the huge increase in loans
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? SUPERFLUOUS BANKERS 127
which must attend the constant expansion of
municipal functions. In 1898 the new munic-
ipal issues aggregated $103,084,793; in 1912,
$380,810,287.
In New York, Massachusetts and the other
sixteen states where a system of purely mutual
savings banks is general, it is possible, with a
little organization, to develop an important mar-
ket for the direct purchaser of bonds. The
bonds issued by Massachusetts cities and towns
have averaged recently about $15,000,000 a year,
and those of the state about $3,000,000. The 194
Massachusetts savings banks, with aggregate
assets of $902,105,755. 94, held on October 31,
1912, $90,536,581. 32 in bonds and notes of states
and municipalities. Of this sum about $60,000,-
000 are invested in bonds and notes of Massa-
chusetts cities and towns, and about $8,000,000 in
state issues. The deposits in the savings banks
are increasing at the rate of over $30,000,000 a
year. Massachusetts state and municipal bonds
have, within a few years, come to be issued tax
exempt in the hands of the holder, whereas other
classes of bonds usually held by savings banka
are subject to a tax of one-half of one per cent.
SAVINGS BANKS AS CUSTOMERS
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? 128 OTHER PEOPLE'S MONEY
of the market value. Massachusetts savings
banks, therefore, will to an increasing extent, se-
lect Massachusetts municipal issues for high-grade
bond investments. Certainly Massachusetts cit-
ies and towns might, with the cooperation of the
Commonwealth, easily develop a "home market"
for "over-the-counter" bond business with the
savings banks. And the savings banks of other
states offer similar opportunities to their munici-
palities.
COOPERATION
Bankers obtained their power through com-
bination. Why should not cities and states
by means of cooperation free themselves from
the bankers? For by cooperation between the
cities and the state, the direct marketing of
municipal bonds could be greatly facilitated.
Massachusetts has 33 cities, each with a popu-
lation of over 12,000 persons; 71 towns each
with a population of over 5,000; and 250 towns
each with a population of less than 5,000. Three
hundred and eight of these municipalities now
have funded indebtedness outstanding. The
aggregate net indebtedness is about $180,000,000.
Every year about $15,000,000 of bonds and notes
are issued by the Massachusetts cities and town!
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? SUPERFLUOUS BANKERS 129
for the purpose of meeting new requirements and
refunding old indebtedness. If these munici-
palities would cooperate in marketing securities,
the market for the bonds of each municipality
would be widened; and there would exist also a
common market for Massachusetts municipal
securities which would be usually well supplied,
would receive proper publicity and would attract
investors. Successful merchandising obviously
involves carrying an adequate, well-assorted
stock. If every city acts alone, in endeavoring
to market its bonds direct, the city's bond-selling
activity will necessarily be sporadic. Its ability
to supply the investor will be limited by its own
necessities for money. The market will also be
limited to the bonds of the particular municipal-
ity. But if a state and its cities should cooperate,
there could be developed a continuous and broad
market for the sale of bonds "over-the-counter. "
The joint selling agency of over three hundred
municipalities,--as in Massachusetts--would natu-
rally have a constant supply of assorted bonds
and notes which could be had in as small amounts
as the investor might want to buy them. It
would be a simple matter to establish such a
joint selling agency by which municipalities,
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? 130 OTHER PEOPLE'S MONEY
under proper regulation of, and aid from the
state, would cooperate.
And cooperation among the cities and with the
state might serve in another important respect.
These 354 Massachusetts municipalities carry in
the aggregate large bank balances. Sometimes
the balance carried by a city represents unex-,
pended revenues; sometimes unexpended pro-
ceeds of loans. On these balances they usually
receive from the banks 2 per cent. interest. The
balances of municipalities vary like those of other
depositors; one having idle funds, when another
is in need. Why should not all of these cities
and towns cooperate, making, say, the State their
common banker, and supply each other with
funds as farmers and laborers cooperate through
credit unions? Then cities would get, instead of
2 per cent. on their balances, all their money
was worth.
The Commonwealth of Massachusetts holds
now in its sinking and other funds nearly $30,000-
000 of Massachusetts municipal securities, con-
stituting nearly three-fourths of all securities held
in these funds. Its annual purchases aggregate
nearly $4,000,000. Its purchases direct from
cities and towns have already exceeded $1,000,000
this year. It would be but a simple extension of
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? SUPERFLUOUS BANKERS 131
the state's function to cooperate, as indicated, in
a joint, Municipal Bond Selling Agency an dCredit
Union. It would be a distinct advance in the
efficiency of state and municipal financing;
and what is even more important, a long step
toward the emancipation of the people from
banker-control.
Strong corporations with established reputa-
tions, locally or nationally, could emancipate
themselves from the banker in a similar manner.
Public-service corporations in some of our leading
cities could easily establish "over-the-counter"
home markets for their bonds; and would be
greatly aided in this by the supervision now being
exercised by some state commissions over the
issue of securities by such corporations. Such
corporations would gain thereby not only in
freedom from banker-control and exactions, but
in the winning of valuable local support. The
investor's money would be followed by his sym-
pathy. In things economic, as well as in things
political, wisdom and safety lie in direct appeals to
the people.
The Pennsylvania Railroad now relies largely
upon its stockholders for new capital.
? 110 OTHER PEOPLE'S MONEY
municipalities pay toll to the banker on all
bonds sold. Why should they? It is not be-
cause the banker is always needed. It is because
the banker controls the only avenue through
which the investor in bonds and stocks can or-
dinarily be reached. The banker has become the
universal tax gatherer. True, the pro rata
of taxes levied by him upon our state and city
governments is less than that levied by him upon
the corporations. But few states or cities escape
payment of some such tax to the banker on every
loan it makes. Even where the new issues of
bonds are sold at public auction, or to the highest
bidder on sealed proposals, the bankers' syndicates
usually secure large blocks of the bonds which
are sold to the people at a considerable profit.
The middleman, even though unnecessary, col-
lects his tribute.
There is a legitimate field for dealers in state
and municipal bonds, as for other merchants.
Investors already owning such bonds must have
a medium through which they can sell their
holdings. And those states or municipalities
which lack an established reputation among
investors, or which must seek more distant
markets, need the banker to distribute new issues.
But there are many states and cities which have
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? SUPERFLUOUS BANKERS 111
an established reputation and have a home
market at hand. These should sell their bonds
direct to investors without the intervention of a
middleman. And as like conditions prevail with
some corporations, their bonds and stocks should
also be sold direct to the investor. Both financial
efficiency and industrial liberty demand that the
bankers' toll be abolished, where that is possible.
The business of the investment banker must
not be confused with that of the bond and stock
broker. The two are often combined; but the
functions are essentially different. The broker
performs a very limited service. He has properly
nothing to do with the original issue of securities,
nor with^their introduction into the market. He
merely negotiates a purchase or sale as agent for
another under specific orders. He exercises no
discretion, except in the method of bringing
buyer and seller together, or of executing orders.
For his humble service he receives a moderate
compensation, a commission, usually one-eighth
of one per cent. (12 1/2 cents for each $100) on
the par value of the security sold. The invest-
ment banker also is a mere middleman. But he
is a principal, not an agent. He is also a merchant
BANKER AND BBOKEB
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? 112 OTHER PEOPLE'S MONEY
in bonds and stocks. The compensation received
for his part in the transaction is in many cases
more accurately described as profit than as com-
mission. So far as concerns new issues of
government, state and municipal bonds, espe-
cially, he acts as merchant, buying and selling
securities on his own behalf; buying commonly
at wholesale from the maker and selling at retail
to the investors; taking the merchant's risk and
the merchant's profits. On purchases of corpo-
rate securities the profits are often very large;
but even a large profit may be entirely proper;
for when the banker's services are needed and
are properly performed, they are of great value.
On purchases of government, state and munic-
ipal securities the profit is usually smaller; but
even a very small profit cannot be justified, if
unnecessary.
HOW THE BANKER CAN SERVE
The banker's services include three distinct
functions, and only three:
First: Specifically as expert. The investment
banker has the responsibility of the ordinary
retailer to sell only that merchandise which is
good of its kind. But his responsibility in this
respect is unusually heavy, because he deals in an
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? SUPERFLUOUS BANKERS 118
article on which a great majority of his customers
are unable, themselves, to pass intelligent judg-
ment without aid. The purchase by the investor
of most corporate securities is little better than a
gamble, where he fails to get the advice of some
one who has investigated the security thoroughly
as the banker should. For few investors have the
time, the facilities, or the ability to investigate
properly the value of corporate securities.
Second: Specifically as distributor. The banker
performs an all-important service in providing
an outlet for securities. His connections enable
him to reach possible buyers quickly. And good-
will--that is, possession of the confidence of regu-
lar customers--enables him to effect sales where
the maker of the security might utterly fail to
find a market.
Third: Specifically as jobber or retailer. The
investment banker, like other merchants, carries
his stock in trade until it can be marketed. In
this he performs a service which is often of great
value to the maker. Needed cash is obtained
immediately, because the whole issue of securities
can thus be disposed of by a single transaction.
And even where there is not immediate payment,
the knowledge that the money will be provided
when needed is often of paramount importance.
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? 114 OTHER PEOPLE'S MONEY
By carrying securities in stock, the banker per-
forms a service also to investors, who are thereby
enabled to buy securities at such times as they
desire.
Whenever makers of securities or investors
require all or any of these three services, the
investment banker is needed, and payment of
compensation to him is proper. Where there is
no such need, the banker is clearly superfluous.
And in respect to the original issue of many of our
state and municipal bonds, and of some corporate
securities, no such need exists.
It needs no banker experts in value to tell us
that bonds of Massachusetts or New York, of
Boston, Philadelphia or Baltimore and of scores
of lesser American cities, are safe investments.
The basic financial facts in regard to such bonds
are a part of the common knowledge of many
American investors; and, certainly, of most pos-
sible investors who reside in the particular state
or city whose bonds are in question. Where the
financial facts are not generally known, they are
so simple, that they can be easily summarized and
understood by any prospective investor without
interpretation by an expert. Bankers often
WHEEE THE BANKER SERVES NOT
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? SUPERFLUOUS BANKERS 11&
employ, before purchasing securities, their own.
accountants to verify the statements supplied by
the makers of the security, and use these account-
ants' certificates as an aid in selling. States and
municipalities, the makers of the securities,
might for the same purpose employ independent
public accountants of high reputation, who would
give their certificates for use in marketing the
securities. Investors could also be assured with-
out banker-aid that the basic legal conditions are
sound. Bankers, before purchasing an issue of
securities, customarily obtain from their own
counsel an opinion as to its legality, which inves-
tors are invited to examine. It would answer
the same purpose, if states and municipalities
should supplement the opinion of their legal
representatives by that of independent counsel
of recognized professional standing, who would
certify to the legality of the issue.
Neither should an investment banker be needed
to find investors willing to take up, in small lots,
a new issue of bonds of New York or Massa-
chusetts, of Boston, Philadelphia or Baltimore, or
a hundred other American cities. A state or
municipality seeking to market direct to the
investor its own bonds would naturally experi-
ence, at the outset, some difficulty in marketing a
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? 116 OTHER PEOPLE'S MONEY
large issue. And in a newer community, where
there is little accumulation of unemployed capital,
it might be impossible to find buyers for any large
issue. Investors are apt to be conservative;
and they have been trained to regard the inter-
vention of the banker as necessary. The bankers
would naturally discourage any attempt of states
and cities to dispense with their services. En-
trance upon a market, hitherto monopolized by
them, would usually have to be struggled for.
But banker-fed investors, as well as others could,
in time, be brought to realize the advantage of
avoiding the middleman and dealing directly with
responsible borrowers. Governments, like private
concerns, would have to do educational work; but
this publicity would be much less expensive and
much more productive than that undertaken by
the bankers. Many investors are already impa-
tient of banker exactions; and eager to deal
directly with governmental agencies in whom they
have more confidence. And a great demand Cv. old,
at once, be developed among smaller investor*
whom the bankers have been unable to interest,
and who now never buy state or municipal bonds.
The opening of this new field would furnish a mar-
ket, in some respects more desirable and certainty
wider than that now reached by the bankers.
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? SUPERFLUOUS BANKERS 117
Neither do states or cities ordinarily need the
services of the investment banker to carry their
bonds pending distribution to the investor.
Where there is immediate need for large funds,
states and cities--at least the older communities
--should be able to raise the money temporarily,
quite as well as the bankers do now, while await-
ing distribution of their bonds to the investor.
Bankers carry the bonds with other people's
money, not with their own. Why should not
cities get the temporary use of other people's
money as well? Bankers have the preferential
use of the deposits in the banks, often because
they control the banks. Free these institutions
from banker-control, and no applicant to borrow
the people's money will be received with greater
favor than our large cities. Boston, with its
$1,500,000,000 of assessed valuation and $78,033,-
128 net debt, is certainly as good a risk as even
Lee, Higginson & Co. or Kidder, Peabody & Co.
But ordinarily cities do not, or should not,
require large sums of money at any one time.
Such need of large sums does not arise except
from time to time where maturing loans are to be
met, or when some existing public utility plant
is to be taken over from private owners. Large
issues of bonds for any other purpose are usually
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? 118 OTHER PEOPLE'S MONEY
made in anticipation of future needs, rather than
to meet present necessities. Modern efficient
public financiering, through substituting serial
bonds for the long term issues (which in Massa-
chusetts has been made obligatory) will, in time,
remove the need of large sums at one time for
paying maturing debts, since each year's maturi-
ties will be paid from the year's taxes. Purchases
of existing public utility plants are of rare occur-
rence, and are apt to be preceded by long periods
of negotiation. When they occur they can, if
foresight be exercised, usually be financed without
full cash payment at one time.
Today, when a large issue of bonds is made, the
banker, while ostensibly paying his own money to
the city, actually pays to the city other people's
money which he has borrowed from the banks.
Then the banks get back, through the city's de-
posits, a large part of the money so received. And
when the money is returned to the bank, the
banker has the opportunity of borrowing it again
for other operations. The process results in
double loss to the city. The city loses by not
getting from the banks as much for its bonds as
investors would pay. And then it loses interest
on the money raised before it is needed. For the
bankers receive from the city bonds bearing rarely
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? SUPERFLUOUS BANKERS 119
less than 4 per cent. interest; while the proceeds
are deposited in the banks which rarely allow
more than 2 per cent. interest on the daily
balances.
CITIES THAT HELPED THEMSELVES
In the present year some cities have been led by
necessity to help themselves. The bond market
was poor. Business was uncertain, money tight
and the ordinary investor reluctant. Bankers
were loth to take new bond issues. Municipali-
ties were unwilling to pay the high rates de-
manded of them. And many cities were prohib-
ited by law or ordinance from paying more than
4 per cent. interest; while good municipal bonds
were then selling on a 4 1/2 to 5 per cent. basis.
But money had to be raised, and the attempt was
made to borrow it direct from the lenders instead
of from the banker-middleman. Among the
cities which raised money in this way were Phila-
delphia, Baltimore, St. Paul, and Utica, New
York.
Philadelphia, under Mayor Blankenburg's
inspiration, sold nearly $4,175,000 in about two
days on a 4 per cent. basis and another "over-the-
counter" sale has been made since. In Balti-
more, with the assistance of the Sun, $4,766,000
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? 120 OTHER PEOPLE'S MONEY
were sold "over the counter" on a 4 1/2 per cent.
basis. Utica's two "popular sales" of 41/2
per cent. bonds were largely "over-subscribed. "
And since then other cities large and small
have had their "over-the-counter" bond sales.
The experience of Utica, as stated by its Control-
ler, Fred G. Reusswig, must prove of general
interest:
"In June of the present year I advertised for
sale two issues, one of $100,000, and the other of
$19,000, bearing interest at 4 1/2 per cent. The
latter issue was purchased at par by a local bidder
and of the former we purchased $10,000 for our
sinking funds. That left $90,000 unsold, for
which there were no bidders, which was the first
time that I had been unable to sell our bonds.
About this time the 'popular sales' of Baltimore
and Philadelphia attracted my attention. The
laws in effect in those cities did not restrict the
officials as does our law and I could not copy their
methods. I realized that there was plenty of
money in this immediate vicinity and if I could
devise a plan conforming with our laws under
which I could make the sale attractive to small
investors it would undoubtedly prove successful.
I had found, in previous efforts to interest people
of small means, that they did not understand the
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? SUPERFLUOUS BANKERS 121
meaning of premium and would rather not buy
than bid above par. They also objected to mak-
ing a deposit with their bids. In arranging for
the 'popular sales' I announced in the papers
that, while I must award to the highest bidder, it
was my opinion that a par bid would be the highest
bid. I also announced that we would issue bonds
in denominations as low as $100 and that we
would not require a deposit except where the bid
was $5,000 or over. Then I succeeded in getting
the local papers to print editorials and local
notices upon the subject of municipal bonds, with
particular reference to those of Utica and the
forthcoming sale. All the prospective purchaser
had to do was to fill in the amount desired,
sign his name, seal the bid and await the day
for the award. I did not have many bidders for
very small amounts. There was only one for
$100 at the first sale and one for $100 at the
second sale and not more than ten who wanted
less than $500. Most of the bidders were looking
for from $1,000 to $5,000, but nearly all were peo-
ple of comparatively small means, and with some
the investment represented all their savings. In
awarding the bonds I gave preference to residents
of Utica and I had no difficulty in apportioning
the various maturities in a satisfactory way.
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? 122 OTHER PEOPLE'S MONEY
"I believe that there are a large number of per-
sons in every city who would buy their own bonds
if the way were made easier by law. Syracuse
and the neighboring village of Ilion, both of which
had been unable to sell in the usual way, came to
me for a program of procedure and both have
since had successful sales along similar lines.
We have been able by this means to keep the
interest rate on our bonds at 4 1/2 per cent. , while
cities which have followed the old plan of relying
upon bond houses have had to increase the rate
to 5 per cent. I am in favor of amending the law
in such a manner that the Common Council,
approved by the Board of Estimate and Appor-
tionment, may fix the prices at which bonds shall
be sold, instead of calling for competitive bids.
Then place the bonds on sale at the Controller's
office to any one who will pay the price. The
prices upon each issue should be graded according
to the different values of different maturities.
Under the present law, as we have it, conditions
are too complies <<k! to make a sale practicable
except upon a basis of par bids. "
THE ST. PAUL EXPERIMENT
St. Paul wisely introduced into its experiment a
more democratic feature, which Tom L. Johnson,
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? SUPERFLUOUS BANKERS 12S
Cleveland's great mayor, thought out (but did not
utilize), and which his friend W. B. Colver, now
Editor-in-Chief of the Daily News, brought to the
attention of the St. Paul officials. Mayor John-
son had recognized the importance of reaching the
small savings of the people; and concluded that
it was necessary not only to issue the bonds in
very small denominations, but also to make them
redeemable at par. He sought to combine
practically, bond investment with the savings
bank privilege. The fact that municipal bonds
are issuable ordinarily only in large denomina-
tions, say, $1,000, presented an obstacle to be
overcome. Mayor Johnson's plan was to have
the sinking fund commissioners take large blocks
of the bonds, issue against them certificates in
denominations of $10, and have the commis-
sioners agree (under their power to purchase
securities) to buy the certificates back at par and
interest. Savings bank experience, he insisted,
showed that the redemption feature would not
prove an embarrassment; as the percentage of
those wishing to withdraw their money is small;
and deposits are nearly always far in excess of
withdrawals.
The St. Paul sinking fund commissioners and
City Attorney O'Neill approved the Johnson
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? 124 OTHER PEOPLE'S MONEY
plan; and in the face of high money rates, sold on
a 4 per cent. basis, during July, certificates to the
net amount of $502,300; during August, $147,-
000; and during September, over $150,000, the
average net sales being about $5,700 a day.
Mr. Colver, reporting on the St. Paul experience,
said:
"There have been about 2,000 individual pur-
chasers making the average deposit about $350
or $360. There have been no certificates sold
to banks. During the first month the deposits
averaged considerably higher and for this reason:
in very many cases people who had savings which
represented the accumulation of considerable
time, withdrew their money from the postal sav-
ings banks, from the regular banks, from various
hiding places and deposited them with the citv.
Now these same people are coming once or fa ice
a month and making deposits of ten or twenty
dollars, so that the average of the individual
deposit has fallen very rapidly during September
and every indication is that the number of small
deposits will continue to increase and the rela-
tively large deposits become less frequent as
time goes on.
As a matter of fact, these certificate deposits
are stable, far more than the deposits and invest-
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? SUPERFLUOUS BANKERS 125
ments of richer people who watch for advanta-
geous reinvestments and who shift their money
about rather freely. The man with three or
four hundred dollars savings will suffer almost
anything before he will disturb that fund. We
believe that the deposits every day here, day in
and day out, will continue to take care of all the
withdrawals and still leave a net gain for the day,
that net figure at present being about $5,700 a
day. "
Many cities are now prevented from selling
bonds direct to the small investors, through laws
which compel bonds to be issued in large denomi-
nations or which require the issue to be offered
to the highest bidder. These legislative limita-
tions should be promptly removed.
SALESMANSHIP AND EDUCATION
Such success as has already been attained is
largely due to the unpaid educational work of
leading progressive newspapers. But the educa-
tional work to be done must not be confined to
teaching "the people"--the buyers of the bonds.
Municipal officials and legislators have quite as
much to learn. They must, first of all, study
salesmanship. Selling bonds to the people is a
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? 126 OTHER PEOPLE'S MONEY
new art, still undeveloped. The general problems
have not yet been worked out. And besides
these problems common to all states and cities,
there will be, in nearly every community, local
problems which must be solved, and local difficul-
ties which must be overcome. The proper solu-
tion even of the general problems must take con-
siderable time. There will have to be many ex-
periments made; and doubtless there will be many
failures. Every great distributor of merchandise
knows the obstacles which he had to overcome
before success was attained; and the large sums
that had to be invested in opening and preparing
a market. Individual concerns have spent mil-
lions in wise publicity; and have ultimately reaped
immense profits when the market was won.
Cities must take their lessons from these great
distributors. Cities must be ready to study the
problems and to spend prudently for proper pub-
licity work. It might, in the end, prove an econ-
omy, even to allow, on particular issues, where nec-
essary, a somewhat higher interest rate than bank-
ers would exact, if thereby a direct market for
bonds could be secured. Future operations would
yield large economies. And the obtaining of a
direct market for city bonds is growing ever more
important, because of the huge increase in loans
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? SUPERFLUOUS BANKERS 127
which must attend the constant expansion of
municipal functions. In 1898 the new munic-
ipal issues aggregated $103,084,793; in 1912,
$380,810,287.
In New York, Massachusetts and the other
sixteen states where a system of purely mutual
savings banks is general, it is possible, with a
little organization, to develop an important mar-
ket for the direct purchaser of bonds. The
bonds issued by Massachusetts cities and towns
have averaged recently about $15,000,000 a year,
and those of the state about $3,000,000. The 194
Massachusetts savings banks, with aggregate
assets of $902,105,755. 94, held on October 31,
1912, $90,536,581. 32 in bonds and notes of states
and municipalities. Of this sum about $60,000,-
000 are invested in bonds and notes of Massa-
chusetts cities and towns, and about $8,000,000 in
state issues. The deposits in the savings banks
are increasing at the rate of over $30,000,000 a
year. Massachusetts state and municipal bonds
have, within a few years, come to be issued tax
exempt in the hands of the holder, whereas other
classes of bonds usually held by savings banka
are subject to a tax of one-half of one per cent.
SAVINGS BANKS AS CUSTOMERS
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? 128 OTHER PEOPLE'S MONEY
of the market value. Massachusetts savings
banks, therefore, will to an increasing extent, se-
lect Massachusetts municipal issues for high-grade
bond investments. Certainly Massachusetts cit-
ies and towns might, with the cooperation of the
Commonwealth, easily develop a "home market"
for "over-the-counter" bond business with the
savings banks. And the savings banks of other
states offer similar opportunities to their munici-
palities.
COOPERATION
Bankers obtained their power through com-
bination. Why should not cities and states
by means of cooperation free themselves from
the bankers? For by cooperation between the
cities and the state, the direct marketing of
municipal bonds could be greatly facilitated.
Massachusetts has 33 cities, each with a popu-
lation of over 12,000 persons; 71 towns each
with a population of over 5,000; and 250 towns
each with a population of less than 5,000. Three
hundred and eight of these municipalities now
have funded indebtedness outstanding. The
aggregate net indebtedness is about $180,000,000.
Every year about $15,000,000 of bonds and notes
are issued by the Massachusetts cities and town!
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? SUPERFLUOUS BANKERS 129
for the purpose of meeting new requirements and
refunding old indebtedness. If these munici-
palities would cooperate in marketing securities,
the market for the bonds of each municipality
would be widened; and there would exist also a
common market for Massachusetts municipal
securities which would be usually well supplied,
would receive proper publicity and would attract
investors. Successful merchandising obviously
involves carrying an adequate, well-assorted
stock. If every city acts alone, in endeavoring
to market its bonds direct, the city's bond-selling
activity will necessarily be sporadic. Its ability
to supply the investor will be limited by its own
necessities for money. The market will also be
limited to the bonds of the particular municipal-
ity. But if a state and its cities should cooperate,
there could be developed a continuous and broad
market for the sale of bonds "over-the-counter. "
The joint selling agency of over three hundred
municipalities,--as in Massachusetts--would natu-
rally have a constant supply of assorted bonds
and notes which could be had in as small amounts
as the investor might want to buy them. It
would be a simple matter to establish such a
joint selling agency by which municipalities,
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? 130 OTHER PEOPLE'S MONEY
under proper regulation of, and aid from the
state, would cooperate.
And cooperation among the cities and with the
state might serve in another important respect.
These 354 Massachusetts municipalities carry in
the aggregate large bank balances. Sometimes
the balance carried by a city represents unex-,
pended revenues; sometimes unexpended pro-
ceeds of loans. On these balances they usually
receive from the banks 2 per cent. interest. The
balances of municipalities vary like those of other
depositors; one having idle funds, when another
is in need. Why should not all of these cities
and towns cooperate, making, say, the State their
common banker, and supply each other with
funds as farmers and laborers cooperate through
credit unions? Then cities would get, instead of
2 per cent. on their balances, all their money
was worth.
The Commonwealth of Massachusetts holds
now in its sinking and other funds nearly $30,000-
000 of Massachusetts municipal securities, con-
stituting nearly three-fourths of all securities held
in these funds. Its annual purchases aggregate
nearly $4,000,000. Its purchases direct from
cities and towns have already exceeded $1,000,000
this year. It would be but a simple extension of
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? SUPERFLUOUS BANKERS 131
the state's function to cooperate, as indicated, in
a joint, Municipal Bond Selling Agency an dCredit
Union. It would be a distinct advance in the
efficiency of state and municipal financing;
and what is even more important, a long step
toward the emancipation of the people from
banker-control.
Strong corporations with established reputa-
tions, locally or nationally, could emancipate
themselves from the banker in a similar manner.
Public-service corporations in some of our leading
cities could easily establish "over-the-counter"
home markets for their bonds; and would be
greatly aided in this by the supervision now being
exercised by some state commissions over the
issue of securities by such corporations. Such
corporations would gain thereby not only in
freedom from banker-control and exactions, but
in the winning of valuable local support. The
investor's money would be followed by his sym-
pathy. In things economic, as well as in things
political, wisdom and safety lie in direct appeals to
the people.
The Pennsylvania Railroad now relies largely
upon its stockholders for new capital.
