The following are given as a few of the advantages which are claimed for corporations and joint-stock companies over partnerships:
1. Union of capital without the active service of the investors.
2. Better facilities for borrowing. It is a common thing for a partnership to be changed to a stock company for the express purpose of raising money by the issue of bonds or stock.
3. Limited agency of directors. A partner may pledge and sell the partnership property, may buy goods on account of the partnership, may borrow money and contract debts in the name and on the account of the partnership. Directors of a joint-stock company must act in accordance with the provisions of the by-laws of the company.
4. The continuous existence of a company.
5. New shareholders are admitted more easily than new partners.
6. A retiring partner is still liable for existing debts. A shareholder may retire absolutely by selling his stock and having it legally transferred.
IV. BORROWING AND LOANING MONEY[10]
THE MONEY MARKET
Money, like other articles of commerce, has for hundreds of years had its fields for the production of the raw products, its manufacturing establishments, its markets and exchange centres, its sellers and buyers, its wholesale and retail dealers, and its brokers and commission merchants. Out of this trade in actual coin has grown a trade in paper notes, which are really only promises to pay coin, and out of this latter trade has grown up during recent years a still further enormous trade in securities representing all kinds of property. Very often these securities are based solely upon the credit of the names attached to them, so that our modern system of borrowing and loaning money is really a system of borrowing and loaning credit.
When our government borrows $100,000,000, as it did a few years ago, it gives "its bond" that the money will be paid. When States, or cities, or railroads, or other corporations borrow money they issue bonds guaranteeing payment at a particular time. When an individual borrows money he gives his "bond" in the form of a promissory note.
These bonds pass from hand to hand and have a fairly constant value in the money market. They really represent the money trade to a much larger extent than does actual coin, so that the borrowing or loaning of money really means, to a very large extent, simply the borrowing or loaning of credit. If we borrow a $10 gold piece we borrow money; if we borrow a $10 bill or an indorser's name for the back of our note we simply borrow credit--in the one instance the credit of the United States and in the other the credit of the man who indorses our paper.
FOOTNOTE:
[10] The student is also referred to Part I. ("General Business Information"), Lesson IX.
BORROWING FROM BANKS
It is the business of a bank to loan money to responsible persons within reasonable limits. The regular customer of the bank is entitled to and will receive the first consideration if the demand is larger than the bank can safely meet. A business man should not hesitate, when occasion requires, to offer his bank any paper he may want discounted, if in his opinion it is good, nor should he be offended if his banker refuses to take it even without giving reasons. A portion of the loans of many banks consists of investments in solid bonds, but the bulk of the loans of banks is made on commercial paper. Time and demand loans are made upon collaterals of many descriptions. The larger banks loan on an average from $50,000 to $100,000 a day. Banks _discount_ paper for their depositors--and simply term the operation discounting; but when they go outside of their line of depositors in making investments in time paper they call it _buying_ paper. They generally buy from private bankers and note brokers. National banks are prohibited from loaning over ten per cent. of their capital to any one individual or corporation except upon paper representing actually existing merchandise.
WHAT ARE COLLATERALS?
If a business man borrow $1000 from a bank on his note and give ten shares of stock to the bank, to be held by it simply as security, the stock thus given would be termed collateral. These collaterals are not the bank's property and the bank is responsible for their safe keeping. If coupons mature while bonds are being held as collateral, the owners are usually allowed to collect the amount for which they sell. Sometimes one note is given as collateral security for another which is discounted.
ACCOMMODATION PAPER
Notes and acceptances that are made in settlement of genuine business transactions come under the head of regular, legitimate business paper. An accommodation note or acceptance is one which is signed or indorsed or accepted simply as an accommodation and not in settlement of an account or in payment of an indebtedness. With banks accommodation paper has a deservedly hard reputation. However, there are all grades and shades of accommodation paper, though it represents no actual business transaction between the parties to it and rests upon no other foundation than that of mutual agreement. No contract is good without a consideration, but this is only true between the original parties to a note. The third party, or innocent receiver or holder of a note, has a good title and can recover its value even though it was originally given without a valuable consideration. An innocent holder of a note which had been originally lost or stolen has a good title to it if he received it for value, the law justly protecting such a holder against the fault or carelessness of others.
NOTE BROKERS
Merchants sell a great many of their notes in the open market--that is, to note brokers. The banks buy these notes from the note brokers.
The assistance of the broker who handles commercial paper is a necessary and valuable aid to the purchasing bank. Fully three fourths of all the paper purchased by banks in large cities is purchased upon the simple recommendation of the note brokers. As a rule these brokers simply transfer the paper without guaranteeing by indorsement its payment. Notes bought by banks from note brokers without their indorsement are held to be guaranteed by them to be all right in all points except that which covers the question of whether they will be paid or not. The bank uses its best judgment in taking the risk. If the note dealer in selling notes to a bank makes what he believes to be fair and honest representations regarding any particular paper--statements of such a straightforward type that upon them no charge of false pretenses can be made to rest--he simply guarantees the note genuine as to names, date, amount, etc., and that in selling it he conveys a good title to the paper. As business men, however, they are very cautious and are exceedingly anxious that the paper they sell shall be paid, and as a rule they make good any losses which grow out of apparent misrepresentations on their part.
BANKERS' RATES FOR LOANS
In loaning money on demand, when it is strictly understood between bank and borrower that the money so advanced is positively minute money--money returnable at any minute when the bank calls for it--banks usually charge low rates of interest. When interest rates are high bankers prefer to deal in long-time paper. This general rule is reversed when the situation is reversed. Bankers aim also to scatter and locate their maturities so that as the seasons roll around they will not have very large amounts maturing at one time and very small amounts at another. They plan also to be "in funds" at those seasons when there is always a large and profitable demand for money.
For instance, in the centres of the cotton-manufacturing interest the banks count on a large demand for money between October and January, when the bulk of the purchases to supply the mills are made. Again, among those who operate and deal in wool there is an active demand for money in the wool-clip in the spring months. The wheat and corn crops are autumn consumers of money. Midwinter and midsummer in the north are usually periods of comparative stagnation in the money market. All these things affect rates, and the successful banker is he who from observation and large experience shows the most skill in timing his money supply.
V. COLLATERALS AND SECURITIES
TWO DISTINCT CLASSES OF SECURITIES
There are two distinct classes of mortgage securities--one class based upon the actual value and the other upon the earning value of the property. When a man lends money upon a dwelling-house he bases his estimate of security upon (1) the cost of the property, (2) its location, (3) the average value of adjoining properties, and (4) the general character of the locality; that is to say, the value of the property is the basis of the security. On the other hand, the lender of money upon railway mortgages, for instance (that is, the buyer of securities known as railway mortgages), considers the general earnings of the road rather than the cost of building and equipping the road as the correct basis upon which to estimate the value of the security.
These two classes of securities differ in other particulars. The value of the mortgage upon ordinary real estate is constant and the security itself is not so likely to change ownership, while the value of the railway mortgage may vary with the success or failure of the road, and the security itself is in the market constantly as a speculative property. The whole property of a railroad company, considered simply as real estate and equipment, is usually worth but a small fraction of the amount for which it is mortgaged. The creditors, as a rule, depend for the security of their money upon the business of the company.
We have already learned that collaterals are mortgages, stocks, bonds, etc., placed temporarily in the hands of lenders as additional security for money borrowed. The student will note, further, that the borrowing value of such securities depends very largely upon the character of the property represented.
MORTGAGES AS SECURITIES
A MORTGAGE is a conveyance of property for the purpose of securing debt, with the condition that if the debt is paid the conveyance is to become void. A mortgage in form is really a deed of the land, with a special clause stating that the grant is not absolute but only for the security of the debt. It is usual for the debtor at the time of executing the mortgage to execute also a bond or promissory note in favour of the creditor for the amount of the debt. This is called a MORTGAGE NOTE. Mortgages are frequently given in cases where there is a debt existing to secure or indemnify the mortgagee against some liability which he may possibly incur on behalf or for the benefit of the mortgagor. For instance, when a man has indorsed another's note for the latter's accommodation or gone on his bond as surety the latter may execute to the former a mortgage of indemnity. The power of a corporation to mortgage its property is usually regulated by its character or by the general law under which it is organised. All mortgages must be recorded in the office of the register of deeds for the county in which the property is located. The object of recording is to give notice of the existence of the mortgage to any one who might wish to purchase the land or to take a mortgage upon it. There may be several mortgages upon the same property. The first mortgagee is entitled to be paid in full first, then the second, and so on. The mortgagee may use his mortgage as security for loans or he may assign it as he pleases. When the requirements of a mortgage are not met the holder has under certain conditions the right to FORECLOSE--that is, to advertise the property for sale and, within a time fixed by law, to sell it to satisfy the mortgage. It is usual for the mortgagor to insure the property for the benefit of the mortgagee.
Although the terms of corporation mortgages are similar to those on real estate such as is represented by dwelling-houses, the commercial conditions make it inconvenient or impossible to foreclose and sell such properties. To stop all business of a railway or to shut down the work of a manufacturing concern would not only result in injury to the public but would reduce largely the earning value of the property. To overcome this difficulty where an active concern is financially embarrassed, the court appoints a receiver, who is responsible for the proper conduct of the business until a satisfactory reorganisation or sale is accomplished.
Mortgages upon improved property, if properly graduated in amount, should be safe and profitable investments. The buyer, however, must exercise great care and good judgment. Should there be collusion between the loaning agent and the land-owner, the money advanced may be largely in excess of the actual property value. Villages with less than a dozen houses are often the sites of investment companies doing business under pretentious names and offering mortgage investments at interest rates which by the local conditions are impossible. One of the devices of these enterprising companies is to offer their own guarantees as to both principal and interest of all mortgages negotiated by them. The investor should be sure of two things: (1) The safety of the principal, and (2) regularity in the payment of the interest. There is great danger of default from causes not anticipated by the mortgagor and over which he has no control.
STOCKS AS SECURITIES
To make a profitable investment in stocks the buyer must anticipate the future. A mill that may be working day and night this year may be obliged to shut down entirely next year. A business which is open to public competition must take its chances on its future success. The greater the earnings, the more certain the competition. Many corporations owning monopolies by virtue of patent rights have made large fortunes, but there is always the possibility of new discovery.
Electricity has succeeded gas; the telephone is competing with the telegraph; the trolley is cutting into the profits of railways. A good thing in stocks to-day does not necessarily mean a good thing next year. Railroad stocks are of such varied character that it is impossible here to make more than general statements. Many of our railroad stocks bring prices far above par and pay liberal interest on investments. Some of them are so profitable that they are really not on the market and cannot easily be bought. Others represent roads loaded down with mortgages and other obligations so heavy as to make the stock really a liability rather than a resource to its owner. The stock quotations represent in a general way the comparative value of these securities. Of recent stock electric-railway stock is the most popular and in many instances the most profitable. The introduction of electric power has reduced the working expense one half and in most instances has doubled the traffic without any reduction in fares. The buyer should make sure that the road is in a busy community able to sustain it, that its franchise will protect it from dangerous competition, and that the securities have been legally issued.
SUBSTITUTION SECURITIES
There have recently been formed several large companies whose business it is to issue bonds on the security of other bonds. The idea is similar to that of real-estate title insurance. Such companies are supposed to have superior facilities for investigating securities.
They purchase those which they consider good and at the best prices possible. These they deposit with some trust company or banking institution. With these bonds which they buy as their original property they issue new bonds of their own, which they sell to the public and which they guarantee. The differences in prices and in interest make up their profits.
LOANS AND INVESTMENTS
With the growth of wealth we find increasing numbers of persons who want to invest their means in good securities. To do this successfully and safely is a very difficult question. It is even more difficult to keep money profitably employed than to make it. Changes and innovations are of continual occurrence. Not only are new securities constantly coming upon the market, but new subjects as a basis of their production are industriously sought after. Every newly discovered force or process in mechanics means the appearance of another detachment of paper securities. The War of the Rebellion popularised the _coupon bond_, in consequence of its adoption by the government, and made it the favourite form of investment paper.
Railroads and other corporations soon availed themselves of the confidence which that species of paper inspired, and States, cities, and counties were soon flooding the country with obligations carrying long coupon attachments. Many persons have purchased and paid good prices for mortgage coupon bonds, giving them no control over their security, who would have rejected share certificates standing for an equal interest in the property pledged and giving them the right to participate in its management, with the possibility of a greater return for their money. Many of the States through careless legislation have permitted corporations to decide for themselves the amounts of obligations they might put out, and the privilege has been very much abused. We now have stocks and bonds upon the market representing nearly all conceivable kinds of property--telegraph and telephone companies, mining companies, cattle ranches, grain farms, water-works, canals, bridges, oil- and gas-wells, electric lighting, trolley companies, factories and mills, patent rights, steamboat lines, apartment-houses, etc. Not only are properties of many kinds used to issue bonds upon, but many kinds of bonds are often issued upon the same properties. One issue of bonds is sometimes made the basis of other issues. Some one has said that there never was a time in the history of the world when it was so easy to invest money--and to lose it. Of the securities that are offered with first-class recommendations it is probable that about one third are actually good, one third have some value, and one third are practically worthless. In making investments the first and main thing to be studied is safety.
Never buy a security of any kind without having read it. Do not buy what are commonly known as _cheap securities_. Do not rely solely upon the advice of a broker; he may have personal interest to serve. By far the greater number of losses to investors have been in securities purchased exclusively on the recommendation of interested commission men. It is a mistake to give preference to _listed_ securities--that is, those reported on the stock-exchange lists. Stocks are too often listed simply for speculative purposes, and the price represents not so much the value of the property as the pitch of the speculation at the time. Securities in the long run must stand upon their merits. As a rule the best time for an experienced investor to buy is when others are unloading.
VI. CHEQUES, DRAFTS, AND BILLS OF EXCHANGE[11]
BANK CHEQUES
[Illustration: Showing cheque raised from $7.50 to $70.50.]
A CHEQUE is an order for money, drawn by one who has funds in the bank, payable on demand. Banks provide blank cheques for their customers and it is a very simple matter to fill them out properly. In writing in the amount begin at the extreme left of the line. The illustrations given here show a poorly-written cheque and a copy of the same cheque after it has been "raised." The original cheque was for $7.50 and shows very careless arrangement. It was a very easy matter for the fraudulent receiver to change the "seven" to "seventy"
and to add a cipher to the amount in figures. The running line was written in on the raised cheque to deceive the bank. In this case Mr.
Carter and not the bank must suffer the loss. Mr. Carter cannot hold the bank responsible for his carelessness. Drawers of cheques should exercise the greatest care in writing in the amount to prevent changes or additions. Draw a running line, thus: ~~~_Nine_~~~ before and after the amount written in words. If the words are commenced close to the left margin the running line will be necessary only at the right. The signature should be in your usual style familiar to the paying teller.
The plain, freely written signature is the most difficult to forge.
Usually cheques are drawn "to order." The words "Pay to the order of John Brown" mean that the money is to be paid to John Brown or to any person he "orders" it paid to. By indorsing the cheque in blank (see indorsements) he makes it payable to bearer. If a cheque is drawn "Pay to bearer" any person--that is, the bearer--can collect it. The paying teller may ask the person cashing the cheque to write his name on the back, simply to have it for reference. Safety devices to prevent the fraudulent alteration of cheques are of almost endless variety, but there has not been a preventive against forgery and alterations yet invented, which has not been successfully overcome by swindlers. A machine for punching out the figures is in common use, but the swindler has successfully filled in the holes with paper-pulp and punched other figures to suit his purposes. The safest cheques are those carefully written upon what is known as safety paper.
FOOTNOTE:
[11] A part of the matter of this lesson has already appeared in Part I. of this book ("General Business Information"), but it is here repeated to preserve the connection.