has, and often exercises the right to sell collateral behind a loan that is insufficiently margined. In case prices of stocks, that are given as collateral for the loan, decline and the loan becomes under margined, the broker may sell, mostly without notice or with a very short notice. The banker generally feels that he has a more responsible relationship to his customer and will carry him along a little further. That may or may not be an advantage. Sometimes it proves to be a disadvantage. It means, however, that the market is less subject to erratic fluctuations because sell of under margined accounts actually intensifies the decline in prices and thus other margins are affected.

The banker can afford to take a little more risk because of the additional security he possesses. He has a note, a little more margin, and the customer's deposit and he has made a more careful credit investigation, so he is generally surer of his ground.

It is true that there have been times in the past when the banks have gotten into difficulty by not selling out their borrowers more promptly, but I might say that those times have been partially due to the very practice of the brokers selling out their clients. The broker will claim that stock-market credit is the safest sort of credit and, as a matter of fact, there are very few records of any losses, simply because the broker is always careful about selling his client out before losses are reached. But that throws the burden on others who do not happen to sell out, especially on the banks that hold collateral behind loans. If the bankers and the brokers and everybody else attempted to sell at the same time, the broker would not always be so fortunate. These differences, in general, describe the nature of the relationship between a customer and the broker. I think I might explain a little more fully the matter of margins.

When an account is opened with a broker, the trader may deposit a certain amount of cash or he may deposit securities. If he wants to buy, say, $10,000 worth of securities, he may give the broker $2,000 in cash, and establish an account. The broker then buys the securities for him at $10,000, and establishes a debit balance on his books against the customer for the remaining $8,000.

On the other hand, the customer may buy the $10,000 worth of securities, and create a debit balance to the full amount of $10,000, but add an additional $2,500 of securities as a margin, giving him what may be called a 20 percent margin in both cases.

There are apparently two ways of figuring percentages of margin. One is to compute the percentage in relation to the total value of securities held. The other is to compute the percentage of margin in relation to the debit balance or amount of loan that the customer may have obtained from his broker. For example, if a customer has a debit balance of $8,000 on a $10,000 commitment, he might be said to have a 20 percent margin, $2,000 in relation to the $10,000, or he may be said to have a 25 percent margin, relating the $2,000 to the $8,000 loan.

In this bill, there is a requirement that under certain conditions the lender cannot advance over 40 percent of the market value of the security. The margin in that case may be called 60 percent, or it may be called, as I noticed in the papers Mr. Whitney has called it, 150 percent.

Last August the stock exchange made a ruling that a minimum margin of 30 percent of the debit balance would be required on each

account having a debit balance of more than $3,500. This permits a broker to make loans up to 77 percent of the value of the collateral, maintaining a margin of only 23 percent against the collateral. It is my understanding that it is, however, the practice of some houses to require 30 percent of the value of collateral, which is a margin of 43 percent, according to the stock exchange method of computing margins against debit balances.

In the case of short selling, there have been various practices with respect to margins. A customer who has sold short has a credit balance with the broker on cash account. That is, the broker owes him money, because he has sold securities for the customer and he has obtained cash returns for these securities. On the other hand, the customer owes the broker for the securities, so he has a debit balance on securities account.

The broker generally requires sufficient margin to protect himself against a rise in the prices of those securities, but frequently it happens that a trader may be long on some securities and short on others, and in the past, at any rate in some cases, the brokerage house has considered that one margin was sufficient, because of the likelihood that if stocks went down, they might all go down together, or if they went up, they might all go up together and losses or gains on long account would be offset by gains or losses on short account.

The next question is how the broker finances his operations. In the course of a day's trading, the broker will buy and sell a great number of securities for a great number of people. The process whereby these transactions are settled is a more or less complicated one, but an exceedingly efficient one. The Stock Clearing Corporation of the New York Stock Exchange receives statements from every broker at the end of the day showing stocks sold and bought, prices at which they were sold and bought, and the dollar value of commitments on both sides. These are all balanced against each other, and each broker obtains or delivers simply the differences. A broker, for example, may sell 500 shares of United States Steel for a number of customers, and may in the course of the day buy 200 shares of Steel for other customers. He will the next day have to deliver only 300 shares.

The brokerage house also has to make other payments in the course of the day. The customer may have a debit balance with the broker

Mr. MAPES. May I interrupt to ask you if that situation will be changed by this bill, the provision which requires the broker to keep the interests of customers separate?

Mr. THOMAS. I should not think it would.

Mr. MAPES. It would have any effect on that feature?

Mr. THOMAS. I should think that might be subject to regulation by the Commission under this bill. The clearing process is largely a bookkeeping transaction, as in clearing houses for banks, etc. I do not believe the bill would involve any change in that respect.

The broker has to make a lot of other payments in the course of the day. For example, he has to pay out taxes, interest, commissions. He may have a loan which is called. Customers may have credit balances with brokers from time to time, and may decide to withdraw them. On the other hand, a broker receives a lot of money in the course of the day. He may get new margin accounts in the form of

cash from customers. He may collect interest and dividends on securities held and he may collect commissions and fees.

These vary from day to day. They vary at month ends, for example, brokers maintain very small cash balances, and they are practically always, until the last few years, indebted to banks or to other interests, so that if they get any more cash in the course of the day than they spend, they use it to reduce their loans. If they have to pay out more than they receive they will increase their borrowings. It would be interesting to examine a broker's balance sheet in order to see the relationship between the different items and to find out why brokers have to borrow, and the various factors that effect borrowings. Unfortunately, the Stock Exchange has never seen fit to publish any composite broker's balance sheet. We do not know exactly what their conditions are, although we know that brokers are always borrowing.

The amount they have to borrow may vary with a number of factors. Generally, the most important of these are the customers' debit balances. That is, the amount of commitments the customers have made; the amounts customers owe the broker for securities the broker has bought for them.

The broker may decide to keep a certain amount of his funds in cash. As I have said that is generally a very small amount.

On the other hand, he may obtain funds from other sources. For example, he has the partners' capital, and he has customers' credit balances. These credit balances are of two sorts. They may be credit balances against short sales or may be so-called "free credit balances", which are practically the same as cash deposits. If a broker can get a lot of deposits from customers, then he does not have to borrow. Deposits are in effect borrowings, but they may be used to reduce bank loans. It is entirely possible to have a situation where a broker would not have to borrow outright at all. This would be true, for example, if all long accounts were exactly balanced by short accounts. That really is quite a technical point, but is what happens in the case of term settlements, which is the practice on European stock markets. In London, for example, purchases and sales are made to be settled at the end of 2 weeks, so that in reality all sales are short sales for a period of 2 weeks, and all purchases are contracts to purchase and pay at the end of 2 weeks. Thus, for the 2 weeks' period no one has to borrow money; the sellers really give the purchasers credit for that time. At the end of the period they have to settle up and some of them may have to borrow in order to pay.

As I have said, however, brokers generally are borrowing, because the long commitments of their customers are always much larger than the short commitments.

Brokers can obtain funds from a number of sources. They can borrow from a bank, with whom they have a customer relationship, just as any business man can go out and borrow from his own bank. They can borrow at the money desk of the stock exchange from sums offered by banks or other lenders to any member of the exchange, who will take the money at the rate established. They can also go to money brokers that operate in the so-called "outside market", lending to brokers funds obtained from various types of lenders.

Most of these loans are "call" loans; that is, they are payable on demand of the lender or they can be paid at the will of the borrower. Some of them are time loans, covering a period of 3 months, or thereabouts; but the call loans are far more numerous than the time loans, making up 80 to 90 percent of the total of all "street" loans.

Call loans are more numerous largely because of the way in which the New York Stock Exchange is operated. Settlements are made on the exchange daily, so that the broker must pay and receive money every day. He likes also to be able to borrow or repay loans every day. If he had a 30-day loan and had some extra cash, the holder of the loan might prefer not to be paid back before maturity. It is largely because of the system of daily settlements that is used in the New York Stock Exchange, that the call loans have become so important.

There is also another factor, which relates to the supply of funds rather than to the demand for funds. Our banks have generally considered it desirable to have a large amount of their funds employed in such a way that they can call them as quickly as possible. That is a custom which grew up in the days before the Federal Reserve system when banks maintained most of their reserves with New York City banks as bankers' balances, on which they received interest.

The New York banks holding these balances, which were subject to call at the slightest notice, felt as though they ought to employ the funds in a way in which they could get the money as quickly as possible. There was no Federal Reserve bank to which they could go and discount paper and obtain funds on short notice. As a consequence they preferred to invest their funds in the call loan market.

Which is the chicken and which is the egg, I cannot say, but the two things grew up together. The system of daily settlements on the stock exchange and the system of holding in New York the balances or liquid reserve funds of outside banks both became inherent parts of our credit mechanism.

The New York call money market is one of the most efficient money markets in the world. It is safe so far as the lenders are concerned, because they are always able to get their money out quickly without loss. It has, however, certain disadvantages. Largely because of the efficiency of this market, stock-market speculation in this country has more abundant credit facilities than are available for stock market speculation in any other country of the world.

This call money market is in a sense our central money market, in that it is a market where banks invest their surplus funds when they have them. Just as in the London money market banks put their surplus funds in bankers' bills, or acceptances, which are based on commerce and trade, in this market the banks employ their surplus funds in the call money market, at least when there is a demand for call loans. Within the past 2 or 3 years there has been little demand as the stock market has generally been relatively inactive.

It has also generally been the practice of banks to withdraw their funds from this call money market whenever there was demand eisewhere. If their customers want to borrow, banks withdraw money from stock-exchange loans and loan it to their customers. tomers' demand always receive preference.

It is for that reason, you might say, that we have erratic fluctuations in interest rates on "street loans." Frequently in times of

stress or stringency the money would be drawn out without regard to the intensity of demands from brokers, and there would follow a very rapid increase in call money rates. The higher rates occasionally attract other funds into the market.

Funds employed in street loans are not entirely surplus funds. Most banks generally consider it desirable to keep a certain amount of their funds invested in as liquid a manner as possible, and they may try to maintain a certain percentage-that percentage may vary from time to time-in street loans, regardless of the demands of customers.

Then, also, the brokers in New York City have a certain customer relationship to New York City banks. The stock market is the central activity of the financial district, and New York City banks feel obligated to furnish their customers with needed funds from time to time and feel a responsibility for maintaining some stability in the market.

This obligation is seen particularly at end-of-month dates. Daily figures of brokers loans that that toward the end of the month outside banks generally withdraw their funds from the street loan market because they need them for other purposes. Brokers, however, need more money around the end of the month than at any other time, because they have to make payments for interest, taxes, wages, salaries, and such like things. Thus brokers' total borrowings increase. The New York banks always come in and increase their street loans for a few days to brokers even though their other demands are also heavy and they may in turn have to borrow from the Federal Reserve bank. Similar developments may also be observed at other times than end-of-month dates, when outside banks suddenly withdraw funds from the "Street."

The ease with which speculation can be financed on the basis of credit has a relationship to the trend of business. There is a common belief that this lending of money of the stock market diverts credit from business or absorbs credit to the detriment of business. To a very limited extent that may be true, at times, in that if there is a shortage of credit and stock market traders are bidding extensively for money, some banks and others may be induced to put money into stock-market loans which they would not do otherwise or they may charge their customers higher rates. That has happened in the past. In general, however, as I have said, banks give their customers preference and will withdraw funds from the stock market in order to supply their customers' demands.

The greatest effect of the stock market on the credit and business situation is that it stimulates a very rapid expansion and contraction of the total volume of credit. Increases in the amount of credit extended to the stock market means that speculators, traders, investors, or corporations issuing new securities or obtaining funds for various uses by selling securities to other speculators and traders, who are borrowing money to pay for the securities purchased. By this process the corporation is not borrowing from a bank, but it is able to sell securities, because traders are borrowing funds to buy securities. Indirectly these new security issues are therefore financed by or brokers loans from banks or from other lenders.