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. Customers' 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.

Thus we may have a situation whereby expansion in the credit supply of the country is purely in response to the speculative enthusiasm of the stock market.

Another aspect of the situation is the expenditure of profits; if a speculator sells his securities and withdraws the profits, he may sell to someone who has borrowed to pay for the purchase. The seller spends his proceeds for automobiles, Park Avenue apartments, Oriental rugs, or whatnot. This buying stimulates a demand for goods, which is based indirectly upon the stock market credit.

When a period is reached at which a large number of people decide to take their profits at once and there are no new buyers, there will be a wide-spread liquidation of securities and declining prices. Everyone who holds securities or has made loans on securities will find his investment is being impaired, and there will be a further rush_to liquidate. This will result in a rapid contraction of credit and a decrease in the volume of purchasing power.

For these various reasons, which grow out of the fact that the stock market in this country can obtain such a large amount of credit, the stock market has a considerable influence on the business situation. Mr. KENNEY. Mr. Chairman.

The CHAIRMAN. Mr. Kenney.

Mr. KENNEY. Would the revival of bills of exchange in this country, in your opinion, make any difference in the situation?

Mr. THOMAS. It has had to a certain extent. We have had an increase in the amount of acceptances, and the banks are now employing a very large amount of funds in acceptances. We notice that in a period of shortage of funds, for example, over the end of the past year when the banks in New York City wanted funds for Christmas and other needs, they turned over their acceptances to the Federal Reserve Bank instead of calling their street loans.

As to whether the volume of acceptances is sufficient to take care of all of the demands of the banks for liquid funds, there is some doubt. It may be that they will need some call loans-$1,000,000,000 or $2,000,000,000 of total brokers' loans is not an excessive amount, if they are kept within that range. It is the expansion and contraction of those loans in a rapid manner which is dangerous.

Short-term Treasury bills the 90-day bills also serve the same purpose. There are more of those now available than there were formerly.

Mr. LEA. Could you inform us as to rates under these three methods of loans-as to how the rates of interest compare?

Mr. THOMAS. That would vary, depending upon the state of the market. At the present time, I should say that call loan rates are much lower than rates charged by banks of their customers, because there is an abundant supply of short money seeking investment and very little demand for it. In 1929, however, the open-market call loan rate the rate brokers would pay-was much higher than the rate charged customers on security loans.

I might also say that of course the rate the broker charges his customer is much higher than the official rate which is quoted in the market, which is the rate that the broker pays to the bank. The broker may charge less than the bank rate on customers' loans when money is easy, but when money is tight he charges considerably more than the banks.

Mr. LEA. You spoke about the diversion of credit on account of the stock market. Do you think that your statement is accurate as it affects the local communities throughout the country?

Mr. THOMAS. It may be that in certain local communities, certain particular situations, there are banks or others who might decide to put their money in the stock market rather than make loans. Certainly it does affect rates. There is no question about that. But customers' rates vary very slightly from time to time. They generally remain about the same.

Mr. LEA. When there are many instances, where the banks or their customers send money to the stock market instead of making local investments--do you not regard that as an important feature-economic feature, of the country?

Mr. THOMAS. I should think so; yes.

Mr. LEA. Which have happened the past few years.

Mr. THOMAS. Yes.

Mr. LEA. It has tended to dry up local credit.

Mr. THOMAS. Well, that may be. It means that those firms that are able to obtain their funds through the stock market, obtain them very cheaply and very easily, whereas those that cannot go to the stock market for their supplies of money have to pay more.

is true.

That

Mr. LEA. What would be the method of computing the margin under the terms of this bill, as you understand it?

Mr. THOMAS. You mean the two methods?

Mr. LEA. You spoke of two methods.

Mr. THOMAS. That is simply a matter of what you want to call it. The actual margin will amount to the same thing in either case.

Mr. LEA. Do you think, under this bill, that we ought to provide a uniform method?

Mr. THOMAS. The bill is very definite about that. It says that the loan can be made only up to the amount of 40 percent of the collateral 40 percent as the basis of the present market price, or 80 percent of the lowest price for the last 3 years, whichever may be the higher, I believe is the provision of the bill. The relation between the loan and the collateral is the same in any particular case, whether you call the margin 60 percent or 150 percent.

Mr. LEA. Would you care to say anything as to the wisdom of borrowing on unlisted securities as collateral?

Mr. THOMAS. As I understand it, the purpose of that provision is to prevent a broker, who is observing the margin on listed securities, from taking a whole bunch of unlisted securities, with some other margin, which would defeat the margin provision of the bill.

Mr. LEA. Who would pass on the sufficiency of that security under those circumstances?

Mr. THOMAS. I think the broker himself does. Of course, if the broker should want to turn over those securities to the bank as collateral for a loan, the bank would pass on it.

I do not know whether there is any provision in the bill whereby the Commission would have any powers over that or not.

Mr. LEA. This bill prohibits the use of unlisted securities as to

the bank; is there a necessity for such a provision?

Mr. THOMAS. I do not know about that provision of the bill. I take it that a bank could make loans on unlisted securities.