NATIONAL SECURITIES EXCHANGES-H.R. 7852

THURSDAY, MARCH 8, 1934

HOUSE OF REPRESENTATIVES,

COMMITTEE ON INTERSTATE AND FOREIGN COMMERCE,

Washington, D.C.

The committee met, pursuant to adjournment, at 10 a.m., in the committee room, New House Office Building, Hon. Sam Rayburn (chairman) presiding.

The CHAIRMAN. The committee will come to order.

STATEMENT OF FRANKLIN W. FORT

The CHAIRMAN. We will today hear from Mr. Franklin W. Fort, who was one of our colleagues for quite a while. In talking to me the other day he expressed some ideas that I thought the committee might be interested in listening to, and so I asked him to come down. Mr. Fort, you may proceed as you desire.

Mr. FORT. Mr. Chairman and gentlemen of the committee: I have no interest whatever, of a personal nature, in this legislation, except insofar as it affects the regulation of banking-none insofar as it affects the regulation of securities exchanges.

The effort to regulate adequately, in the public interest, securities exchanges, if we are going generally into the regulation of business of various types, it seems to me is a proper and perhaps a necessary part of the general program; but this bill attempts also to regulate banking as a part and as though banking were a part of the speculative machinery of the country.

It seems to me that banking has been too close in many cases to the speculative machinery of the country to have that relationship definitely ingrafted into the law.

Most of the evils in banking in the past 6 or 7 years, most of the troubles in banking, have come from the fact that banking psychology has become distorted until it has approached broker psychology in the handling of loans, and unless the line of cleavage between sound banking and speculation is made absolutely clear, the evils of the past 5 or 6 years are going to be perpetuated and repeated.

Personally, as a banker, I do not want to have to operate in terms of the stock-market ticker. I do not want to have my judgment as a banker controlled and influenced, by law or otherwise, by considerations of speculative values, and this bill attempts to do that thing. Not only does it attempt to do it, by making the price on the stock exchange the measure of my lending capacity to my customer, but it attempts to do it in a tar more serious and a far more dangerous way, because it divides the authority and the control over banking now lodged in the Federal Reserve Bank Board and the Comptroller of

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the Currency, in the Federal Trade Commission in its capacity as the guardian and supervisor of speculation. Sound banking, gentlemen, is only going to be fostered in America, if you place control of your banking solely in institutions and departments of the Government which have no relation to anything but banking.

The section of the bill which primarily accomplishes these things is section 6, chiefly paragraphs (c) and (d).

It may surprise you gentlemen to know that there is in the banking laws of this country today no definition whatever of the basis on which a banker may loan on collateral or other like security. The only definition is that in loans on real estate he may loan on "actual value-not on price. This bill attempts to fix upon banking the yardstick of market price, and that will be as disastrous in the future as it has proven in the last 6 years, when bankers have been too much guided by market price.

In the studies which, in the period of my service on the Home Loan Bank Board, we had to make of the mortgage loan situation in America, the conclusion was inescapable that the evils of overlending which had almost wrecked the mortgage institutions of America had come from the substitution in the minds of the lenders of the factor of market price for the factor of actual value.

Mr. MAPES. Mr Chairman, may I interrupt?

Mr. FORT. Yes, sir.

The CHAIRMAN. Mr. Mapes.

Mr. MAPES. What do you say about section 6, paragraph (c), applying after the party has owned the securities after 30 days or

more?

Mr. FORT. I did not quite get the question. I was trying to get my copy of the bill.

Mr. MAPES. I say, what do you say in regard to section 6, paragraph (c), having any application insofar as securities owned by the borrower for more than 30 days are concerned?

Mr. FORT. By section (d) the Commission is given power to prescribe the time and specific means by which values shall be calculated for purposes of this section. The time within which initial and subsequent payments shall be made by the customer, and the notice to be given, and the method to be followed in closing out accounts, all of which relate equally to the provisions of section (c) and the provisions of section (b), as they are both in the same section.

Mr. MAPES. You think section (d) relates to the loans by banks as well as by brokers?

Mr. FORT. I think so, sir, because it refers to the entire section. Mr. MAPES. Assuming that that is true, would not this specific provision of paragraph (c), which limits the discretion of the bank as to securities owned by the borrower for a period of less than 30 days control?

Mr. FORT. In part. I think that I am coming to a more direct connection of the 30-day provision a little bit later, but I still feel that this bill is making the first attempt here to define the capacity of banks in making a collateral loan in any respect.

Mr. MAPES. What I had in mind was leading up to this question, if the restriction is confined only to loans on securities which have been owned for 30 days or less, would that be an undue restriction in your opinion?

Mr. FORT. Very.

Mr. MAPES. To what extent would that limit the ordinary loans of a bank?

Mr. FORT. In two. Will you permit me to reach that just a moment later?

Mr. MAPES. I did not know that you were going to come to that. Mr. FORT. Yes. In order to reach that question, I want to call attention, just briefly, to the complete change that has come in banking and in corporate finance in the last 30 years.

Until about the beginning of this century, the vast majority of businesses were individually owned. Loans were made by the banks to the owners of the business on the basis of their personal reputation, their ability to repay, and the value of the business. Those loans were almost exclusively for working capital.

Well, what has happened since? In the past 30 years, business has become almost entirely corporate. Actual borrowing by the corporations from the banks for working capital has become practically nil, as is shown by the disappearance of the old commercial paper market. What has happened? What has taken place? The corporations of America, large and small, have gotten funds from working capital as well as for plant, by the sale of stock to their stockholders. Usually that sale has taken place in the form of rights to old stockholders to purchase additional stock, and 90 percent of the money has been provided indirectly to the corporation by direct loans of banks to the stockholders of the money with which to buy stock on the rights issued to them by the corporation or by bank loans to the person to whom stockholders have sold or transferred their rights to buy.

In other words, banks today are loaning the working capital and the other funds which corporations need, not in the form, in the majority of the cases, of direct loans to the corporation in the first instance; but in the form of loans to the stockholders of that corporation of the funds with which to buy stock.

I am connected with one corporation which increased its capital five times between 1918 and 1928, every time by the issuance of rights to its stockholders to buy stock. In every case the stockholder had to finance that purchase, not 30 days after he owned the stock, but the day he became the owner of the stock.

Mr. MAPES. When did he have to finance these rights?

Mr. FORT. He had to finance them the day that he exercised his rights and paid for the stock. He could not wait. If he waited 30 days he could not become the owner. His only chance to exercise his right to buy was to pay for the stock the day that the corporation fixed for that payment.

Now, if you are going to bar that kind of loan out of the banks, what are you going to do? You are going to say that no man can borrow more than 40 percent of the money he wants because we cannot loan him more than 40 percent until he has owned it outright for 30 days.

And the moment you do that, gentlemen, you force one of two things: Either a complete change in the modern method of acquiring capital for corporations through the sale of stock to their own stockholders, or a requirement that all stock be unlisted.

We are barred under this legislation from making any of those loans. Take the case of the United States Steel Corporation, which issued stock to its stockholders in 1929 at $140 per share. The rights to buy that stock were highly esteemed by the stockholders and they took up the entire issue. The majority of them took it up by loans from their banks, borrowing what they had to and paying the rest in cash. The majority of them bought it with the idea of holding it for a permanent investment.

I think the vast majority of them rarely dealt with brokers, did not know how to deal with brokers, but did know how to deal with a bank, and the vast majority of them borrowed with the idea of paying off the loan a few hundred dollars at a time, or a hundred dollars at a time, as they were able to pay for it.

Under the language of this act, no bank in the country could make them a loan for that purpose, in excess of 40 percent of their needs, nor unless the repayment provisions suited the Federal Trade Commission. Mr. MAPES. Just so that we understand each other: The man, of course, to have any rights, would have to own some stock.

Mr. FORT. Yes, sir.

Mr. MAPES. If he owned the stock, he could take that to the bank and put it up as collateral, if he had not already done that.

Mr. FORT. Sometimes his rights would exceed the amount he could borrow on that basis, and, suppose he had already borrowed on the first stock, as often has happened.

Mr. MAPES. Your statement assumes that he is going to try to borrow on the rights.

Mr. FORT. Borrow on the new stock as he gets it. The usual form. that those loans were handled in was this, the customers brought in the rights, endorsed them, wrote out a collateral note which recited that he was purchasing so many shares of United States Steel to be presently issued, and delivered the certificate for the rights to the bank, which subscribed for him, using his cash to supplement the amount of their loan; bought the stock for him, had it mailed to the bank in his name, holding a blank power of attorney, and put it up as collateral for the loan.

That was done in thousands upon thousands of cases. I have done it myself on stocks that I have had the privilege to buy, and have handled my securities in that way, and I have no doubt many other men have done the same thing.

Consequently, gentlemen, any provision which forbids a bank loaning more than 40 percent of the market price of that stock at the date of or within 30 days after, its issue, puts an absolute hobble on corporation financing of the soundest type, since there is no question but that the best way, from the general economic standpoint, for a corporation to raise money is to raise it by stock rather than by fixed obligations.

It is due to this form of financing more than any one other thing that major industrial insolvencies have been avoided during this depression, because the corporations had secured, by the sale of their stock in the boom periods, sufficient funds to carry them through the depression.

You are, if you leave that language in the bill, therefore, not only making bankers think in terms of price rather than of value, but you

are also making the whole ability of American corporations to finance themselves in the soundest possible way a matter of grave difficulty. You are doing another thing, and that is the thing that I particularly do not like, as a banker, and I think I may say, as a citizen. Where has American banking fallen down in the past 5 years? It has fallen down because it has adopted the broker's method of rating collateral loans.

The broker-concerned only with the day-by-day fluctuations of the market-dealing with speculative securities, and chiefly with speculators rather than investors-interested in the rapid fluctuations of the market-has always treated his accounts as though they were day-to-day loans, where the collateral alone established their value.

Up until 1925, or thereabouts, bankers in this country outside the city of New York, and one or two other places-cities which were directly in the atmosphere and affected by the psychology of speculation-made collateral loans on the basis of loans to investors; made them only to the normal customers of the bank, and then let them run for years, undisturbed, and usually without revaluing the collateral.. Why? Because they had dealt only with customers; because the name of an honorable man was still an asset in American banking.

Today, and through the depression, the overemphasis of the price psychology-the reliance of the banker only on the same security of current price that the speculative broker was interested in-has resulted in bankers and bank supervising officials and examiners listing loans as good or bad, only if the market price of the collateral exceeded the face of the loan.

There is no other thing which has bankrupted so many men in America; there is no other thing which has wrecked so many banks in America as the discarding of the name of an honorable man as entitled to credit independently from the market price of his collateral. Now, what are you gentlemen here planning to do to the banker? In the first 30 days of his customer's ownership you are saying to him, "It does not make any difference who it is that comes to you to borrow money; it does not make any difference whether he is a man of high standing and character, whose obligations are good, whose name means something, who has a good income and a reasonable ability to pay his debts, or whether he is a sheer speculator who has accumulated a little money to act as margin on the purchase of a security. You cannot loan any more to the decent, honorable citizen of ability to pay than you can loan to the speculator who is working on more or less of a shoestring."

And right there, gentlemen, you are putting in this legislation market price for the first time in the history of American banking as the sole criterion of a loan.

Mr. LEA. Mr. Chairman

The CHAIRMAN. Mr. Lea.

Mr. LEA. Mr. Fort, is not that pretty much the situation, regardless of this bill, today?

Mr. FORT. It has been unfortunately too much so, Mr. Lea; but you gentlemen are hearing in connection with this bill of banking as it is conducted in New York City and Chicago and 1 or 2 other places, particularly subject to the speculative atmosphere. It is not true in American banking to the same extent, even in my home city of