CHAPTER XIX

THE INVESTMENT BANK

CONSIDERATION has thus far been given mainly to the various aspects of commercial banking which supply business men with short-term credit to meet their current needs. Reference has occasionally been made to investment or long-term credit which furnishes funds for permanent economic improvements through such instruments as stocks, bonds, and notes. The following four chapters will present the essential characteristics of investment banks, as well as savings banks, trust companies and agricultural credit banks which may also be regarded as investment institutions.

I. DEVELOPMENT OF THE INVESTMENT Bank.

Investment bankers originated in the Middle Ages, when governments and kings received long-term loans for conducting wars and maintaining courts. Notable among the early money lenders were the Hansa merchants who supplied funds to many of the European kings and emperors, but usually with ample assurance of return. The ruler received a certain sum of money in the form of gold or silver bullion, and in return he gave the lender the rights over revenue derived from tariffs or taxes for a certain period of years. Loans were also extended on real property such as mines, fisheries, and forests owned by the government, and the products of the mines were applied to the payment of principal and interest. These early magnates were also merchants, and they were able to use their own money directly in granting loans; in this way they differed from the modern investment bankers who act as intermediaries in gathering the funds of others for making advances to bor

rowers. With the close of the Napoleonic wars, financial supremacy shifted from Amsterdam and the Continent to London, and with this change the modern investment bank as an intermediary institution between borrower and lender was developed.

The same general evolution was repeated in the financial history of the United States. During the first quarter of the nineteenth century American states and municipalities secured whatever capital they needed from merchants. During the second quarter, the westward movement caused an extension of such internal improvements as canals and railroads, and capital for these purposes was raised mainly from investors in England and in other European countries. Securities marketed in this country consisted largely of municipal bonds which were sold, usually without public notice, to local bankers who in turn marketed them among insurance companies, savings banks, and private investors. In order to secure a better price for bonds, municipalities began to advertise their new issues and their sales were conducted on a competitive basis. Blocks of these bonds were purchased by individuals for the purpose of reselling them on a retail basis, and these individuals thus performed in a small way the mediation function of the modern investment banker.

The development of free banking encouraged the organization of many banks, and until the opening of the Civil War there was considerable investment of capital in bank stock. After the Civil War the growth of transcontinental railways led to the issue of large blocks of bonds which were absorbed by American and European investors, whose contributions of capital made possible also the organization and development of great industrial combinations at the opening of the twentieth century.

The World War changed the movement of capital between Europe and America. At first a large proportion of American railroad and industrial securities held abroad were repurchased, and later the war obligations of the European governments found a market in the United States.

II. ORGANIZATION OF AN INVESTMENT BANK.

The modern investment bank is seldom organized in the form of a corporation, but rather as a partnership including from two to twenty members. In addition, large commercial banks have either opened bond departments or have organized separate securities companies which perform all the functions of investment houses.

The investment bank may emphasize certain features of its business more than others, and so its organization varies accordingly. It usually includes buying, selling, statistics and treasury departments. The function of the buying department is to investigate the various proposals submitted by corporations or other investment houses and to buy the securities if conditions warrant such action. The buying departments of large investment houses usually maintain close contact with industries in which they are interested. Also a large firm keeps itself informed through traveling representatives, who report conditions in these enterprises. After the securities are purchased they are turned over to the selling department. This is headed by a general sales manager, who directs the work of salesmen and, at times, the operation of the branch offices. The majority of sales are made by representatives who travel through the territory allotted to them, build up a regular clientele, and thus dispose of new issues of securities. Each salesman keeps in touch with the home office and reports regularly to the sales manager. If a salesman shows ability he is frequently placed in charge of a branch office and is allowed to participate in the profits of the business.

The sales force receives considerable assistance from the statistical department, which compiles lists of customers, securities already purchased by them, and their preferences in investments. The department aids in conducting a sales campaign by preparing circulars and press notices. This department also answers customers' inquiries for information on investments. Another important task of the statistical department is to analyze proposals submitted to the consideration of the investment house.

The treasury department is concerned with such fiscal affairs as the securing of loans from banks and the carrying of accounts of customers who purchase securities on a marginal basis or on an installment plan.

III. CLASSES OF INVESTMENT BANKS.

Investment institutions may be divided into three general groups-wholesale houses, large retail houses, and small retail, or bond, houses. The first group is composed of about a dozen large banking firms with many correspondent connections abroad. They "originate" or undertake the marketing of the larger issues of railroads and of foreign governments, exceeding at times $100,000,000 in amount, by selling them, usually not to the public directly, but indirectly through other houses. As wholesale houses are engaged mainly in the purchase of securities, the organization of their buying department is of special importance, and so it usually retains the services of engineers, accountants, lawyers, and other experts for the complete evaluation of the properties on the basis of which the securities are issued.

For the selling of these securities the wholesale houses in most cases associate themselves with the large retailers, who are much more numerous. These "participating" houses have their home office in New York City, or in some other Eastern money center, or in Chicago, and operate in other important cities through their own branches or through partnerships and corporations which are independently organized but always closely affiliated with the home office. The securities companies of national banks and the bond departments of trust companies are, of course, not permitted to organize branches, but instead operate correspondent offices which perform about the same activities as private investment banks. The large retailers will purchase securities for their own account directly from the issuing corporations to a limited extent only, and for relatively small amounts. In the case of large issues, the retailers will not usually assume the responsibility alone, but join with others in a syndicate or group of houses, of which each takes over a portion of the securities. As the main task of

a large retail house is the disposing of securities, the sales department is the most important unit in its organization.

Large retail houses may be grouped according to the form of the securities or the nature of the issues in which they are interested. Thus there are houses specializing in bonds, or stocks, or in both forms of securities. Other firms handle only such issues as government bonds, railroad, public utility, or industrial securities. While most investment banks naturally press the sale of their own specialties or issues, at the same time they will also execute orders to buy and sell other stocks and bonds either directly as members of the various stock exchanges or indirectly through brokers.

The branches and the affiliated offices of the large retailers throughout the country come into active competition with the bond houses or small retailers. These are of several classes, such as small banks and brokerage houses dealing in all kinds of securities, or handling specialties such as Standard Oil stocks, equipment bonds, and issues of local corporations. The organization of the small investment house is quite similar to that of the large retail firm, but on a more limited scale, for usually the buying and selling departments are conducted by only one person, who controls the entire business. The small bond house at times finds difficulty in obtaining high-grade securities, for those yielding a satisfactory profit are handled by the large retail houses themselves, which allow only a small commission on these sales.

IV. FUNCTIONS OF AN INVESTMENT BANK.

As already indicated, the types of investment banks considered perform in general one or more of the following functions: (1) investigating proposals, (2) forming syndicates for underwriting, (3) selling securities. In addition, investment houses may render the public such services as advice in selecting securities, information to customers, and protection in case of failure of the corporation issuing the securities. These functions are exercised by the several classes of investment banks to a degree varying with their