Security Markets Reflect Acute Credit Stringency

A. W. BLUE May 1 1929

Security Markets Reflect Acute Credit Stringency

A. W. BLUE May 1 1929

Security Markets Reflect Acute Credit Stringency



Hundreds of thousands of dollars are lost annually in Canada through careless investment. Fraudulent and worthless securities are being: constantly poured on to the market to trap the unwary. A g-eneral observance of this simple maxim will assist in the reduction and elimination of this economic waste—


NOVICES in the art of speculation have acquired a vast amount of useful experience since the beginning of the year. They have been presented with concrete evidence of the unstable character of security values, and have discovered that stocks can decline with equal or even greater precipitancy than they can advance. All shades of market activity were compassed within the first three months, ranging from buoyantly bullish markets in January and early February to a hesitating market in later February and early March, followed in turn by a reactionary market that culminated on March 26 in one of the most drastic breaks in Canadian financial history. The speculator who was able to stand the strain of that fateful Tuesday, has merited the spurs so painfully won, for on that day more than half a billion dollars in security values evaporated into air; scores of thinly margined accounts were wiped out, and strongly entrenched accounts were worth much less at the end of the day’s session than at the commencement.

While there may have been more spectacular reactions in the past it is safe to say that aggregate paper losses never heretofore attained the colossal figure indicated on this occasion, nor touched so wide a range of investors. Echoes of the break reverberated from coast to coast, and thousands of people were affected more or less acutely. International Nickel, for example, accredited with creating scores of fortunes, slumped to 41, compared with the high of the year of 72, a decline of thirty-one points, or in terms of the old stock, a drop of 186 points in quoted values. This decline represents a depreciation in value of the stock outstanding of roughly between four and five hundred million dollars. Brazilian Traction common, another widely held and favorite speculative security, broke in similar fashion, and its thirty-point-decline involved an aggregate loss of many millions. The experience of these two key issues was shared by virtually every stock listed on the Canadian boards; few, if any, were spared; even gilt-edged bonds felt the pinch.

Nor was this experience peculiar to the Canadian markets. New York, on the same day, experienced one of the most violent declines on record, followed by an equally abrupt rally, all within the fivehour session. Call money on that occasion ran up to twenty per cent, the highest point in nearly a decade, and liquidation of stocks was fast and furious. Total turnover was well over eight million shares, and the ticker ran an hour and a half after the close of the market before the record of the final transaction was broadcast throughout the continent. The sharp reversal of trend which appeared in the later session, resulted when influential bankers rushed in large supplies of funds to the market for the purpose of averting a financial panic that appeared impending. The salutary influence of this support was immediate and decisive.

All this and subsequent developments to date are now history, and there is no need to dwell on them. But it is well to consider the conditions responsible for this interval of chaos, and to weigh cause and effect for future guidance.

Business Outlook Brighter

DE VERTING to the domestic situation, the break in the Canadian markets came at a time when the business horizon was never brighter. Bankers and other business leaders have emphasized time and again the very promising outlook for Canadian business this year. Under such circumstances the moment would scarcely appear opportune to become permanently bearish on the market, for it is only on the eve of a general business decline that the market embarks on one of those prolonged and major setbacks, which are so distressing to holders of stocks. The cause was undoubtedly concerned with something substantially less significant, and even temporary in character—and students of the market ascribe the cause to money stringency—to scarcity of funds for speculative purposes.

The stock market has been advancing for the past four years. It is well known that speculation is largely financed with borrowed capital. The individual speculator as a rule advances only a portion of the cost price of his stocks, and borrows the balance from the banks, or empowers his broker to borrow for him. It is quite obvious, therefore, that when markets have been consistently advancing, and the number of speculators steadily increasing, more and more is borrowed for market speculation. The bulk of these funds is secured from the banks, and finally aggregate borrowings had reached a stage where the banks were faced with the necessity of curtailing speculative loans, in order that sufficient resources would remain to meet the legitimate needs of business. For after all is said, banks were designed primarily to supply credit to commerce and industry, rather than finance stock speculation. And when the latter seems to be encroaching on the preserves of the former, then necessity for determined action arises. For some months, accordingly, Canadian banks have followed a policy of rigid retrenchment so far as loans for market purposes were concerned. The final step, which broke the final resistance of the market, was the raising of the call loan rate to 6 U per cent, as against a rate of six per cent hitherto prevailing for years. As brokers tack on another one per cent to recompense themselves for the routine work involved in arranging loans, keeping records, etc., the customer is now paying 7^2 Per cent for credit accommodation; and as interest is compounded monthly, the annual charge on the client is somewhat greater than 7 Jri per cent.

Credit Stringency in U.S.

rT*HIS has been described as a “money” L market. As this applies more literally to New York, it is necessary to study the New York situation for a moment in order to get a comprehensive view of the whole picture. Bankers of the United States have faced a situation similar to that which has existed in Canada, only in intensified form. The Federal Reserve Board, and its twelve district member banks—whose task it is to control credit and rates, and to see that the credit needs of business receive primary consideration, and that no other influence impedes the flow of funds into legitimate commercial channels—have faced a curious and perplexing dilemma. Loans on call to brokers on customers’ account have passed far beyond the tremendous and hitherto unprecedented figure of five billion dollars. Speculative enthusiasm continued at fever pitch, and the loan figure was steadily on the upgrade. Private institutions and corporations, attracted by high call rates, loaned funds readily, and rendered ineffective for a time the efforts of the banks to reduce loans. It mattered not to the speculative public that call rates were exorbitantly high, eight, ten and twelve per cent scarcely casting a ripple on the speculative pool; but these high rates were a distinct menace to business, for no agency has as yet been contrived, whereby rates on loans for speculative purposes can be boosted without finding some corresponding reflection in the rates on commercial paper.

The term “call money’’ as applied to the New York market means exactly that. In other words, a bank or corporation with funds on loan for market purposes can “call” in these funds in whole or in part at virtually a moment’s notice, and receive them back almost immediately whenever desired. The Canadian “call” market has not been so thoroughly developed, and while we have a so-called “call” market, it is really not a “call” market at all, for a bank must allow its client some latitude when a call is sent out. The immediate return of the funds cannot be assured, for usually the broker requires a little time to get the money and to arrange fresh accommodation to fill up the gap. But the call loan market of New York is popular, not only on account of the high rates that obtain, but also because of the ease with which funds may be recovered. Hence, there is always the disposition on the part of American banks and corporations, and Canadian banks as well, to send funds not immediately required in ordinary business into the New York market, where they can be profitably and conveniently employed.

Demand Presses on Supply

' I 'HE problem that has faced the

Federal Reserve Board of the United States arising out of acute credit stringency is summed up in the words of Governor Roy A. Young, a member of the Federal Reserve Board. “For six years or more there has been an unusual demand for a form of credit that can be properly termed speculative; in fact, the unusually high rates in that field made it evident that demand has pressed hard on the supply, as measured by the willingness of the banks to lend for such purposes.

“However, when the funds were not forthcoming from the banks, which are the regular distributors of credit, the speculator made the rates so attractive that corporations and individuals, both foreign and domestic, supplied the funds. The unusual demand for this particular form of credit has had an effect upon the cost of other forms of credit, so that practically all lines of commerce and industry have been affected to a certain degree.

“There are many people who feel that because of some power that, I am frank to confess, is unknown to the Federal Reserve Board, low rates could be maintained to commerce and industry indefinitely, even though the speculator pays higher rates.

“There are approximately 27,000 bankers in the United States, and in the conj duct of their own institutions they I operate as independent units, and while I they take care of local needs when they have funds to employ outside of their own community and are offered call loans at rates from three to four per cent above credit based upon production and distribution, obviously, they extend that credit which brings the best rate, all other things being equal. This forces the commercial borrower to make his offer more attractive, with the result that in course of time every one pays higher rates.

“High rates have drawn credit and gold from many quarters of the globe to satisfy the appetite of the speculative borrower. The foreign banks of issue have already had to raise their rates to protect their own position. If this continues, others no doubt will have to follow. The final cost may not be reckoned in terms of interest charges alone, but may involve the impairment of our commerce and industry.”

Actuated By Common Desire

CANADIAN and United States’ bankers have been actuated by the common ambition to get speculative loans down, so that there would be ample funds for business at reasonable rates. And it was their repeated warnings and veiled threats of drastic action if the market did not right itself of its own ; accord, coupled with the advance of call money to the rate of twenty per cent, that wore down ragged nerves to the frazzled edge and culminated in the sweeping declines referred to.

Whether the Canadian situation has been adjusted to the satisfaction of the banking fraternity cannot at the moment of writing be determined. Beyond doubt, loans were materially reduced as a result of wholesale liquidation. Of course, the market recovered substantially almost immediately, reflecting the confidence of the public in the business outlook of the country, but many small investors who could ill afford to lose, were caught in the deluge, and derived no satisfaction from the upturn of the market. But speculators of this type usually speculate on thin margins, and in the aggregate their borrowings amount to a tremendous figure. It may be that the bankers will be disposed to regard the temporary collapse of the market as triumphant victory, complete and final, for themselves, or will merely notch one point in their favor in the tussle for lower speculative loans.

Viewed from its general aspects, the fundamental cause of the market’s reaction appears to be nothing more serious than credit stringency, which may or may not have been thoroughly corrected. But after all, the stringency was due as much to increased requirements of business as to enlarged demands for speculative purposes—one of those unusual and paradoxical situations where prosperity begets calamity.

And, finally, now that the smoke of battle has drifted away, what lessons can we draw? First, foremost and last: Speculation is a hazardous business and is not for those who cannot afford to take a loss. In the second place, it is the height of folly to buy more than one can pay for. Even if trading on margin, have sufficient I in reserve to complete payment if necessary. In a period of stress, good stocks can go down as emphatically as the mediocre—class distinctions in stocks are subordinated when the public is in a selling mood. But good stocks will usually come back more quickly and decisively when the storm has spent its force, and it pays, therefore, to buy good stocks. A final point; the Canadian markets closely reflect the shifting moods of Wall Street, and we are too close to that canyon of finance to work entirely independently. And what New York will do is anybody’s guess.