Books: Lombard Street: A Description of the Money Market
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Walter Bagehot >> Lombard Street: A Description of the Money Market
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In the present day, also, private banking is exposed to a
competition against which in its origin it had not to struggle.
Owing to the changes of which I have before spoken, joint stock
banking has begun to compete with it. In old times this was
impossible; the Bank of England had a monopoly in banking of the
principle of association. But now large joint stock banks of deposit
are among the most conspicuous banks in Lombard Street. They have a
large paid-up capital and intelligible published accounts; they use
these as an incessant advertisement, in a manner in which no
individual can use his own wealth. By their increasing progress they
effectually prevent the foundation of any new private bank.
The amount of the present business of private banks is perfectly
unknown. Their balance sheets are effective secretsrigidly guarded.
But none of them, except a few of the largest, are believed at all
to gain business. The common repute of Lombard Street might be wrong
in a particular case, but upon the general doctrine it is almost
sure to be right. There are a few well-known exceptions, but
according to universal belief the deposits of most private bankers
in London tend rather to diminish than to increase.
As to the smaller banks, this naturally would be so. A large bank
always tends to become larger, and a small one tends to become
smaller. People naturally choose for their banker the banker who has
most present credit, and the one who has most money in hand is the
one who possesses such credit. This is what is meant by saying that
a long established and rich bank has a 'privileged opportunity'; it
is in a better position to do its business than any one else is; it
has a great advantage over old competitors and an overwhelming
superiority over new comers. New people coming into Lombard Street
judge by results; they give to those who have: they take their money
to the biggest bank because it is the biggest. I confess I cannot,
looking far forward into the future, expect that the smaller private
banks will maintain their ground. Their old connections will not
leave them; there will be no fatal ruin, no sudden mortality. But
the tide will gently ebb, and the course of business will be carried
elsewhere.
Sooner or later, appearances indicate, and principle suggests, that
the business of Lombard Street will be divided between the joint
stock banks and a few large private banks. And then we have to ask
ourserves the question, can those large private banks be permanent?
I am sure I should be very sorry to say that they certainly cannot,
but at the same time I cannot be blind to the grave difficulties
which they must surmount.
In the first place, an hereditary business of great magnitude is
dangerous. The management of such a business needs more than common
industry and more than common ability. But there is no security at
all that these will be regularly continued in each generation. The
case of Overend, Gurney and Co., the model instance of all evil in
business, is a most alarming example of this evil. No cleverer men
of business probably (cleverer I mean for the purposes of their
particular calling) could well be found than the founders and first
managers of that house. But in a very few years the rule in it
passed to a generation whose folly surpassed the usual limit of
imaginable incapacity. In a short time they substituted ruin for
prosperity and changed opulence into insolvency. Such great folly is
happily rare; and the business of a bank is not nearly as difficult
as the business of a discount company. Still much folly is common,
and the business of a great bank requires a great deal of ability,
and an even rarer degree of trained and sober judgment. That which
happened so marvelously in the green tree may happen also in the
dry. A great private bank might easily become very rotten by a
change from discretion to foolishness in those who conduct it.
We have had as yet in London, happily, no example of this; indeed,
we have hardly as yet had the opportunity. Till now private banks
have been small; small as we now reckon banks. For their exigencies
a moderate degree of ability and an anxious caution will suffice.
But if the size of the banks is augmented and greater ability is
required, the constant difficulty of an hereditary government will
begin to be felt. 'The father had great brains and created the
business: but the son had less brains and lost or lessened it.' This
is the history of all great monarchies, and it may be the history of
great private banks. The peculiarity in the case of Overend, Gurney
and Co. at least, one peculiarity is that the evil was soon
discovered. The richest partners had least concern in the
management; and when they found that incredible losses were ruining
them, they stopped the concern and turned it into a company. But
they had done nothing; if at least they had only prevented farther
losses, the firm might have been in existence and in the highest
credit now. It was the publicity of their losses which ruined them.
But if they had continued to be a private partnership they need not
have disclosed those losses: they might have written them off
quietly out of the immense profits they could have accumulated. They
had some ten millions of other people's money in their hands which
no one thought of disturbing. The perturbation through the country
which their failure caused in the end, shows how diffused and how
unimpaired their popular reputation was. No one in the rural
districts (as I know by experience) would ever believe a word
against them, say what you might. The catastrophe came because at
the change the partners in the old private firmthe Gurney family
especiallyhad guaranteed the new company against the previous
losses: those losses turned out to be much greater than was
expected. To pay what was necessary the 'Gurneys' had to sell their
estates, and their visible ruin destroyed the credit of the concern.
But if there had been no such guarantee, and no sale of estates, if
the great losses had slept a quiet sleep in a hidden ledger, no one
would have been alarmed, and the credit and the business of
'Overends' might have existed till now, and their name still
continued to be one of our first names. The difficulty of
propagating a good management by inheritance for generations is
greatest in private banks and discount firms because of their
essential secrecy.
The danger may indeed be surmounted by the continual infusion of new
and able partners. The deterioration of the old blood may be
compensated by the excellent quality of the fresh blood. But to this
again there is an objection, of little value perhaps in seeming, but
of much real influence in practice. The infusion of new partners
requires from the old partners a considerable sacrifice of income;
the old must give up that which the new receive, and the old will
not like this. The effectual remedy is so painful that I fear it
often may be postponed too long.
I cannot, therefore, expect with certainty the continuance of our
system of private banking. I am sure that the days of small banks
will before many years come to an end, and that the difficulties of
large private banks are very important. In the mean time it is very
important that large private banks should be well managed. And the
present state of banking makes this peculiarly difficult. The detail
of the business is augmenting with an overwhelming rapidity. More
cheques are drawn year by year; not only more absolutely, but more
by each person, and more in proportion to his income. The payments
in, and payments out of a common account are very much more numerous
than they formerly were. And this causes an enormous growth of
detail. And besides, bankers have of late begun almost a new
business. They now not only keep people's money, but also collect
their incomes for them. Many persons live entirely on the income of
shares, or debentures, or foreign bonds, which is paid in coupons,
and these are handed in for the bank to collect. Often enough the
debenture, or the certificate, or the bond is in the custody of the
banker, and he is expected to see when the coupon is due, and to cut
it off and transmit it for payment. And the detail of all this is
incredible, and it needs a special machinery to cope with it.
A large joint stock bank, if well-worked, has that machinery. It has
at the head of the executive a general manager who was tried in the
detail of banking, who is devoted to it, and who is content to live
almost wholly in it. He thinks of little else, and ought to think of
little else. One of his first duties is to form a hierarchy of
inferior officers, whose respective duties are defined, and to see
that they can perform and do perform those duties. But a private
bank of the type usual in London has no such officer. It is managed
by the partners; now these are generally rich men, are seldom able
to grapple with great business of detail, and are not disposed to
spend their whole lives and devote their entire minds to it if they
were able. A person with the accumulated wealth, the education and
the social place of a great London banker would be a 'fool so to
devote himself. He would sacrifice a suitable and a pleasant life
for an unpleasant and an unsuitable life. But still the detail must
be well done; and some one must be specially chosen to watch it and
to preside over it, or it will not be well done. Until now, or until
lately, this difficulty has not been fully felt. The detail of the
business of a small private bank was moderate enough to be
superintended effectually by the partners. But, as has been said,
the detail of bankingthe proportion of detail to the size of the
bankis everywhere increasing. The size of the private banks will
have to augment if private banks are not to cease; and therefore the
necessity of a good organisation for detail is urgent. If the bank
grows, and simultaneously the detail grows in proportion to the
bank, a frightful confusion is near unless care be taken.
The only organisation which I can imagine to be effectual is that
which exists in the antagonistic establishments. The great private
banks will have, I believe, to appoint in some form or other, and
under some name or other, some species of general manager who will
watch, contrive, and arrange the detail for them. The precise shape
of the organisation is immaterial; each bank may have its own shape,
but the man must be there. The true business of the private partners
in such a bank is much that of the directors in a joint stock bank.
They should form a permanent committee to consult with their general
manager, to watch him, and to attend to large loans and points of
principle. They should not themselves be responsible for detail; if
they do there will be two evils at once: the detail will be done
badly, and the minds of those who ought to decide principal things
will be distracted from those principal things. There will be a
continual worry in the bank, and in a worry bad loans are apt to be
made and money is apt to be lost.
A subsidiary advantage of this organisation is that it would render
the transition from private banking to joint stock banking easier,
if that transition should be necessary. The one might merge in the
other as convenience suggested and as events required. There is
nothing intrusive in discussing this subject. The organisation of
the private is just like that of the joint stock banks; all the
public are interested that it should be good. The want of a good
organisation may cause the failure of one or more of these banks;
and such failure of such banks may intensify a panic, even if it
should not cause one.
CHAPTER XI.
The Bill-Brokers.
Under every system of banking, whether that in which the reserve is
kept in many banks, or one in which it is kept in a single bank
only, there will always be a class of persons who examine more
carefully than busy bankers can the nature of different securities;
and who, by attending only to one class, come to be particularly
well acquainted with that class. And as these specially qualified
dealers can for the most part lend much more than their own capital,
they will always be ready to borrow largely from bankers and others,
and to deposit the securities which they know to be good as a pledge
for the loan. They act thus as intermediaries between the borrowing
public and the less qualified capitalist; knowing better than the
ordinary capitalist which loans are better and which are worse, they
borrow from him, and gain a profit by charging to the public more
than they pay to him.
Many stock brokers transact such business upon a great scale. They
lend large sums on foreign bonds or railway shares or other such
securities, and borrow those sums from bankers, depositing the
securities with the bankers, and generally, though not always,
giving their guarantee. But by far the greatest of these
intermediate dealers are the bill-brokers. Mercantile bills are an
exceedingly difficult kind of security to understand. The relative
credit of different merchants is a great 'tradition'; it is a large
mass of most valuable knowledge which has never been described in
books and is probably incapable of being so described. The subject
matter of it, too, is shifting and changing daily; an accurate
representation of the trustworthiness of houses at the beginning of
a year might easily be a most fatal representation at the end of it.
In all years there are great changes; some houses rise a good deal
and some fall. And in some particular years the changes are immense;
in years like 1871 many active men make so much money that at the
end of the year they are worthy of altogether greater credit than
anyone would have dreamed of giving to them at the beginning. On the
other hand, in years like 1866 a contagious ruin destroys the
trustworthiness of very many firms and persons, and often,
especially, of many who stood highest immediately before. Such years
alter altogether an important part of the mercantile world: the
final question of bill-brokers, 'which bills will be paid and which
will not? which bills are second-rate and which first-rate?' would
be answered very differently at the beginning of the year and at the
end. No one can be a good bill-broker who has not learnt the great
mercantile tradition of what is called 'the standing of parties' and
who does not watch personally and incessantly the inevitable changes
which from hour to hour impair the truth of that tradition. The
credit' of a personthat is, the reliance which may be placed on his
pecuniary fidelityis a different thing from his property. No doubt,
other things being equal, a rich man is more likely to pay than a
poor man. But on the other hand, there are many men not of much
wealth who are trusted in the market, 'as a matter of business,' for
sums much exceeding the wealth of those who are many times richer. A
firm or a person who have been long known to 'meet their
engagements,' inspire a degree of confidence not dependent on the
quantity of his or their property. Persons who buy to sell again
soon are often liable for amounts altogether much greater than their
own capital; and the power of obtaining those sums depends upon
their 'respectability,' their 'standing,' and their 'credit,' as the
technical terms express it, and more simply upon the opinion which
those who deal with them have formed of them. The principal mode in
which money is raised by traders is by 'bills of exchange;' the
estimated certainty of their paying those bills on the day they fall
due is the measure of their credit; and those who estimate that
liability best, the only persons indeed who can estimate it
exceedingly well, are the bill-brokers. And these dealers, taking
advantage of their peculiar knowledge, borrow immense sums from
bankers and others; they generally deposit the bills as a security;
and they generally give their own guarantee of the goodness of the
bill: but neither of such practices indeed is essential, though both
are the ordinary rule. When Overends failed, as I have said before,
they had borrowed in this way very largely. There are others now in
the trade who have borrowed quite as much.
As is usually the case, this kind of business has grown up only
gradually. In the year 1810 there was no such business precisely
answering to what we now call bill-broking in London. Mr.
Richardson, the principal 'bill-broker' of the time, as the term was
then understood, thus described his business to the 'Bullion
Committee:'
'What is the nature of the agency for country banks'It is twofold:
in the first place to procure money for country bankers on bills
when they have occasion to borrow on discount, which is not often
the case; and in the next place, to lend the money for the country
bankers on bills on discount. The sums of money which I lend for
country bankers on discount are fifty times more than the sums
borrowed for country bankers.
'Do you send London bills into the country for discount?--Yes.
'Do you receive bills from the country upon London in return, at a
date, to be discounted?--Yes, to a very considerable amount, from
particular parts of the country.
'Are not both sets of bills by this means under discount?--No, the
bills received from one part of the country are sent down to another
part for discount.
'And they are not discounted in London?--No. In some parts of the
country there is but little circulation of bills drawn upon London,
as in Norfolk, Suffolk, Essex, Sussex, &c.; but there is there a
considerable circulation in country bank-notes, principally optional
notes. In Lancashire there is little or no circulation of country
bank-notes; but there is a great circulation of bills drawn upon
London at two or three months' date. I receive bills to a
considerable amount from Lancashire in particular, and remit them to
Norfolk, Suffolk, &c., where the bankers have large lodgments, and
much surplus money to advance on bills for discount.'
Mr. Richardson was only a broker who found money for bills and bills
for money. He is further asked:
'Do you guarantee the bills you discount, and what is your charge
per cent?--No, we do not guarantee them; our charge is one-eighth per
cent brokerage upon the bill discounted, but we make no charge to the
lender of the money.
'Do you consider that brokerage as a compensation for the skill
which you exercise in selecting the bills which you thus get
discounted?--Yes, for selecting of the bills, writing letters, and
other trouble.
'Does the party who furnishes the money give you any kind of
compensation?--None at all.
'Does he not consider you as his agent, and in some degree
responsible for the safety of the bills which you give him?--Not at
all.
'Does he not prefer you on the score of his judging that you will
give him good intelligence upon that subject?--Yes, he relies upon
us.
'Do you then exercise a discretion as to the probable safety of the
bills?--Yes; if a bill comes to us which we conceive not to be safe,
we return it.
'Do you not then conceive yourselves to depend in a great measure
for the quantity of business which you can perform on the favour of
the party lending the money?--Yes, very much so. If we manage our
business well, we retain our friends; if we do not, we lose them.'
It was natural enough that the owners of the money should not pay,
though the owner of the bill did, for in almost all ages the
borrower has been a seeker more or less anxious; he has always been
ready to pay for those who will find him the money he is in search
of. But the possessor of money has rarely been willing to pay
anything; he has usually and rightly believed that the borrower
would discover him soon.
Notwithstanding other changes, the distribution of the customers of
the bill-brokers in different parts of the country still remains
much as Mr. Richardson described it sixty years ago. For the most
part, agricultural counties do not employ as much money as they
save; manufacturing counties, on the other hand, can employ much
more than they save; and therefore the money of Norfolk or of
Somersetshire is deposited with the London bill-brokers, who use it
to discount the bills of Lancashire and Yorkshire.
The old practice of bill-broking, which Mr. Richardson describes,
also still exists. There are many brokers to be seen about Lombard
Street with bills which they wish to discount but which they do not
guarantee. They have sometimes discounted these bills with their own
capital, and if they can re-discount them at a slightly lower rate
they gain a difference which at first seems but trifling, but with
which they are quite content, because this system of lending first
and borrowing again immediately enables them to turn their capital
very frequently, and on a few thousand pounds of capital to discount
hundreds of thousands of bills; as the transactions are so many,
they can be content with a smaller profit on each. In other cases,
these nonguaranteeing brokers are only agents who are seeking money
for bills which they have undertaken to get discounted. But in
either case, as far as the banker or other ultimate capitalist is
concerned, the transaction is essentially that which Mr. Richardson
describes. The loan by such banker is a rediscount of the bill; that
banker cannot obtain repayment of that loan, except by the payment
of the bill at maturity. He has no claim upon the agent who brought
him the bill. Billbroking, in this which we may call its archaic
form, is simply one of the modes in which bankers obtain bills which
are acceptable to them and which they rediscount. No reference is
made in it to the credit of the bill-broker; the bills being
discounted 'without recourse' to him are as good if taken from a
pauper as if taken from a millionaire. The lender exercises his own
judgment on the goodness of the bill.
But in modern bill-broking the credit of the bill-broker is a vital
element. The lender considers that the bill-brokerno matter whether
an individual, a company, or a firmhas considerable wealth, and he
takes the 'bills,' relying that the broker would not venture that
wealth by guaranteeing them unless he thought them good. The lender
thinks, too, that the bill-broker being daily conversant with bills
and bills only, knows probably all about bills: he lends partly in
reliance on the wealth of the broker and partly in reliance on his
skill. He does not exercise much judgment of his own on the bills
deposited with him: he often does not watch them very closely.
Probably not one-thousandth part of the creditors on security of
Overend, Gurney and Co., had ever expected to have to rely on that
security, or had ever given much real attention to it. Sometimes,
indeed, the confidence in the bill-brokers goes farther. A
considerable number of persons lend to them, not only without much
looking at the security but even without taking any security. This
is the exact reverse of the practice which Mr. Richardson described
in 1810; then the lender relied wholly on the goodness of the bill,
now, in these particular cases, he relies solely on the bill-broker,
and does not take a bill in any shape. Nothing can be more natural
or more inevitable than this change. It was certain that the
bill-broker, being supposed to understand bills well, would be asked
by the lenders to evince his reliance on the bills he offered by
giving a guarantee for them. It was also most natural that the
bill-brokers, having by the constant practice of this lucrative
trade obtained high standing and acquired great wealth, should
become, more or less, bankers too, and should receive money on
deposit without giving any security for it.
But the effects of the change have been very remarkable. In the
practice as Mr. Richardson described it, there is no peculiarity
very likely to affect the money market. The bill-broker brought
bills to the banker, just as others brought them; nothing at all
could be said as to it except that the Bank must not discount bad
bills, must not discount too many bills, and must keep a good
reserve. But the modern practice introduces more complex
considerations. In the trade of bill-broking, as it now exists,
there is one great difficulty; the bill-broker has to pay interest
for all the money which he receives. How this arose we have just
seen. The present lender to the bill-broker at first always used to
discount a bill, which is as much as saying that he was always a
lender at interest. When he came to take the guarantee of the
broker, and only to look at the bills as a collateral security,
naturally he did not forego his interest: still less did he forego
it when he ceased to take security at all. The bill-broker has, in
one shape or other, to pay interest on every sixpence left with him,
and that constant habit of giving interest has this grave
consequence: the bill-broker cannot afford to keep much money
unemployed. He has become a banker owing large sums which he may be
called on to repay, but he cannot hold as much as an ordinary
banker, or nearly as much, of such sums in cash, because the loss of
interest would ruin him. Competition reduces the rate which the
bill-broker can charge, and raises the rate which the bill-broker
must give, so that he has to live on a difference exceedingly
narrow. And if he constantly kept a large hoard of barren money he
would soon be found in the 'Gazette.'
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