CHAPTER VIII. OF THE VARIOUS MODES RESORTED TO BY SOME BANKS TO AUGMENT THEIR DIVIDENDS.

EVERY sound thinker who has taken notice of the high rates of dividends that were declared by many of the banks throughout the United States, during the years 1836, 1837, and 1838, whilst their number was increasing, and when, upon every known principle, their dividends ought to have decreased, must be satisfied in his own mind, that these extraordinary dividends did not result from the legitimate operations of banking, that is, from the lending of money or credit at the rate of interest authorised by law. The charters of most of our banks restrict their operation to the lending of money and to trading and dealing in bills of exchange, gold and silver bullion, and certain specified public securities; and hence, all other transactions are in violation of the laws. I have stated in a former chapter, that the charge of one half per cent, interest taken beforehand, in connection with the practice of charging interest for sixty-four days upon a note payable in sixty days with three days grace, is equal to 6 per cent, per annum, and this it is evident is all that a bank has a right to claim for the use of its money or credit. Modern competition, however, has operated upon some, and led them to adopt numerous modes of getting more than this rate. Amongst these are the following:

1. The practice of giving a preference in their discounts to those customers, who by agreement, express or implied, stipulate to leave in the bank, never to be drawn for, a certain proportion of the amount borrowed; by which virtually the bank receives interest for money or credit which it does not lend. Examples have been known wherein a sum equal to twenty, thirty, or forty per cent, has been expected to remain as a permanent undrawn balance, thus adding to the profits of the bank, by a sheer evasion of the laws against usury. Borrowers upon such terms are seldom to be found amongst the most responsible traders, but can always be had in abundance amongst that class of needy men, who, without such a facility, would be obliged to borrow in the open market at a higher rate of interest. If this principle had been extended to the loans of all the banks of the United States, amounting in 1838 to upwards of $500,000,000 as far as five per cent, upon an average, the banks would have derived from it a profit equal to the interest on twenty-five millions of dollars, that is, upwards of a million and a half of dollars.

2. The practice of discounting notes, and instead of giving cash for the net proceeds, giving post notes payable at thirty or sixty days date, by which means the bank gains a profit equal to the interest for the time the note has to run. In other words, if a bank discounts a note having ninety days to run, and gives in exchange for it a post note payable in thirty days, it receives interest for ninety days for the loan of money for sixty days, inasmuch as the post note is not money until it becomes due, as will hereafter be shown. The extent to which this practice has been carried throughout the United States is very great, and it is defended upon the ground that the emission of post notes enables merchants who have remittances to make to distant points, to effect that object more securely and conveniently than by the transmission of bank notes payable to bearer, on account of the security afforded by the former’s being only transferable by endorsement. This is true, but it is manifest that this end would be as completely attained by a post note payable in three days after date, as by one payable in sixty days. But this is not all. Post notes at long dates, not only enable banks to profit by evading the laws against usury, but they enable banks to raise money for their own use when they are embarrassed, without appearing to borrow, a facility which renders them less careful of expansions of the currency than they otherwise would be.*

3. The practice of lending the notes of a bank with an express understanding that the borrower is not to put them into circulation within a certain distance of the place where the bank is located, or within a certain time from their coming into his possession, by which means the bank would receive interest for the time that would thus intervene, without having made any loan. An example of this species of contract was exposed in the examination of the affairs of the Chelsea bank near Boston, in 1837, two of the directors of which borrowed the notes of the bank which they were not to put in circulation, but which they were to pledge for money borrowed, elsewhere, and it was probably with the view of preventing a resort to such expedients, that the legislature of Massachusetts in that year prohibited banks from issuing notes that are not to go into immediate circulation.

4. The practice of discounting notes, and instead of paying the net proceeds in money, stipulating with the borrower that he is to take the notes of distant banks, known to be in the market at a discount. This expedient has been extensively resorted to all over the United States, and in some cases in such flagrant violation of the laws aginst usury, as to be accompanied by a regular bargain to purchase back by the bank, at the market rate of discount, the very paper just handed to the borrower. Nay, transactions have been even conducted in so barefaced a manner, that discounts have been made payable in distant paper which the bank did not possess, and which she purchased back at a discount, thus substituting a constructive sale and purchase of what possessed no existence, for the sake of avoiding a direct usurious transaction. Many flagrant examples of the expedients here described, extending to nearly all the banks of Providence, were exposed by a committee of the legislature of Rhode Island in June, 1836, in a report, a copy of which accompanied the secretary of the treasury’s report on the condition of certain banks, of January 4, 1837.

5. The practice of discounting domestic or inland bills of exchange, by which advantage has been taken under the color of exchange, to charge, besides the legal interest, and a fair charge for collecting, the most extortionate rates of profit, having no real relation to the actual expense of collecting, but only to the necessities of borrowers.* In the examination, by a committee of the legislature of New York, in 1838, of the affairs of one of the city banks, some gross malpractices of that institution were developed. It was proved to have charged from five to ten per cent, exchange on the collection of drafts, when the market rate of exchange on similar drafts was not more than from three to six; had discounted paper with the express understanding that the party accommodated was not to receive cash for the net proceeds, but a draft at par upon some distant place, worth in the market one to three per cent, less than the rate at which it was taken; and had even purchased back their own drafts at such a rate of discount. What this bank did, has been done, more or less, by a large portion of the banks in the United States, and the evil has become so extensive that funds which should be devoted to the discounting of real paper payable on the spot, have been diverted to the purchase of fictitious bills, created for the very purpose of raising money, and not in the ordinary course of trade.

6. The practice resorted to by some banks, of discounting notes in the market, through the instrumentality of brokers, at usurious interest, instead of discounting them at lawful interest, in the regular way. The New York bank above referred to, was proved to have discounted at usurious interest out of doors, the very notes that had been offered to the bank and been rejected by the board of directors.

7. The practice of speculating in stocks, and, in the case of some of the Mississippi banks and others, transacting the business of cotton factors, and cotton exporters.

8. The practice of buying up the depreciated paper of other banks, under a suspension of specie payments, and holding it until redeemed in coin. Large sums were invested, in 183S, by some of the Philadelphia and New York banks, in purchases of the notes of the Mississippi banks from ten to twenty-five per cent, discount, and loaned to the latter at par for their bonds payable at a subsequent period.

9. The practice adopted by many of the banks of New England, and perhaps of other places, of lending to brokers on interest, repayable on demand, a large proportion of the amount which banks in other places consider themselves bound to keep on hand, in coin, to meet possible demands.

10. If to these items be added the amount of profit made by the banks during the late suspension, by drawing interest on money that belonged to their creditors and not to themselves, we shall have the true sources from which the large dividends were derived. What proportion of the whole interest received is to be ascribed to this source, is not precisely ascertainable; but this much may be known with certainty, that it was equal to the income arising from that proportion of the aggregate mass of loans made by all the banks, that exceeded the amount that could have been sustained under a convertible currency.