Mercantile credit

Preface

This volume represents an attempt to discuss one branch of the credit family, Mercantile Credit. The theory of credit, and the different kinds of credit are considered only in so far as the treatment of these subjects makes more clear the nature, scope, and functions of mercantile credit. Bankruptcy legislation has to do largely with those who give and those who receive mercantile loans, and for this reason it has been considered of sufficient importance to warrant treatment.

While treating mercantile credit from a theoretical standpoint, an attempt is made to view the problems of mercantile credit as far as possible as a business man would view them. For this reason the author has described with much detail the work of the credit man, the organization of his office, the sources of credit information, the forms he uses to secure this information, and the principles which govern him in the granting of credit. He also discusses at considerable length the development of legislation with reference to credit, and the attitude of credit men toward this legislation.

Since economic phenomena should be viewed in the same way as phenomena in any other science, it is the first task of the economist to state clearly and to describe accurately the facts which come within the scope of his

v vi PREFACE

investigation and then interpret them in the light of economic knowledge. In this volume the author has attempted to do this.

This book is intended primarily for students in the colleges or schools of commerce, for those engaged in the many phases of credit work, and also for those who are interested in the general subject of credit.

Chapters IV, VI, VIII and XIV were published in

whole or in part in the American Journal of Accountancy,

and acknowledgement is made to the editors of this

magazine for their courtesy in permitting the use of the

material of these chapters in this volume. The writer

acknowledges his indebtedness to his colleagues in the

Department of Economics and Sociology of the Ohio

State University for helpful criticisms, and especially

to Mr. B. G. Watson, the secretary of the Columbus

Credit Men's Association, who read several chapters of

the manuscript and offered many helpful suggestions.

James Edward Hagerty.

Ohio State University, Columbus, Ohio. June, 1913.

CHAPTER I Theory and History of Credit

Page Definition of Credit, Credit Transaction and Credit System — Credit and the three periods of economic development — Credit in Rome — The Code of the XII tables — Credit in Babylon — Credit and the Great Fairs — Medium of Exchange^— Function of credit — Credit of General Acceptability and credit of Limited Acceptability — Credit instruments— Essential characteristics of Credit — Confidence as a basis of loans — Relation between credit, money and goods — What limits the amount of credit — Credit not Wealth or Capital 3

Chapter II

Two classes of credit instruments, (1) Promises to pay and (2) orders to pay — Definition and uses of Promissory Notes, Bank notes , book accounts, stock certificates, bonds, checks — The travelers check, letters of credit, Post office Money orders, bank drafts, Bills of Exchange, Drafts, Bills of lading and warehouse receipts 19

CHAPTER III Kinds op Credit

Different classifications of credit — Banking credit — Functions of modern banks — Credit creation — Relation between vii viii CONTENTS

Page banking and mercantile credit and between banking and personal credit — Setting of credit standards — Accommodation paper — Loans on collateral — Credit departments.

Public credit: Floating loans — Paper money — Causes of Public Debts.

Investment credit: Its extent — Stocks and Bonds — Investments and Public Credit — Investment and mercantile credit — Kinds of investment credit 37

Chapter IV

Dependence of mercantile on banking credit — Who receive mercantile credit — Changes in granting mercantile credit — Sources of credit information — Terms of credit — Rates of discount — Mercantile rates of interest high — Credit instruments— Note brokers — Book accounts — Methods of lending on book accounts — Dating ahead and its influence on credit 54

Chapter V

Definition — Personal and mercantile credit compared — Personal and banking credit compared — Changes in giving personal credit — Classes that receive personal credit — Mercantile houses which give personal credit — Factors determining the granting of credit by retailers — Granting of credit and extravagance — Credit given by company stores and installment houses — The consumer bears the burden of unwise credit 75

Chapter VI

The organization of mercantile industry — The work of the credit man — Sources of information — Character of the knowledge the credit man should possess — Book-keeping and credit — Bank and mercantile credit — The signed statement — Importance of work of credit man 90

CONTENTS ix

Page CHAPTER VII

Purposes of system — A typical system — Wherein office systems differ — Credit inquiry forms — Property statements — Property forms — Traveling salesmen and local attorneys as sources of credit information — Comparative property statement forms — Credit limitations — Credit departments of banks 108

CHAPTER VIII mercantile agencies

What the agency does — Industrial conditions responsible for the agency — Failure of early methods of granting credit — Origin of agencies — Development of agencies — Organization of agencies — Control of territory by district offices — Organization of foreign offices — Methods of securing credit information — Classifying, filing and distributing information— Magazines of the agency — Value of the agencies. . 134

CHAPTER IX general sources

Salesmen: Differences between salesman and credit man — Salesman as collector — Inquiry blanks — Attorneys — Method of securing information from attorneys — Banks, kind of information obtained from them — Traveling credit representatives — Methods by which they secure credit information 158

CHAPTER X credit exchange

Credit exchanges developed in last 15 years — Exchange of ledger information — The New Orleans and Minneapolis x CONTENTS

Page systems — Two classes of bureaus to-day — The card index system — The credit report system — Credit exchange bureaus of retail merchants associations — Retail grocers credit exchange bureaus 170

CHAPTER XI

Origin of adjustment bureaus and their aims — Value of adjustment bureaus — Ordinary methods of closing estates — How estates are closed by adjustment bureaus — Plan of organization — Three methods of organization — Relation of National Association of Credit Men to bureaus — Income from adjustment bureaus — Costs of closing estates by adjustment bureaus — Distribution of bureaus — Conclusions reached at conference of adjustment bureaus managers 184

CHAPTER XII

Relation of collections to a credit department — Qualifications of a collector — Office system in retail methods of collecting accounts — Classes of accounts — Methods of collecting accounts 200

CHAPTER XIII

Channels of distribution — Methods of giving mercantile credit — Over-trading — Influence of rising and falling prices on credit — A cause of the crisis of 1893 — Number and extent of mercantile institutions — Changes in the character of commodities produced 211

CHAPTER XIV

History of National Association of Credit Men — Its origin — Purposes — Membership — Difference in work of national

CONTENTS xi

Page and local associations — Work of committees — Co-operation of National and local associations in having State laws passed — Local associations of credit men — Their purposes and methods 225

PART II Legislation CHAPTER XV Bankruptcy Legislation

Contracts of primitive peoples — Early legislation with reference to debts — Modern views with reference to the relations between debtors and creditors — Modern States regulate relations between debtors and creditors — Insolvency, simple bankruptcy, and fraudulent bankruptcy — Bankruptcy proceedings — Preventive compositions — Treatment of bankrupts in different countries 247

CHAPTER XVI

The Bankrupt Law op 1800

National bankrupt laws — Right of National Government to legislate on bankruptcy — Principles in bankruptcy legislation of progressive countries — Law of 1800 limited to traders — Blackstone's views on bankruptcy — Who could be declared bankrupts under law of 1800 — Bankruptcy proceedings — Amount of property allowed a bankrupt — Reasons for retaining the law — Why the law was repealed. 257

CHAPTER XVII

Proposed bankruptcy acts and what they aimed to accomplish — Why traders made a special class — Foreign experience — New York's insolent laws — Purposes of a bankrupt law — Supreme Courts decisions on bankrupt and insolvent laws — Crisis of 1837 — Provisions of Act of 1841 — Volunxii CONTENTS

Page tary bankruptcy — Involuntary bankruptcy — Preferences and penalties for them — Assignees and their duties — Courts having jurisdiction — Strength of law — Reasons for its repeal 273

CHAPTER XVIII

Bankruptcy Act op 1867

Agitation for a third bankrupt law — Law of 1867 a compromise measure — Administration of the law — Attempt to make the courts accessible to the people — Registers appointed by district judges when recommended by the Chief Justice of the United States — Voluntary bankruptcy — Selection of assignees and their duties — Discharge — Involuntary bankruptcy — Control of debtor's estate by creditors — Defects of the Act of 1867 — The Amendments of 1870 and 1874 — Repeal of the law and why it was a failure. . . . 293

CHAPTER XIX

Conventions to formulate a bankruptcy law — Purposes of proposed measure — Act which passed was a compromise measure — The five acts which either make a debtor a bankrupt or which give grounds for bankruptcy proceedings — What a bankrupt is required to do — His privileges — A county the administrative unit — Trustees, their duties and compensation — Debts which have priority — Interests of debtors and creditors contrasted — Elements of strength in the law — Its weak features — Advantages of a good voluntary law — Amendments of 1903 and 1910 — Compositions— Corporations may become voluntary as well as involuntary bankrupts — Attempts to repeal law of 1898 — Advantages of a National bankrupt act 316

CHAPTER XX

Bankruptcy and the constitution — Why State insolvency laws are inadequate — Voluntary and involuntary insolvency

CONTENTS xiii

Paqej laws — Methods of procedure in each case — Voluntary insolvency in Utah and Oklahoma — Conditions of discharge in different states — Bankruptcy in New England — Insolvent laws in Texas, Georgia, and Lousiana 345

CHAPTER XXI Laws Regulating the Sale of Goods in Bulk

Bulk sales' laws passed as a result of systematic campaign — Chief abuse which bulk sales' laws correct — Provisions of model law — Louisiana bulk sales' law drastic in character — What most bulk sales' laws require — Bulk sales' laws of Oregon, Connecticut, and South Carolina — Acts passed by Nebraska, North Carolina, and Nevada in 1907 introduce new features — Some laws declared unconstitutional — In most instances Supreme Court decisions sustain bulk sales' laws as constitutional 357

Index 379

PART I

ORIGIN, DEVELOPMENT AND PRESENT STATUS OF MERCANTILE CREDIT

CHAPTER I No economic term has been given a greater variety

of meanings, even by economic writers, than the term

credit. This fact makes it important at the beginning of

an economic study to state clearly the meaning which

the term is intended to convey. For purposes of the

present discussion, credit means " the power to

secure commodities or services at the present x.e "

r tions.

time in return for some equivalent promised at a future time."1 Closely allied to the meaning of credit is a credit transaction which is "a transfer of goods, services, or money, for a future equivalent."2 The credit system may be defined as the great variety of means by " which transactions in credit are conducted, and the tremendous volume of debts and credits are brought into being, passed from hand to hand in the routine of business, and finally liquidated."3

In the business world a man has good credit if he always pays his debts when due. To the bookkeeper credit means that something is owed on an account.4 Credit is given people in general when they do some-

1 C. J. Bullock: Introduction to the Study of Economics.

2 Ely: Outlines of Economics.

3 Prendergast : Credit and Its Uses.

4 Johnson : Money and Currency.

thing upon which society places a favorable estimate. Among the economists we also find a variety of definitions: Mill defines credit as "the permission to use another's capital. " Macleod defines it as "the present right to a future payment." Fawcett defines it as "the power to borrow money." Laughlin defines it as "machinery invented to aid in accomplishing the purposes of capital." The differences of opinion among the economists as suggested by these definitions are more apparent than real, for their discussions of credit show them to be at variance only on minor matters, and these come into the foreground only when the author attempts to establish certain theories with reference to the implications of credit.

Professor Hildebrand, one of the founders of the German Historical School of Political Economy, in treating of economic evolution, says that credit ^iVhcrc credit ap- comes relatively late in economic development.

pears in His three periods are those of natural econeconomic omy, money economy and credit economy. eve op- jn ^e grg^ pe0pie consumed what they produced; or where exchange occurred, it took the form of barter. In the second stage, money economy, exchange played an important role in economic life and money as a medium of exchange facilitated the selling and buying of goods. The third period of credit economy was characterized by deferred payments, loans, etc.

It cannot be maintained that each of these periods existed exclusively of the others. From the point of view of historical development there may be an advantage in considering these periods as emphasizing a certain class of phenomena. Among primitive peoples a simple form of credit existed as n*?* lve soon as barter came into existence and this was a phenomenon almost as important as barter itself. From the records of all primitive peoples we have an abundance of evidence to establish this. Lending food was everywhere common. It was a common practice for those who were successful in the chase to lend game or food to those who were unsuccessful. This was treated as a loan which the borrower was to return after the next hunt. The credit was in the form of an understanding and this simple method of credit has persisted to the present. In early historical times the loaning of cattle and other domestic animals was common, and even to-day in rural communities the loaning of corn and household provisions to neighbors is a common practice.

This simple form of credit, nowever, nas no importance in the modern system of credit. The beginnings of our present system of credit are difficult to trace. H. D. Macleod1 maintains that "the whole system of credit, banking and bills of exchange, was originated by the Romans, and a long series of illustrious lawyers had brought the theory of credit to a state of absolute perfection: and their doctrines were embodied and declared to be law in the great code, or digest of roman law, called the Pandects, published by Justinian in the early

1 H. D. Macleod: Theory and Practice of Banking, p. 159.

part of the sixth century. They were adopted and confirmed in the Basilica, the Reformed Code promulgated by the Basilian dynasty in the tenth century: and they have been the mercantile law of Europe, except England, for 1,300 years. They are fully set forth in all the great continental jurists: but, from that unfortunate aversion which the common lawyers of England so long entertained against the Civil Law, they were comparatively unknown in this country : though adopted in equity : and they have never yet found their way into any treatise on Political Economy either, foreign or English." The same author maintains that the Roman lawyers brought the theory of credit to perfection as early as the sixth century. He furnishes us with an abundance of evidence concerning the forms and uses of credit during the first part of the mediaeval period. He states that "when the practice of writing became common at Rome, it was established as a custom, or law, that every Dominus, or head of a house, should keep a family ledger as strict and exact as those of a modern banker. In this he was obliged to enter all his receipts and disbursements: all sums of money borrowed and lent: all trade profits and losses; and these family ledgers were the only legal evidence of debt among Roman citizens received in courts of justice. And it was from these family ledgers that the whole modern system of Book-keeping and Credit has been developed."1

In lending money, actual contracts were made by formal ledger entries in which both creditors and debtors

1 H. D. Macleod: Theory and Practice of Banking, p. 163.

made entries in their respective ledgers by mutual consent. "In the year 469 A D., the Emperor Leo abolished the strict formalities of the Stipulation, and enacted that a consent given in any form what- R ever, so long as the parties agreed about it, should be valid. 1 There was no necessity for any writing or any witnesses." Bills of exchange were used in foreign credit in the time of Cicero, as his writings bear ample testimony. At the time of the Roman Conquests, these were invented by Roman bankers who established correspondents abroad, and bills were given on these correspondents when Romans traveled abroad or when it was desired to meet obligations away from home. The family ledgers gradually fell into disuse and by the time of Justinian they were discontinued entirely. A documentary acknowledgment of a debt known as a cawtia and a formal contract or promise to pay, a cheirographum, had taken its place. These were transferable.

Under the Code of the XII Tables, debts could not be sold, or rather the purchaser of an account could not bring action in the name of another to collect it. However, if the debtor agreed that the creditor f , , might transfer his right of action, it could be done. Both in Roman and in English law, creditors began to establish devices by which they could sell debts without the consent of their debtors. The Emperor Alexander Severus in 224 A. D. published a constitution2

1 H. D. Macleod: Theory and Practice of Banking, p. 168.

2 Macleod: Theory and Principles of Banking, p. 208.

"by which the absolute freedom of the sale of debts without the knowledge or consent of the debtor was recognized and allowed. " This practice has been recognized since as a principle of the mercantile law of Europe except in England. The earliest bills of exchange contain no statement of negotiability, yet they have been from the outset negotiable in all Europe except England.

At the present time the laws of Scotland do not require a statement of negotiability on a bill of exchange or promissory note to make it salable. This is because the common law of Scotland has adopted the general mercantile law of the continent. On the other hand, the common law of England is the early Roman law and a bill of exchange or promissory note to be salable must be drawn payable to order or to bearer. As the United States follows the common law of England, with reference to negotiable instruments, bills of exchange and promissory notes must be made out payable to order or to bearer to make them salable.

The early banking system of Greece and Rome undoubtedly gave rise to the institutions of credit and of

banking in mediaeval and modern Europe. B" . in However, good authors claim that everything

of value in banking and in credit in Greece and Rome was preceded by similar institutions in Babylon several hundred years before Christ. The early bankers of Babylon were more than changers, as they received money on deposit, paid interest for it, and loaned it for commercial enterprises.

In mediaeval times, throughout Europe merchants brought their surplus products to great markets or fairs and there exchanged them for the surplus products of other countries.1 These products were of cre<iit bartered, the merchants bringing with them on the metals which were used in settling balances. Great To facilitate exchange, money changers established places of business at these markets and thus made possible a money economy in place of the system of barter. By degrees the great merchants learned that it was unnecessary to bring their goods to the fairs; that instead of doing so they could send their products directly to the purchasers and secure their pay by writing bills of exchange. We have already seen that foreign bills of exchange were used to facilitate travel and to pay debts in foreign countries in the early part of the Christian era. Their use to facilitate foreign trade by introducing a means of payment for exported goods came much later. At first the bill of exchange was drawn by the money brokers and bankers who had agents abroad. By the end of the fourteenth century it had attained its present use in England.2

The essential feature of credit is the exchange of goods, services, etc., for a promise to pay in the ]y[e(jium 0f future. In the performance of this function exchange it is an important medium of exchange. Its function great use, however, consists in its service in transferring capital. In economic treatises in recent

1 Encyclopaedia Britannica.

2 See Cannonists.

years the medium of exchange function of credit has received most attention. This is due to the amount of attention that has been given to the subject of money because nations have assumed that it was necessary to adopt a policy with reference to their coinage system involving the use of two metals or one as the basis of the monetary system. Supplementing the use of money, the influence of credit in determining prices naturally received a great amount of attention.

Into the subject the influence of credit as a means of exchange, it is not our purpose to go in any detail. However, its importance warrants brief consideration. To the extent that money is an improvement over barter in effecting exchanges, to the same extent is credit an improvement on money.

Professor Johnson,1 in treating of credit as a medium of

exchange, divides it into (1) credit of general acceptability

and (2) credit of limited acceptability. The

Tw0 former, or credit money, includes those in-

classes

of credit, struments of exchange which all people of a

country are willing to accept, such as the greenback, the bank note, the silver dollar and the silver certificate. They consist of those instruments of exchange whose value depends upon faith in their convertibility; that is, the belief that the government or agency which issues them, or is responsible for them, will accept them in exchange for real money. For all practical purposes these instruments of exchange are money.

The instruments of credit of limited acceptability

1 Money and Its Uses, pp. 2 and 44.

have use as a medium of exchange in a restricted field. "They include the promissory note, the bill of exchange, various forms of bank credit and the book account.' ' These instruments, the real instruments of credit, are limited in scope, but to a large extent they dispense with the need for money. All large payments of money are made by check or draft, and practically all payments due in foreign countries are made by foreign bills or drafts. The great bulk of the exchanges of a country is effected by these means. The industrial prosperity of the country would be greatly retarded if it were not for these instruments for effecting exchanges.

The extent to which these instruments are in use in the various countries as a medium of exchange depends somewhat on the habits of the people, the decree of confidence which business men have in What

governs each other, and also the condition of pros- the extent

perity. On the continent of Europe people to which are much less inclined to pay bills by writ- credit ining checks against deposits in banking institu- Me used tions than English and American people are. This is due to their conservative habits. In prosperous times people use credit instruments to a much greater extent than in periods of depression or of inactivity. Relatively speaking, where free use is made of credit instruments as a means of exchange, but little use is made of money, and where but little use is made of credit instruments, money must be freely used.

The area over which credit instruments are used as a means of exchange is limited by the area over which business men have confidence in each other. Consequently the larger the area of business confidence the greater will be the resort to credit instruments for this purpose.

As has been stated, the great function of credit is to

promote the production of wealth and to facilitate the

exchange of capital. It consists in the ex-

The chief change 0f commodities, money or services,

functions _ ° . . , -

of credit. *or a Promise to pay m the future. The

various producing industries — mining, manufacturing, agriculture, mercantile and transporting — must secure raw materials, machinery and other instruments of production as well as funds for building and other purposes. This is advanced at the outset by investors as capital credit, and later the various in stitutions engaged in production find it necessary to secure funds, usually from banking institutions, in exchange for their promise to pay. Public credit is also to an increasing extent used to secure funds for productive purposes.

The use of credit funds for exchange and production purposes may be seen from the following illustrations

from the manufacturing industry. The manu-

®. facturer engaged in the production of ma-

lustrated. chines has not sufficient capital, raw materials,

machinery and funds to employ laborers to carry on the productive process until his products, the machines, are sold. He goes to the producer of raw materials and asks him to exchange the raw materials for a promise to pay at a time usually when his products are sold. If his credit is good, he secures the raw material and gives in exchange his promise to pay a sum which is somewhat more than the present value of the raw materials. This amount, known as interest, which is greater than the present value of the goods sold, is to compensate the seller for waiting for his money, and is a large or small amount as the risk of not being paid is great or small.

To carry on the productive process it is necessary to employ many workers who labor for wages which are usually paid weekly or who labor for salaries which are usually paid monthly. If the manufacturer has good credit the wage earners will advance their services throughout the week for a promise to pay at the close of the week; and those who work for salaries will advance their services during the month for the promise to pay at the close of the month. The contracts for these credit transactions may be written, but in the great majority of cases they are oral but are none the less binding on that account.

The same manufacturer must secure an advancement of money or funds from banking institutions because he must pay his labor before he can realize on the goods they are producing and often because in selling his goods he must wait several months before he can secure his pay for them. The banker whose function is to deal in credit, advances money or the right to draw funds at any time in exchange for the promise of the manufacturer to pay in the future.

Professor Laughlin1 is right in insisting that if "an essential function of capital is to discount the future, the essential characteristic of credit is the element in Essential ** °^ futurity." Any transaction which does character- not involve the promise or the obligation to istic of pay in the future is not a credit transaction. A barter or a cash sale in which the transaction is closed, is just the opposite of a credit transaction which calls for payment in the future.

There ought to be no reason for a quarrel between Professor Laughlin in claiming that the essential thing Confi- *n cre^^ *s futurity and those who insist on

dence as a the importance of confidence in credit. Each basis of plays an important although a distinct role. Futurity is the distinctive factor in credit itself, while confidence lies at the basis of the granting of credit. Professor Laughlin himself makes this distinction, but unfortunately in the minds of his critics he assigns to confidence a subordinate role. In mercantile credit confidence is especially important. The seller of goods accepts the promise of an individual without means to pay only (1) when he has confidence in his ability to pay and (2) when he has confidence in his willingness to pay in the future. These two factors are important in all mercantile loans. A commercial loan is not based on goods as many suppose. The goods advanced are offered for sale by the purchaser and the original seller has no specific claim on them or on the proceeds of their sale only in exceptional

1 Laughlin: The Principles of Money, p. 73.

cases. Confidence in willingness and in ability to pay are the foundations of all mercantile credit. In bank loans where collateral is demanded and in all mortgage loans, the situation is different. In these cases, the one who accepts a promise to pay receives with it securities which insure payment when the debt is due. However, bank loans based on collateral are decreasing in importance as contrasted with loans made to corporations and business houses based on their credit standing and their ability to pay their debts.