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'0‘ 3' Ida-3‘1...» , .' .3 :Véé: ”UV" *VE‘S ' .‘E'V‘I‘VIS‘Yx 11¢,v"",’ "$33333 .3“ 1th ‘ .‘° .;-'.1 . 1‘ 12% A. . V" '. '.’.“..‘-"~..c:3.4 -;. ‘ ‘91'1‘ 574‘. 3‘33}. ‘ H17; 9. ' 4"‘i’7.:'r1::51 .414,» ”V” ..c. I; 0-,." Viit‘fi'o' .¢- 31'." ‘ 9‘". Ara} ’V.‘ (L , ‘3 . ., f. 'z :1 i‘.‘ _’ - 99,2.” III. I, (5%. . - 5'5: té's A °' .1 - .l‘ ..I l.‘-""$ -‘ 'L- 3'13.“ ‘9 .p.. 4- fibQ" ‘ " 'fl ~‘t"'|-- ‘- 0-. *-"'\ .f'- 0.3‘ Yul I1J' '3 3‘ .Agt-‘VV . ..VVV ‘t‘h = . wagnubrfifluwj 2... a .. ..c... #Jdrrg. I~.l , .- :9. .. o ‘ p¢ ......r . .’ ‘ 0 5”“ I A o . 0 o s, I; .. v ' . o. I f .. .. 4.: .Cr ~ 0 ‘9 .9 O .. 1...} . c 0.. r L, . (w. . 34%... «K: . a . .... O. . .. xii.” .. .1”. xx! x f . . . v A ~38 ._'4 u" ,. Eh HARGIN REQUIREMENTS AS AN INSTRUMENT OF CREDIT CONTROL IN SECURITY SPECULATION Thesis for degree of M. A. Michigan State College Gary E. Fisher 1937 THL'SSIS ACKNOWLEDGEMENT The writer desires to acknowledge the valuable guidance and assistance of Dr. Herman Fiyngarden in the selection and development of this investi— gation; also {Veriticisms and suggestions of Prof. H. s. Patton in the presentation of the thesis. ’2 . U 3,; U (:3 {1' TABLE OF CONTENTS Page CHAPTER I. INTRODUCTION 1 Demand for Federal Investigation of Security Speculation 1 Investigation of the Securities Exchanges 3 Federal Regulation of Security Speculation 7 Scope of Study 12 Controversial Questions of Margin Control of Security Credit 13 CHAPTER II. - PUBLIC POLICY IN REGARD TO SECURITY SPECULATION 18 Security Speculation . 18 The Question of Public Regulation of Security Speculation . 26 Alternative Forms of Regulation of Security Speculation 33 CHAPTER III. EFFECTIVENESS OF HIGH MARGINS AS A DEVICE FOR FEDERAL COETROLICFJSECURITY SPECCLATION 46 The Plan For Margin Control or Credit 45 Effectiveness of High margins in Preventing Security Speculation 60 CHAPTER 1v. STATUTORY VERSUS DISCRETIONARY _ CONTROL OF MARGIN REQUIREMENTS 59 Objectives And Operation of the Statutory Plan 60 Objections to the Statutory Plan 62 Results of the Statutory Plan 64 The Control of Margins by a Commission 66 Objections to the Commission Plan 69 The Plan Adapted for Fixing Margins 70 CHAPTER V. Page THE LOCATION OF LISCRETIONARY CONTROL OF .MARGINS 2 Powers of the Commission in Margin Control . 73 The Selection of a Commission for margin Regulation74 Location of the Regulatory Body 83 CHAPTER‘VI. . THE PROBLEM OF UNLISTED SECURITIES 84 Provisions of the Bill Requiring Listing 86 Objections to Listing Requirements 87 Possible Results of Listing Requirements 89 Changes in Listing Provisions of the Bill 91 CHAPTER VII. ' EXPERIENCE IN GOVERNMENT REGULATION OF MARGIN REQUIREMENTS 94 Controversial Questions of High Margins . 95 Success of High margins in Preventing Speculation 96 History of High margins in.Preventing Speculation 100 Effect of High Margin Requirements on the Market . ‘ 102 Discretionary Control of Margin Requirements by the Board of Governors 107 Elimination of margin Trading « lll Unlisted Securities 112 Summary ' 113 Anmmnux 117 GENERAL BIBLIOGRAPHY 121 CHARTS AND TABLES Pug 8 Chart No. I - N. Y. S. E. Member Total Borrowings on Collateral 44 II - N. Y. S. E. Total Market Values of Listed Shares 44 III - N. Y. S. E. Money Desk-Call Loan Renewal Rates 45 IV'- All Federal Reserve Member Banks-Loan to Customers 45 (Except Banks) on Securities V - Margins . 55 VI - Summary of Margin Provisions, Original Bill and 57 Enacted Securities Exchange Act of 1934 VII - Loan Values of Four Common Stocks Compared with 58 Market Values VIII - New Capital and Market Activity 115 II - Listed Stocks-Total Shares and Total Market Values 115 X - Average Monthly Volume of Trading on the New York 115 Stock Exchange During 1934 XI - Average Monthly Price of Shares on the New York Stock 116 Exchange During 1954 116 XII Membership Prices of New York Stock Exchange Seats CHAPTER I INTRODUCTION DEMAND FOR FEDERAL INVESTIGATION 0? SECURITY SPEGULATION lhe public's attention was focussed on the securities ex- changes by the collapse of the inflated security values following September 1929. The market collapse was closely associated by the general public with the depression.which followed. As a result, it was evident that there was much public demand for government inves- tigation of stack exchange practice and speculative trading in secu- rities. This demand was made known through the press and through telegrams to those in responsible government positions. The Presi- dent stated, in a letter to the Senate Committee on Banking and Currency that ”...the condition which prevailed after the stock market crash of 1929 led to much popular demand for the restriction of the use of the exchanges for purely speculative purposes."1 .The President further stated that he did not feel that the public "would be satisfied with anything less than drastic restriections."2 It is probable that the demand for federal investigation of stock exchange practices and speculative trading in securities was the outcome of nationwide losses sustained through the rapid de- flation of security values after September 1929. The following figures indicate the extent of the decline in security values. The total value of stocks listed on the New York Stock Exchange l. The President's letter to the Senate Banking and Currency Committee, 2. Ibid 2. eighty-nine dollars a share, atgthe peak of the market in 1929, to less than sixteen.billion dollars, or about twelve dollars a share at the low point of 1932.3 Bonds listed on the Exchange shrank in value by eighteen billion dollars, declining from forty- nine billion dollars in September 1930 to thirty-one billion dollars in.April 1933.‘ The collapse of security values follow- ing 1929 was one of the aggravating causes of the closing of at least six thousand banks in the United States involving total de- posits of three and a half billion dollars.6 This led to the feel- ing on the part of the public that speculation on the sedurities exchanges was an important cause of the depression which followed the rapid deflation of security values. Excessive speculation in securities was held to be the cause of the great increase in security prices. The general public entered the market to speculate. That is they buy and sell in order to make a profit out of the fluctuations in the market price of their holdings. They operate almost like gamblers with little or no knowledge of the real value of the issues in which they dealt. This was a big factor in bringing about the speculative 'boom' in securities. Credit was widely used for carrying on security speculation. Speculators bouglt shares of stock on margin and then, as their ‘ securities increased in value, they pyramided their holdings on the basis of the increase can value. The practice of pyramiding on a rising market had a tendency to still further inflate secu- rity prices. Thus the use of credit allowed spgculators to in- 3. Twentieth Century Fund, Stock Market Control, Appleton, Century Company, New York. p. 7 4. Ibid 5e lbid, p. 9 . 3. crease greatly the sire of their operations and was an.important factor in bringing about a general increase in security values. INVESTIGATION OF THE SECURITIES EXCHANGES The investigation of stock exchange practices and specu- lative trading in securities by the Senate Committee on Banking and Currency had its beginning in Senage Resolution Eighty-four. This resolution.was adopted in April 1932. Its scape was such as to confer upon the committee the power to investigate stock ex- change and banking practices with respect to the buying and sell- ing and the borrowing and lending of listed securities. Early in the life of the Seventy-third Congress a minor crisis developed when the powers of the committee were challenged while it was attempting to investigate individual transactions for income purposes.6 In order to increase the powers of the inves- tigating committee the Senate adapted Regulation Fifty-six and Ninety-seven. These resolutions empowered the committee to "investigate the matter of banking operations and practices, transactions relating to any sale, exchange, purchase, acqui- sition, borrowing, lending, financing, issuing, distributing, or other disposition of, or dealing in, securities or credit by any person or firm, pardnershipl company, association, corporation, or other entity, with a view to recommendin necessaiy legislation under the taxing power of other to oral power." As a result of the preliminary investigation of the secu- rities exchanges two groups were selected by Senator Fletcher, Chairman of the Committee on.Banking and Currency and of the Sub- committee on Stock Exchange Practices, to undertake the responsi- bility of dgawing up a regulatory bill. One of these groups wag 6. Senator Duncan.U. Fletcher, I'Our Financial Racketeers', Liberty gggazine, March 6, 1934. 7. one o esolu ions 66 and 97. 4e headed by Ferdinand Pecora, and the other by Mr. Landis, a commissioner of the Federal Trade Commission. Various govern- ment officials who assisted in these groups were Eugene Black, Governor of the Federal Reserve Board, Dr. E. A. Coldenseiser and Noodlief Thomas, both of the Division of Research and Statis- tics of the Federal Reserve System, Thomas G. Corcoran, counsel for the Reconstruction Finance Corporation, and Tom K. Smith, Assistant Secretary of the Treasursty. The members of the Federal Reserve gave special attention to the credit control provisions of the bill. The provisions for the protection of investors from evils in market machinery were drafted by Perdinand Pecora's staff. The provisions for the protection of investors in the market from corporate insiders were drafted by Mr. Presley, manager of one of the biggest investment trusts in.New York City, and a profession- al investor who invests for twenty thousand stockholders. The consideration of the administration bill was conducted by the lab-committee on Stock Exchange Practices of the Senate Committee on.Banking and Currency.8 These hearings are popularly known.a§ thg "gaggrg Investigation” due to the importantipart S. The Sub-committee on Stock Exchange Practice was made up of the following members: uncan.U. Fletcher, Florida, Chairman Carter Glass, Virginia . Peter Norbeck, South Dakota8 Alben I. Barkley, Kentuckyl Johh C. Townsend, Delaware Edward P. Costigan, Colorado James Cuusens, luchigan Alva B. Adams, Colorado 1. Alternate, Thomas 3. Core, Oklahoma 2. Alternate, Phillips Lee Goldsborough, Earyland Rebert 3. Bulkley, Ohio, Williams Gibb McAdoo, California, Robert D. Carey, Wyoming, and Hamilton F. Kean, New Jessey, who were members of the main Senate Committee on Banking and Currency displayed an active interest in the investigation. The investigating committee made use of the services of Ferdinand racers, counsel to the committee, Julius Silver and David Saperstein, Associate counsel to the committee, and Frank Meehan, chief statistician to the committee. Ferdinand Pecora had won considerable recognition through conducting earlier federal investigations. 5/ taken by Ferdinand Pecora in conducting them. This investigation and consideration of the administration bill lasted from February 26 to April 6, 1934. ‘During the course of the hearings opportunity, was given for all interested parties to give their views on the bill. . The findings of the "Pecora Investigation" have been publish- ed in a series of volumes. The volumes which are used as the main source of information for this study are Parts Fifteen and Sixteen of the published report of the hearings before the Committee on Banking and Currency of the United States Senate during the first session.of the Seventy-third Congress.9 These two volumes comprise a total of one thousand three hundred and thirty-seven pages. lhile the administration bill would affect banks, businesses, investors, and the organized exchanges throughout the nation, the New York Stock Exchange representatives were the most active in offering objections to the bill. Fundamentally the issues which were raised and discussed in the hearings were those which.were argued between the drafters of the bill and the representatives of the New York Stock Exchange. The most active representatives of the Exchange were its President, Richard Whitney, and its counsel, Roland Redmand. Small stock exchanges were largely represented by district representatives of a group of exchanges. Business men.were not particularly active in the hearings and expressed their opinions in letters and telegrams. The Vice- presideat of the National Manufacturers Association was present. Certain.members of the Committee showed an.active and con- structive interest in the ro osed 1e islation. Senators Kean and refirred "“""‘” 9. These volumes will hereinafter be WEE to as Senate Hearings, Part 15 or Part 16. 6. McAdoc questioned the feasibility of attempting to regulate secu- rity speculation by law. Senator Bulkley backed a plan for the elimination of margin trading. Senator Glass expressed views in regard to federal credit control. Senator Fletcher was a determin— ed critic of speculation on the securities exchanges. Th. Tgeptieth Contugy Fund Marggt Survgz Just previous to the “Pecora Investigation" the securities market survey staff of the Twentieth Century Fund, Incorporated, completed a non-partisan, scientific study of the securities markets from the point of view of the interests of the American public. This study is of importance because some of the ideas of the Twen- tieth Century Fund committee were used in the preparation of the administration bill. The director of the investigation which resulted in the Twentieth century Fund market survey report was Alfred L. Bernheim. The report was drafted by a staff of thirty market specialists and investigators. The senior members of the staff were as follows: N. R. Danielman, Instructor in Economics, Harvard University, Paul D. Dickens, Department of commerce, Wilford JEi.teman., Associate Professor of Economics, Albion College, G. Wright Hoffman, Professor of Insurance, University of Pennsylvania, Frederick W. Jones, form- erly managing editor, Jgurnal of Commerce, and William Howard Steiner, Chairman of the Department of Economics, Brooklyn College, and George Sould, Director of the National Bureau of Economic Re- search and Editor_of the New Repub;ig. A digest of the findings of the staff and their recommendations for federal regulation of the markets, published in book form under the title Stock Market Contggl, by the Appleton-Century Company of New York, was formally submitted to the members of the Senate Sub-committee on Stock Exchange Practice. 7. FEDERAL REGULATION OF SECURITY SPECULATION Host proposed and attempted methods of controlling stock market speculation have been directed at the supply and cost of funds for such speculation. This task has been undertaken by the Federal Reserve System. Through the use of open-market operations and the redisoount rate the Federal Reserve Banks can increase or decrease the supply and cost of reserve funds available to member , banks. Since the expansion and contraction of street loans by banks reflect changes in their surplus funds, it is said that control over the surplus is all that is needed. Experience has shown, how- ever, that once a speculative movement has begun it may not be easily halted. The withdrawal of bank funds results in an increase in.money rates, and notionly banks but other lenders are attracted to the market. This proved to be the case when the speculative movement was not checked by limitations on the supply and cost of money in 1928 and 1929.10 Brokers at this time obtained loans from non-bank lenders. The indications seem to be, then, that when there are opportunities for large profits, speculators are not checked by high money rates. The t 933 and the Securities Act of 1933 The Banking Act of 1933 and the Securities Act of 1933 were designed, partly, for the regulation of security speculation. These acts give the federal government additional powers over the control of credit for speculative purposes and provide a standard for issuing securities. The provisions of these two acts which pertain to security speculation will be discussed here. 10. Woodlief Thomas, "Credit in Security Speculation", American Economic Review, Vol. XIV, No. l, March,1935, p. 25 8. The Banking Act of 1933, which was introduced during the first session of the Seventy-third Congress provides means for the rederal Reserve control of the use of credit for speculative pur- poses. This is'brought about by placing limitations upon the lend- ini and borrowing powers of member banks. ‘ Section Three of the Banking Act of 1933 is relative to con- trol of credit for security speculation. *t provides that 'each federal Reserve Bank shall keep itself informed of the general character and the amount of the loans and investments of its member banks with a view to ascertaining whether undue use is being made of bank credit for speculative trading of/or trad- ing in securities, real estate, or commodities, or for any other purpose inconsistent with the maintenance of sound credit con- diticns." In determining whether to grant or refuse advances, rediscounts, or other credit accomodations, the Federal Reserve Bank officials "shall give consideration to such information." The Chairman of the Federal Reserve Bank shall report to the Federal Reserve Board any such undue use of bank credit to any member bank to-gether with his recommendations. Whenever, in the Judgement of the Federal Reserve Board any member bank is making such undue use of bank credit, the Board may as its discretion and after reasonable notice and an opportunity for a hearing suspend such.member bank from the use of credit facilities of the Federal Reserve System for a time. There are some other important protective devices in the Banking Act of 1933. Member banks are forbidden to act as agents in.placing loans to brokers for non-banking corporations or persons. This is.a blow to bootleg loans. Banks are forbidden to pay interest on demand deposits. This is a blow at the pratice of out-ef-tcwn banks sending funds into the New York Money market to pile up there at interest and to be used in the market while there. How- 1 ever, there is nothing in the law, apparently, which will prevent 9. a.mmmber bank in.New York from placing funds in.brokers' loans for out-of-town banking corporations under an agency agreement. The movement for federal control of security markets was advanced by the passing of the Securities Act of 1933. Thistot provides for the registration of securities with the Federal Trade Commission.11 Certain information.is required before securities can be registered. This information is for the purpose of protecting the purchasers of securities and makes it possible for the purchaser to consider the real value of a security. Such consideration.will tend to discourage the type of security speculation which may be called gambling. The mechanism for the control of credit for security specu- lation.by the Federal Reserve System possessed certain weaknesses prior to the enactment of the Banking Act of 1933. The control of the supply of funds for security transactions could be exercised only by making stock market activity the principal guide of credit policy. The use of such a policy of increasing the cost of credit in order to check its use in security operations increased the cost of credit to agriculture, trade, and industry. The Banking Act of 1933 makes it possible to control the amount of credit for use in security speculation. It is possible to exercise a restraint on security speculation without limiting the supply or raising the cost of credit to agriculture, trade, and industry. This means of control also makes it possible to exert a restraining influence on the use of credit for speculation in the -stock market before it has reached a stage at which the general business and credit situation is unfavorably affected. . It might be observed, then, that the Federal Reserve System possessed.mmchanism.for the control of the use of credit for secu- 10. rity speculation.but it would have to make the stock market the chief basis for its policy. This should not be done because it is undesirable that the general credit policy of the country should be based upon the fluctuations of security speculation. In order to control security speculation pressure must be exerted early in the development of the speculative movement and at a time when the general business situation may indicate no need for restriction. The control of security credit needs to be exerted over that portion of the supply of credit that is being used for undue security specu- lative activity. The Securities Act of 1933 is in the nature of federal con- trol over security collateral. By providing a standard for the issuing of securities, the quality of collateral is improved. This places a check on the use of credit for the flotation of securities which might not be considered sound. The Fletcher-Rayburn Bill The administration.bill, which was popularly known as the Fletcher-Rayburn bill, for the regulation of securities exchanges was introducedin.the second session of the Seventy-third Congress. The demand for regulation was because of certain evils which.were asserted to exist in the securities exchanges. These evils con- cerned margin trading, short selling, and pool operations. It was contended that speculative excesses are encouraged by easy margin requirements. It was further believed that short selling dislocates the market and disturbs business generally, and that it produces violent declines out of proportion to the intrinsic values of secu- rities. Finally, the charge was made that pool operations are penmitted to manipulate prices and to unload stocks upon the public 11. at unwarranted high prices. The iletcher-fiayburn bill, was accord- ingly designed to remedy these evils. The bill proposes to bring the securities exchanges under federal regulation through the use of the commerce powers of the national government. This is accomplished by compulsory registration of all securities exchanges doing an interstate business. In order to acquire such registration an.exchange must submit certain data and agree to comply with federal regulations. The bill gives the federal government added powers of con- trol over the use of credit for security speculative purposes. The Bankigg Act of 1933 is strengthened by prohibiting brokers from borrowing upon any listed security from any source save a ,memhcr bank of the Federal Reserve System or a non-member bank which agrees to comply with rules of the System with reference to market loans and loans on Securities. This is designed to rule out the whole system of non-bank or bootleg loans. This makes it possible for the Federal Reserve System to restrain the amount of credit going to the market. The use of credit for security speculation is still further restrained by the federal determination of margin requirements. By the use of such requirements the collateral talus of securities can be controlled. This is a continuation of the movement for the selective control of credit. The control of the total supply of credit for speculative purposes is accomplished through the Banking Act of 1933. Through the federal control of margins the amount of credit which.hay be used in the purchase of a security is determined. The use of securities as collateral in a margin transaction is still further restricted by providing that such securities must be regis- tered on a nationally registered securities exchange.f 12. Other provisions of the bill are for the purpose of eradi- cating the evils of manipulative practices and short selling, and other evil practices on the securities exchanges. The prevention of manipulation in the securities exchanges is accomplished by prohibiting the organization of pools and the circulation of false reports. The regulation of short selling is entrusted to a commission. Penalties are provided in order to enforce these and various other provisions of the bill which are for thepurpose of eradicating securities exchange evils. The regulation of the over-the-counter trading in secu- rities is placed in the hands of a commission.‘ This regulation is important because of the relationship of the over-the-counter markets to the organized exchanges. If the over-the-counter markets were left free of regulation and the organised markets were subject to severe regulation there would be danger of a flight of securities from the organized exchanges. ‘ SCOPE OF STUDY This study is limited to the controversial issues arising in.the ”Pecora Investigation" concerning the provisions of the Fletcher-Rayburn bill having to do with the contemplated use of margins as a device for limiting security speculation. Since the subject of the study is controversial, the problem is to determine the issues, indicate the stand taken by various groups, and mar- shal the arguments supporting the various views in regard to the issues which arose. In doing this it is necessary to deal largely with Opinions of those who took part in the Senate Hearings. As far as possible the attempt will be made_to show the weight of Opinion backing various viewpoints. It will not be possible to 13. give a consensus of opinion. Such a consensus would be impossible to give because particular individuals were asked to speak on certain parts of the bill, only, in order to avoid too much repetit~ ion. Also, other individuals were official or unofficial represent- tatives of groups. The attempt will be made, however, to quote enough authorities to show the trend in regard to the various con- troversial issues which arose in the hearings. 0f the various means of federal control of security specu- lation, this ptudy is lflmited to the regulation of speculation by credit control. It has been.noted that there are several means for federal control of credit. This study T! further limited to the control of security credit through the use of margins. It has been noted, also, that the purpose of federal control of the exchanges is to prevent excessive speculation. The use of margins, as a device for the control of security credit, was but one of the means provided in the Fletcher-Rayburn bill for the federal regula- tion of security speculation. CONTROVERSIAL QUESTIONS 0F MARGIN CONTROL OF SECURITY CREDIT Several controversial questions arose, in the hearings, as a result of the contemplated use of higher margins as a means for the control of security credit. The purpose of this control was to prevent excessive security speculation. There were many objec- tions to such a use of margins. As a result of these objections the margin provisions of the bill as finally passed were consider- ably changed. The controversial questions relative to the use of margins for the control of credit for security speculation will be outlined below. 14. P Fed , C ntro of Mar ns . The Fletcher-Rayburn bill was proposed for the purpose of preserving to the market the useful functions of speculation and protecting the market against its abuses. It was asserted that the effective operation of the securities exchanges was prevented by excessive speculation. 'Booms’ and the panics which follow, are said to be due to excessive speculation and they have adverse effects on investors and national institutions. . The possibility of successful legislative control of secu- rity speculation was refuted. It was contended that security specu- lation.cannot be regulated by law. It was predicted that the attempt to do so by passing the administration.bill would result in the destruction of the organised security exchanges and the devel- opment of an unorganized market to the detriment of the nation. Method of Federal Control of Security Credit The administration bill is predicated on the assumption that excessive security speculation develops because of too free use of credit and that it can be brought under control by granting the federal government greater credit control. The bell provides a means for the control of credit by making it possible to regulate the collateral value of securities through the use of margins. The federal determination of margins as a device for the limitation of the use of credit in security trading was opposed. It was asserted that additional control should be found through , the use of federal powers already existing for the control of the general supply of credit. it was further contended that the proper margins cannot be fixed by rules of law or by a government commission The determination.of proper margins should be left in the hands of the security brokers and the organised exchanges. 15. Method F Mar no The standard of margin requirements were stated in law in the proposed bill. The margin requirements were so designed as to exert an automatic restraint on speculative trading by imposing a higher margin requirement on securities having a rapid rise than on more stable securities. The power to raise margin requirements above the statutory requirements was granted to a commission. The feature of the bill which fixed margins by law was opposed. It was held that it would be impossible to pass a regula- tion rigidly controlling the collateral value of securities. If margin requirements are to be regulated by the federal government such regulaticn should be by a commission rather than by a statute. The reason for this is that credit conditions are constantly chang- ing and margin requirements should be subject to constant review and change. This could be accomplished by a regulatory commission but a law could not be readily changed. a on o Di reticnar Contro of ins The question of the location of discretionary control over margin.requirements was considered important. The exercising of this power was placed in the hands of the Federal Trade Commission by the bill. There was a great deal of opposition to granting such control to that body. The market authorities favored the setting up of a body upon which they would be given some represen- tation. If such a body could not be set up they favored the grant- ing of discretionary control over margin requirements to the Fed- eral Reserve Board. There were many others who favored this body because it is a credit control body and the control of margins is in the nature of credit control. 16. The Elimination of Margin Tradigg There was some support for the complete elimination of all margin trading. The proponents of this idea were of the opinion that credit for security trading might better be obtained through the banks. This could be done through security traders arranging loans on securities directly with bankers. The government author- ities on credit agreed that this might eventually be a wise move but they were of the opinion that it would be too radical a move to make at the present time. Registration of Securities The bill required that securities must be registered on a national securities exchange in order to be eligible for margin trading. Certain securities were exempted from listing require- ments by the bill. The federal listing of securities would make it possible to regulate them. The granting of margin trading privileges to unlisted securities would be deemed unwise. By refusing such privileges to unlisted securities an incentive for the listing of securities would be provided. The refusal of margin trading privileges to unlisted secu- rities was opposed by those who were interested in securities which because of their nature could not be listed on a nationally registered securities exchange. It was contended that the value of unlisted securities would be impaired by not making them eligible for margin trading. Chagggg 1.1ng g the Original Bill There were many changes made in the proposed bill before it was enacted. The altered form of the bill may be attributed to 17. the attacks which.were made on it by those who-would be most affect- ed by it. These changes were made in various parts of the bill. The changes which had to do with margin provisions concerned the size of margins, the exemption from registration requirements, and the administration of margin requirements. The result of these changes was to do away with some of the most undesirable features of the bill. In the Act as passed loans are permitted up to one hundred per cent of the lowest value for the preceding three years instead of eighty per cent of such.value as stated in the original bill, but a maximum limitation of seventy-five per cent of the current market value is established instead of eighty per cent. In the Act fifty- five per cent of the current market price may be loaned in any case instead of forty per cent. A11 loans on exempted securities and loans by banks on secu- rities other than equity securities are specifically excepted from the margin provisions of the Act. Under the Act, as contrasted with the orginal bill, banks are not subject to prescribed margin requirements, except that when a bank makes a loan on an equity security, any excess over the amount that a broker could loan is subject to such rules and regulations as the Federal Reserve Board may prescribe, to prevent the use of such excess for the purchase or carrying of securities. ‘Under the terms of the original bill the administration of margin requirements was vested in the Federal Trade Commission, which could increase but not decrease margin requirements. Under the Act, control over margin requirements is placed under the Federal Reserve Board, who may increase margin requirements and, under certain extraordinary chcumstances, they may also decrease them‘ 18. CHAPTER 11 PUBLIC POLICY IN REGARD TO REGULATION or SEGJRITY srxcctinon The Fletcher-Rayburn bill proposed to bring the control of the exchanges under the federal government. In the past the exchanges have been selferegulated. The proposed change from private to gov- ernment control was opposed strongly by the market interests. It I was asserted by government authorities that government control of the exchanges is rendered necessary in order to regulate security speculation. Such regulation is necessary because the exchanges have failed to regulate security speculation properly. The purpose, then, of federal control of the securities exchanges is to control security speculation. The public importance of such speculation lies in the fact that it may inflict damage upon several million investors who do not speculate and upon the economic security of the whole country. The objective of federal regulation of the securities exchanges, therefore, is to protect the bona fide investors and economic society from the harmful re- sults of security speculation. SECURITY SPECULATION There is considerable difference of opinion concerning the place of security speculation in economic society. Those who favor federal regulation of security speculation generally concede‘ that such speculation performs a useful function in economic society. When security speculation becomes excessive, however, it is harmful.’ Speculation may be considered harmful when it does not perform its true function on the securities exchanges. It will be the purpose of federal regulation to eliminate excessive speculation but to l9. preserve to the markets the economioly useful‘functions of specu- lation. The market authorities held that this purpose would be impossible of accomplishment. The question of the proper function of security speculation and the possibility of its regulation by the federal government will now be discussed. Rglgtign 91 Spggulatign to Market Functions Security speculation may be defined as any operation in which one buys or sells securities with the design to make a profit out of the changes in the market price of such securities. An investor, on the other hand, takes a chance in the success or failure of an enterprise and not in the change in value of the securities. Secu- rity speculation becomes 'mere gambling' when people with no special knowledge of factors affecting security prices undertake to speculate. . The objective of government regulation.is stated by Tom.K. Smith, Assistant Secretary of the United States Treasury, in evidence before the Senate Sub-committee, as an attempt to pre- vent the ill-effects of excessive speculation without hindering the proper economic function of the market.1 The ideal market should (1) register prices for securities which are as closely as possible in line with present and future earnings: (2) furnish securities the marketability and price continuity necessary to serve the needs of investors; and (3) induce the most productive' flow of savings into the nation's economic activities. If these desirable results are to be accomplished.a.certain amount of specu- lative trading is necessary. It was the opinion of ur. Smith that the real question is to determine the amount of speculation necessary and to find means to prevent gxcessive speculation.2 1. Senate Hearings, Part 15, p. 6734. 2. Ibid. . 20. Other things being equal investors would prefer that the market price of a stock deviate as little as possible from its trend so that in case of forced liquidation they would be able to obtain an amount very near that which they would receive if they could sell at leisure. It is claimed that speculation reduces this deviation and, by so doing, performs a service for the investor. Speculation contributes to marketability and price continuity. 1n the performance of this function the principal requirement is a large and continous volume of transactions. For stocks and bonds to be readily marketable at all times there must also be buyers and sellers ready to trade. Insofar as speculators and activd on both sides of the market they assist in.maintaining a liquid and continous market. The investor, on the other hand, because his transactions are less frequent, might be supposed to contribute less to the market's liquidity. Security speculators contribute to the flow of savings into the nation's economic activities. The invdstor who is seeking security and stability of income is unwilling to assume the risks involved in financing new and untried enterprises. Without the speculators willing to rish large losses in the hape of large profits, young enterprises would find it difficult to secure cap- ital. The performing of this service by the speculator makes his activityvuseful. Excessive Security Speculation The question as to what constitutes excessive speculation and as to what its harmful effects are will be discussed here. There are two features of excessive speculation.which.may be noted. Security speculation becomes excessive if it is carried on in such 21. volume that the market price of securities are inflated above their true value. The market value of a security should reflect its present and probable future earning power. Such speculation, in a huge volume, is made possible through the use of credit.3 As the price of a security advances, it becomes the basis for ad- ditional credit to finance new security purchases. This practise, 7g known as pyramiding llu'pgflgfi; , .. the proper evaluating function of the market.4 . The other type of security speculation which may be char- acterized as excessive and harmful is that carried on by the un- informed public. Such speculators do not buy securities because \they have carefully considered the possibility of benefiting from the increased prosperity of the industry in which they are buying participation. They buy, rather, like they would buy a lottery ticket, or a number in a number game. This type of speculator buys without informing himself of market conditions but with the hope that the securities may be disposed of at a profit. Such speculators serve no useful social function. On the contrary, it performs a I'very dangerous part in our economic machinery“, and is distructive and disastrous to many individuals and also to the prosperity of the country as a whole.6 The harmful results of excessive security speculation are not confined to the ppeculators, or to investors. The entire prosperity of the country is involved through its effects on the business and credit structure. Speculation on the securities exch as is held to be a ver direct and im ortant factor in 3. ficodlief Thomas, evidence before enate earingsiwfait-IET p. 6439. d. Evidence of Dr. E. A. Goldenweiser, Director, Division of Research and Statistics, Federal Reserve Board, Senate Hear- ings, Part 15, p. 6439. 5. Alfred L. Bernheim, evidence lefore Senate Hearings- Part 15 22. the progression and the regression of business activity. Dr. E. A. Goldenweiser states that "unregulated speculation in securities was one of the most hmportant contributing factors in the artificial and un- warranted 'boom' which hadnzo much.to do with the terrible conditions following 1929. The‘Use of Credit_For SecurityZSpeculation very easy facilities existed for obtaining credit for pur- chasing securities. Much of this credit was obtained by buying stocks and bonds on margin. A purchaser might provide twenty or twenty-five per cent of the purchase price of a security and borrow the remainder, using the stock certificate or bond as collateral. These funds, which may be called brokers' loans to customers, were borrowed from brokers. The brokers had easy access to funds through the New York money market which was supplied with the surplus funds of banks and corporations throughout the country. The New York Stock Exchange bulletin contains statistics indicating the relationship of the volume of brokers' loans, stock values, and call lean rates during the development and collapse of the securities 'boomi. These statistics are useful in,ref1echm ting the degree of connection between the stock market and the credit system. The figures for brokers' loans on the New York Stock Ex- change shows that from 1927 to 1929 these loans increased from three billion dollars to eight and one half billion dollars.7 Brokers' loans subsequently decreased to less than a half billion dollars in 1932.8 This panic shrinkage of brokers' loans greatly disturbed the credit sygtgm 9f the country. In this connection Wogdlief . senate Hearings, Part 15, p. 6442. g: ngdchart No. I at the end of this chapter. ' 23. Thomas, of the Federal Reserve Board, Division of Research and Statistics, stated thafiuhe use of a I'moderate and relative stable volume” of credit cannot be severely criticised.9 The danger arising from the use of credit in stock market speculation grows out of the extreme fluctuations that characterize the security markets.10 The total market value of stocks listed on the New York Stock Exchange rose from about thirty-four billion dollars in 1925 to about ninety billion dollars in 1929.11 When the break in secu- values came in 1929, the value of securities collapsed very rapidly to a low total value of about eighteen billion dollars in 1932.12 It is asserted by Dr. E. A. Goldenweiser that the rapid rise in security values, with the great volume of brokers' loans support— ing them, which preceded 1929, was an important contributing factor toward the over-expansion of‘business activity and the stimulation of speculation in many fields.13 The increase from four per cent to eleven per cent during 1928 and 1929, in the New York Stock Exchange renewal rate for call loans, indicates the increased demand for funds for security trading. Du l928nand 1929 the supply of funds available to banks was reduced by the Federal Reserve opendmarket operations and banks withdrew funds from street loans and sold some of their investments.15 This withdrawal of funds was followed by increased call loan rates. The supply of funds for brokers' loans was then continued by non- bank lenders. Thus, new capdit was drawn into use for security s ecu at ur a. 9. Senate Hearings, Par 5, p. . . id. 11. See Chart No. II at end of this chapter. 12. Ibid. 13. Senate Hearings, Part 15, p. 6438. 11. See Chart No. III at end of this chapter. 15. Ioodlief Thomas, "The Use of Security Credit in Speculation", Aggrloan.Economic Review;, march. 1935. Pp. 550-555. 24. The large and unnecessary volume of speculative activity which took place previous to 1929 was made possible by the use of credit. The use of credit enables the trader to conduct larger operations than would be possible if he were restricted to the use of his own resources. It has been further contended that the use of credit in margin buying absorbs credit which would otherwise go into productive industrial uses and that, by magnifying speculative activity,it hinders the markets in performing their proper functions. ,The report of the stock market survey commdttce of the Twentieth Century fund contains a discussion of the relationship of the use of credit in spcurity speculation to the business and credit struct ture.16 A summary of this discussion.will be given here. - The use of credit in margin trading disrupts the nation's credit mechanism. The normal flow of savings into investments, and of bank credit into commerce is interrupted. The result is that short-term bank credit is improperly drawn into long-term invest- ments, and the volume of bank credit is abnormally inflated. Such a use of bank credit is of questionable economic soundness. It cannot be proved that the use of bank credit for security trading results in a withdrawal of funds from business. This is true because the total lending powers of the banks of the country is not a fixed sum but is capable of expansion. 'It can be shown, however, that the inflation of credit due to speculative demand for funds had unfortunate results for banks themselves, for industry, and for business. It is the chief function of commercial banks to advance short- term funds to finance self-liquidating loans. The termination of s-cc V‘;L¥ e't-H:t «:_l' -r»v des th: funds for the O97'n6nt or .= 16. Twentieth Century Fund, Stock Market Control, Appleton- ;n- tury Company, pp. 89-95. 25. bank loan. Brokers' loans do not meet this requirement. Such a loan is terminated by the buyer-borrower selling to another buyer- borrower. The result is that when for any reason individual and corporate lenders withdraw their funds from the market the banks must take over the loans in order to protect the values of the secu- rities which they are holding as collateral.17 Thus, it will be seen that there is a close connection.between bank and stock exchange activity through the money market. A large part of the proceeds of brokers' loans goes into the purchase of new issues or into the purchase of other old issues. Another portion goes directly into expansion of plant and equipment by those sellers who are corporations or owners of business concerns. Still a third goes to the purchasing of consumer goods. This takes place when security owners withdraw their profits. Thus, the stock exchange becomes the mechanism for making bank credit available to finance increased capital equipment and plant expansion, and for the purchase of consumer goods. Such a.use of commercial bank credit is questionable. Increasing the volume of brokers' loans and rising stock prices, out of proportion to productive activity, has an inflation- ary effect. When the increased credit is used to increase plant expansion and for the purchase of consumer goods during the develops ment of a business 'boom' the movement is still further accentuated. Business suffers further because of the inflation of values, because of high prices for raw materials, and because of high interest rates. These were the main evdls which.come about due to the excessive use of credit for security speculation according to the Twentiety Century Fund re ort. ‘ 13. $66 Chart No. 17 at the end of this chapter. 22;. THE QUESTION OF PUBLIC REGULATION 03 SECURITY SEEGULATION It has been pointed out that the results of excessive secu- . rity speculation are harmful and widespread. 'While speculation has a useful place in the proper functioning of the market, it is rendered harmful by excess. The result of excessive speculation is that the useful function of the market is impaired. Furthermore, such security speculation results in 'bocms' and panics. It follows from this that public policy requires that security speculative activities be brought under control. The objectives of this con- trol should be to see that security speculation adds to and does not detract from the valuable functions which the security exchanges are designed to perform; and so that such activities will no longer create credit disturbance and other maladjustments throughout our economic structure. The view of security speculation which has been discussed above was that taken by the government officials and Congress. It is upon this view that the public policy of federal regulation of the securities exchanges is based. .The market interests werehot in favor of federal regulation of the exchanges. Their objection to such regulation was'based upon a different view of the effects of security speculation. The arguments upon which their opposition to regulation.were based will now be discussed. Richard Whitney, President of the new York Stock Exchange, opposed the plan to regulate security speculation on the exchanges by the federal government.18 He contended that it is yet to be e u n is the au e of 'bcom ' and cs d 18. Senate Hearings, Part 16, p. 6732. 27. further, that the elimination of all speculation on its curtail- . ment will not prevent 'booms' and panics. Any attempt to regulate security speculation by statute would be ihmpossible to accomplish, according to Mk. Whitney, because rules of law, which would be effec- tive today, would be worse than useless under changes circumstances in the future. In order to indicate the need for speculation and to show the folly of attempting toregulate it by law, Mr. Whitney quoted statements of former Justice of the'United States Supreme Court, Oliver Wendell Holmes as follows: "People will endeavor to forecast the future and to make agreements according to their prophecy. Speculation.cf this kind by competent men is the self-adjustment of society to the probable. Its value is well known as a.means of avoiding or mitigating catastrophes, equalizing prices, and providing for periods of want. It is true that the success of the strong in- ‘duces imitation by the weak, and the incompetent persons bring themselves to grief by undertaking to speculate in their turn. But legislatures and courts generally have recognised that the natural evolutions of a complex society are to be touched only with a very cautious hand, and that such coarse attempts at a remedy for the waste incident to every social function as a simplglgrohibition and laws to stop its being are harmful and vain. The protection of investors is a part of the public policy of the Fletcher-Rayburn bill. It was asserted by ur. Whitney, in this connection, that the bill would legislate against the best 20 interests of investors rather than protect them. This would be true because the bill would impair the collateral value of secu- rities by seriously decreasing the amount of trading in the organ— ised exchanges thus reducing their liquidity. Since approximately one hundred billion.dollars, of the nation's stealth 01 about three or four hundred billion dollars, is in listed securities the inves- tor ould receive consider ble considerationl21 19. Senate Hearings, Part 15, p. 6 54. 20.1bid, p. 6605. 21. Ibid. 28. The advisability of attempting government regulation of the securities exchanges was questioned by Edwin F. Chinlund, Repre- 22 It was his sentative of the Controllers Institute of America. opinion that the greater benefits to the American people might be secured through the evolutionary process of reform, rather than by government regulation. The process of reform should be continues through "education of public, security dealers, brokers, and issuing oorporations."23 He further stated that "setting up stringent regulations" would result in a setback to the real progress which has been made.‘?'4 Eugene Thompson,.President of the Associated Stock Exchange Firms of Washington, D. C. ‘was of a similar opinion and did not believe that "practical and accepted habits and customs" should be discarded in favor of the "theories and experimentation" of persons who have had little contact with the exchanges and its problems?5 It was his opinion, further, that the proponents of government regulation of the exchanges were opposed to anything 'conventional or institutional" and that they have a "vague" idea that the exchanges should be so classifiedja6 Senator Gore, a member of the investigating committee, did not believe that any kind of speculation can be prevented by law because it is human nature to speculate.27 The Eighteenth amend- ment was cited as an example of the folly of attempting to regulate human behavior by law. This has led to such evils as the Florida land 'boom' and land speculation in farm states. The desire to gain through gambling results in lotteries doing a thriving business "It is im oss- 22. Senate earings, , p. 23. Ibid. 24. Ibid. 25. Senate Hearings, Part 15, p. 6981. 26. Ibid. 27. Senate Hearings, Part 15, p. 6488. 29. ible to protect the fool against his folly" by passing 1aws.28 Another objection, which was raised to government regulation, was that such regulation would run the risk of destroying the secu- rities exchanges. l. C. Paul, Secretary of the Los Aggiles Stock Exchange, asserted that this would occur upon the date of adoption of the Fletcher-Rayburn bill.29 The result of the stringent regula— tions would be that the investors who could not deal through the regular market channels would be forced into the hands of boot- leggers. This would result in undisciplined dealings which could never be regulated. Mr. Paul was of the opinion that the present open, free, and public market in securities is much to be preferred over such a consliition.5-o A phasphlet entitled, "German.3egulstion of Stock Exchanges 1896-1908." by J. Edward Meeker, was submitted to the investigating wommittee by Roland Redmand, Attorney for the New York Stokk Exchangg~ This pamphlet set forth the unsuccessful results of the German government to regulate speculation of the securities exchanges by legislation. The legislation was introduced following the collapse of a speculative"bocm' in the German securities markets. many requests flooded the Reichstag asking for intervention by the ‘government to halt speculative abuses. A careful study of the situation was made and the "Exchange Law of 1896" was passed to regulate the Boerse. It had been the feeling in the Reichstag that there were three principal evils in connection with speculation.on the exchanges: (1) the manipulation of commodity prices against the interests of producer and consumer alike; (2) the manipulation of t - c t n b nex erienced or one of l 28. Senate Hearings, Part 15, p. 6488. 29. Senate Hearings, Part 15, p. 6773. 30. Ibid. 31. Senate hearings, Part 15, pp. 7158-7165. means, who almost always lost money in the end. To minimize or obviate these real or alleged evils the Exchange Act of 1896 accordingly resorted to three principal provisions; (l)dealings "in grain and flour on the German exchange on.creditwg,g forbidden; (2) similiar transactions on the German exchanges on credit in certain classes of shares(speculativel were forbidden; (3) a ”Stock Exchange Register" was established, wherein all speculators enter- ing into exchange transactions of a spedulative character must incribe their names. The German attempt to halttSpeculation did not achieve its purpose. It simply led to other and more roundabout methods of conducting it. Exchange brokers left the Boerse and set up business elsewhere. Trade degenerated into a crude "over-the-counter" market with direct settlements and less actual regulation than had been in force before the Exchange Act of 1896 was passed. The results were soon.felt and led to the discovery on the part of the govern- ment of the value of organized speculation. A great many detrimental results of the law soon became apparent. Transactions in German securities were driven into foreign markets. Speculative manipulation was facilitated rather than curtailed. The Berlin money market was strained and demoralized The law proved to be a grave obstacle to business activity. ‘ The results of several studies by experts in.Germany and the'United States resulted in condemnation of the law.32 Attacks on the law gained in force and resulted in unsuccessful attempts to amend it in 1904 and 1906. These early attempts at revision, though ans 8 f d the we 0 on for its.eventua re ea . 32. Professor Henry C. cry of ale; phamplet, ten Years of Regulation of the Stock Exchange in Germany." The Hughes Commission of 1908. Dr. Wachler in German Bank Inquiry of 1908-1909. 31. The Committee of the Federal Counsel, which{was hostile to speculation and which had originally passed the Act of 1899, stated in its report on the bill proposed in 1904: "The dangers of Speculation have been increased, the power of the market to resist one-sided movements has been weakened, and the possibilities of using inside information have been enlarged." As a result of the many attacks on it, the Boerse Law of 1896, as it related to security dealings was considerably changed in certain stringent provisions. The Exchange register provision was repealed entirely. This action, as the Hughes Commission Report states, proves conclusively that "Insofar as the Reichstag in 1896 had aimed to prevent small speculators from wasting their substance on the Exchange, it not only failed, but***added a darker hue to ovals previously existing." The previous restriction.against industrial security futures was also withdrawn, although these contracts were still made subject to the discretion of the State. By a law passed in 1908, the Government might, in its discretion, authorize specu- lative transactions in industrial and mining securities of companies capitalized at not less than $5,000,0000. It is our Opinion that the alleged failure of the German attempt to regulate security speculation by law should not be accepted as conclusive pvddehce of the probable failure of such an attempt in the United States. It is tune that we should benefit from the experiences of government regulation in other countries. It is not fiTways possible to make a fair com- ;parison between countries, however. This is due to a variation :1n the institutional developments in different countries. ' _ _g 32. In defense of security speculation it has been asserted that it is not the cause of the evils attributed to it. Any attempt to regulate security speculation by law would be impractical and would run the risk of doing more harm than good. The enactment of the proposed bill would do a great deal of damage. Investors in securities would be harmed rather than benefited by it. The busi- ness structure would be harmed33 and recovery would be retarded.34 Security trading might be forced off the organized exchanges and in- to the over-the-counter markets. Finally, the failure of the German attempt to regulate speculation by law was urged as evidence of the impracticability of undertaking to pass a regulatory law in this country. The question of the preper public policy in regard to secu- rity speculation has been discussed. It is apparent that there were two fundamental and inter-related issues involved in the question of public policy relative to security speculation. The first of these was the question as to the results of security specu- lation. The second issue, which is based on the first, was the question of the regulation of security speculation on the exchanges. The government and market authorities were divided by these two issues. The government authorities asserted that security specu- lation is rendered harmful by excess only. Consequently, since the general public is concerned, the government should regulate the securities exchanges to prevent excessive speculation. The market authorities asserted that speculation is necessary to the proper functioning of the markets, the destruction of which would be detri- mental to the whole country. Furthermore, since speculation cannot ;;§:egulated by law the exchanges should continue to be self-regula- 34. Evidence of A.W.Sewa11, Pres. Gen. Asphalt Co.Senate Hearings, P e e e e To 1 H .32.?55.£-.3122.r1%ts.“ Eaten. Kim-PM mu Manf- x 33. ALTERNAEIVE FORMS OF REGULATION OF SECURITY ' srscnmrxon The federal regulation of security speculation on the ex- changes requires that the government provide a plan for regulation. In all of the various plans for regulation of the securities markets two features are included.35 One of these plans is that the market itself shall be an exchange which shall be autonomous within limits set by the government.' This autonomy would include responsibility to the government for the immediate policing of the exchangel In the other plans some government agency would supervise the secu- rities markets with varying degrees of authority. The latter of these two features is embodied in the Fletcher-Rayburn.bill. It has been noted that the market aughorities desired to have the control of margin requirements remain in the hands of the brokers and the organized exchanges rather than to be controlled by the federal government as contemplated by the administration bill._ It has further been indicated that the ease of obtaining funds for security speculation by means of borrowing on the margin has resulted in excessive speculation. This condition indicated a need for making margin trading for speculative purposes more difficult. Such a condition.might be brought about by requiring higher margins on such transactions. The question as to how the margin requirements should be determined was a point about which there was considerable disagreement. The market authorities took the position that if margins are to be determined by the govern- .ment, they should be determined by a commission. The government authorities, on the other hand, favored a statutory formula for «flagging maggin requirements. 35. Flynn, John T., Sgcurity Speculation, fiarcourt, Brace and'53.. p. 279. 34. The whole question of determining margin requirements might have been settled by simply doing away with.all margin trading. Such a proposal was made during the course of the Pecora hearings. The description of this plan, the arguments supporting it and the arguments against its adoption, and the feasibility of adopting such a plan will be discussed here. The Propcsg;_to Prohibit Margin Trading Throughpgrokers' Loans The proposal to prohibit margin trading on the securities exchanges was introduced into the hearings by Senator Bulkley who continued to give the plan his support throughout the hearings. It is not to be supposed that the proposal was rejected without the investigation and examination of it. There was considerable support for the plan and qualified government officials were called upon to discuss it. Woodlief Thomas, who had studied the English system of financing security transactions,stated that "the proposed paan.is mubh like that in use in England."3§ with the help of Dr. E. A. Golden- weiser he compared the English system.of financing security opera- tions and the financing of security operations by the use of margins. Eugene Black, Governor of the Federal Reserve Board, gave an opinion concerning the advisability of adopting the proposed plan. Alfred L. Bernheim, director of the market survey of the Twentiety Century Fund, made several criticisms of the plan to prohibit margin trading. The proponents of the plan to do away with all margin trad- ing criticized such trading because of the lack of any direct credit relationship begween the borrower of funds and the lender of those funds. In order to carry on a margin transaction a borrower does no 0 ake' erscna contact with the broker lendin the 36. Senate Hearings, Part 15, p. 6440. 35. funds. Brokers have no means of selecting and of determining the credit standing of their clients.37 Security loans are automatically made, and, if more em. are not supplied when additional margin is necessary, they are automatically called. The result of a lack of any direct credit relationship be- tween a broker and his client is that margin trading is made entire- ly too easy. This encourages speculative trading in securities. A margin trader ”needs no credentials...or line of credit."38 All That he needs is "a few dollars to put up as margin" and the rest of the funds are supplied by the broker who has "very easy, perfect access to the credit reservoir through the banks."39 One who borrows funds should feel liable for the return of those funds_if the collateral for the loan fails. This is not the case with margin traders who are not made to feel any such liability. The funds supplied for the margin is considered only as I'evidence of good intentions."40 It was the opinion of Dr. E. A. Goldenweiser that the margin trader is not aware ”that he is really signing up for a verydarge loan, and if the. :rgkzgii:tgotoagigcfigrgéspaie of his security in time, he has The trading in securities by borrowing on the margin is carried on "42 "like a game. If stocks go down the trader loses and if they go up he wins. An interesting moral argument for prohibiting margin trad- ing was made by Federal Judge William Clark. It was the opinion of Judge Clagk that bankruptcies, embezzlements, and suicides may 37. Evidence of Dr. E. A. Goldenweiser, Senate Hearings, Part 16, p. 6440. 38. Ibid. 39. ibid 40. Ibid. 4!. Senate Hearings, Part 15, p. 6441. 42. Ibid. as. often be traced to speculating in securities on the margin. He cited experiences, as a federal Judge, which indicted the practice of.margin trading. Judge Clark related: 'I have had to send men to prison because they had used the'money entrusted to them by poor depositors to 'proteot' margin accounts. The district attorney for my district advised me that about half of our national bank emblezzlements in the last five years are the result of stock speculation. There has been since 1929 an increasing number of suits in.my court on insurance policies where, under the terms of the standard policy, the issue was: accident or suicide? The com- pany has been, therefore, obliged to establish a motive, and in nearly every instance the motive has been,_'wiped out in the stock market'. In 1930 and 1931, I conducted with the aid of the Yale Law School and the Department of Commerce, what we called a ' 'Bankruptcy Clinic'...We examined a large number of persons who had filed petitions in the New Jersey court for the purpose of discovering the whys and wherefores of their unfortunate con- dition...We were shocked to ind the large number of individuals, , both-business men and wage e rners who had taken a 'fling' in the a market as a sideline, with, of course, fatal results. my knowledge of these things led me to the conclusion that margin trading in an unconscionable number of cases led to either death, dishonor, or distress. I have been endeavor- ing for several years now to impart the: conclusion to the stock-exchange authorities themselves." 3 Thomas G. Gorccran, in the office of counsel for the Recon- struction finance Corporation states two: common: justifications for margin trading. The first of these is that the use of margins makes purchases of securities on the instalment plan possible.‘lhen security prices are low and there are prospects for an increase, it is possible for an investor to make a down payment and to pay the balance later. The second Justification is that margin trading makes an active market. If the market is to be a liquid market it must be an active market. To be an active market it must be a speculative market, because a market of investors, alone is not active enough. To have a speculative market it is necessary to have a margin market. i,_ 43. Senate HearingsfPart 15, p. 6928. 44. Senate Hearings, Part 15, p. 6484 and p. it, .40.. 6499. 37. These two mustifications for margin trading were criticised by Mr. Corcoran. The difficulty of the instalment plan of buying securities is that, on a rising market, human nature is such, that investors never pay for the securities as they advance in price. The investor becomes a speculator and pyramids on his profits by purchasing more securities. The argument that margin trading is necessary in order to have speculation and a liquid market, is a controversial question. Its merits rests with the purely pragmatic question of how valuable speculation is in the market. This question has been discussed above. Th an or P hibiti Bar in Tradi Certain of the evils existing in the credit relationship between brokers and their clients in margin trading Operations have been indicated. We will now proceed to describe the means by which security transactions would be financed under the plan urged by those desiring the prohibition of margin trading. The most impor- tant change that would be brought about by prohibiting margin trad- ing would be that brokers would be taken out of the banking business . and all transactions on the securities exchanges would be placed on a cash basis.“'5 A purchaser of securities, if he wanted to borrow funds, would have to go to a bank. This would establish a direct credit relationship in place of the indirect credit relationship which exists in margin borrowing. Senator Bulkley pointed out many advantages which would flow from the financing of security trading through the banks."'6 Under this arrangement bankers could secure necessary credit in- formation before making a loan to a security trader. The credit negds of hgrggggrg qould pg cgnsidsred and borrowers wqulg not 4 . Evidence of Senator Bulkley, Part 15, p. 6484. 45, Ibid, agrt 15 éenate Hearings ’ DO 7’}96. 38. escape responsibility for repayment of a loan if their collateral fails. In regard to the federal control of security credit, Senator Bulkley believed that‘bank loans on securities might be controlled through the Federal Reserve System. He also felt that "banks would be moved by a greater degree of social and economic consideration than brokers" would be in making loans on securities.47 A great deal of the support for the financing of security transactions through banks rather than by means of margin borrowing was based on the more desirable credit relationship which would be established. This relationship was rather fully discussed by Ibodlief Thomas.48 He made a comparison of the responsibility of borrowers, the protection of lenders, and the effect on a rising and falling market, which would come about through the use of either of the two methods for securing funds for the purchase of securities. . The responsibility of borrowers from bankers and the respon- sibility of'borrowers from brokers was compared by Mr. Thomas. In the sass of a bank loan the borrower must sign a note for the amount borrowed and if he increases his commitments he has to sign a new note. In the case of a brokerage house, long commitments are simply entered as a debit in the books of thdbroker, and short commitments are entered as a credit. The principal requirgment in the case of a brokerage house is that the account be properly margined. According to Mr. Thomas, bankers who make security loans are betterprotected than brokers.‘ This is true because banks, generally, deal only with their customers who maintain a deposit balance in addition to their collateral. They app alspmlikely to require 17. Senate Hearings, Part 16, p. 6592. 48. Senate Hearings, Part 15, pp. 6449- 52. 39. larger margins than brokers. Also, bankers are more particular in arranging credit transactions for the purpose of stock market trading than brokers who do not select their customers. It was the opinion of Mr. Thomas that bank loans for fin- ancing security transactions have a better affect on the market thandloans by brokers. A close check is kept on the market by brokers who do not hesitate to sell out accounts that are under- margined. This makes rapid.sales necessary on a declining market and tends to make the market more erratic. On a rising market brokers encourage clients to increase their commitments. This encourages pyramiding. ‘Undermargined accounts are likely to be carried longer by banks than by brokers. The bankers can do this because they are protected by the customers' note, a larger margin an additional. deposit, and a knowledge of the customers' credit standing. on a rising market bankers do not encourage the extension of speculative loans. The result is that pyramiding is not encourage by bankers, while it is by brokers. It was pointed out by Mr. Thomas that the adoption of the plan to prohibit margin trading would bring about a credit situation in security transactions similiar to that in flngland. It was his opinion that the plan "should not be adopted without a study of the higlish p1an.“49 Eugene Black was of a similiar opinion. He stated that although it might ”ultimately be a good thing" it would be "too drastic" to adopt without considering the English practices and the robable results of their adoption in this country.60 :9. Senate Hearings, Part 15, p. 7188. 50. Senate Hearings, Bart 16, p. 7427. . 40. The lish S s of F c Seourit T ad In.the discussion of the English system for financing secu- rity trading it was revealed that 'in.London.margin trading of the kind and to the extent prevalent in New York is unknown.'51 Woodlief Thomas stated that "the facilities for margin trading seemed to be very difficult“ and that ”he could not find a broker who would admit that he did a margin business."52 The method of securing funds, in England, for security trad- ing was described by Dr. E. A. Goldenweiser. He stated that in England a security trader "must establish a line of credit" with a bank or broker in order to secure funds.53 This would bring about a direct credit relationship. In establishing the line of credit the ”needs and the financial responsibility of a borrower are con- sidered" and the fmere possession of security collateral“ is not enough. 54 A client's request “must go before the board of directors" of the lending institution and it must "be approved" before the client's line of credit can be increased.56 This method of fin- ancing security trading would not be susceptible of the two criticism which have been made of margin trading in the United States. Namely, these criticism, which were made earlier in the chapter, arc that the borrowing of funds on the margin is made too easy and that in a mar in transaction no direct credit relationshi is established. omas, ear s, , . 7185 52. Ibid. ing p 53. Senate Hearings, Part 15, p. 6440. 54. Ibid. 55. Ibid. _ 41. The market authorities, evidently, did not fear that the plan to eliminate all margin trading would be adopted. This may be inferred because of the lack of participation by market authorities in the discussions concerning the plan. It must be inferred, However, that they would have objected to its adoption even.mcre than they objected to the adoption of the administration bill. This is probable because its result would be to entirely elminate margin trading; whereas, the result of the administration.bill would be the reduction of margin trading only. The most active criticism to the immediate adoption of the plan came from the credit representatives of the government. Like- wise, the results of the survey of the securities exchanges carried on.by the Twentieth Century rund were not favorable to the plan to prohibit margin trading. P Among the objections to the prohibition of margin trading was the assertion that it would not accomplish its intended results. Alfred L. Bernheim did not believe that "borrowing on securityhollateral directly from banks instead of from brokers could besgxpected to reduce the volume of speculation.materially." ‘ An important reason why the measure might not be effective in accomplishing its intended result was the possibility that secu- rity trading might find some new means of securing funds. It might be impossible to control this new source of'credit and hence a bootleg loan market of huge proportions might be developed. The danger of the development of such a market was foreseen by Roland Hgdmand "if in an expreme effort to stoR speculation on b%rrowed 56. Twentiety entury Fund, sgggk market ontrol,Apple on-Century Company, New Yorke De 1? e 5 42. funds all collateral loans were made illegal.”57 It should be observed that there are many banks which are not members of the Federal Reserve System and that their loans on security collateral_ could not be federally controlled. In addition, there would be. danger of the organized exchanges setting up private banks for financing security trading. Another objection to the prohibition of loans on the margin was that it would result in the impairment of the collateral value of securities. This, it was asserted, would be unfair discriminatic against a certain class of property. It would seem unwise to pro- hibit the purchase of securities on credit on their use as collatera when other property is not so restricted.68 It is probably true that many loans on security collateral are made for purposes other than further-security purchases. The lenders of such funds could not be expected to exert effective control over the use borrowers made of the funds advanced to them on security loans. The curtailing of credit by the probition of margin trad- ing was further objected to because of the danger of destroying the proper function of the securities markets. It was pointed out in this connection that if the market is to perform its proper, function it must be a speculative market. The drastic curtailment of credit which would come about as a result of the prohibition of margin trading might so reduce the amount of trading that the liquidity of the market would be impaired.59 The marketing of new securities by corporations is an important means of securing new funds. If margin trading werdwo be prohibited the marketing of these new securities might be made difficult. The representatives of business contended that because of 53133°°£E°r3t1$§ financing would be made difficult. 58-59.“:i'wen549ihn03n r'y run , ‘t c'k m- 'at _gontrol 43. Gamprcmise Policy_in Public Regulation of_§ggugity_gggg;t The Fletcher-Rayburn bill is a compromise between those who desired to have margin trading remain unregulated by the government and those who favored the complete elimination of margin trading. The drafters of the bill did not wish to risk destroying the liquidit: cf the securities market by doing away with all borrowing.60 It was thought, by them, to be a better plan to reduce, rather than to prohibit margin trading. The plan to finance all security trading through the banks which would have been brought about by a law prohibiting margin trad- ing doubtless has certain merits. Its results, if adopted, in this country, would be questionable. Although the plan may work in Englanc it should be observed that our credit practices and the custOms followed in our securities exchanges are not like those employed in England. Furthermore, the change from the margin practices which have long been followed to an entirely different practice would be a drastic change. If the elimination of margin trading is desirable it might be wiser to make the change gradually. ‘ The Fletcher-Rayburn bill provides for less drastic changes in the use of margin trading than would be brought about by the pro- hibition of such trading. It is obvious that it would not be as likely to have harmful results. The bill can be expected to erad- icate many evils pointed out by the critics of margin trading by providing for higher margins. In addition, the bill may be expected to have a tendency to discourage margin trading and bring about more financing of securities through the banks. This would bettrue becaus the margin regulations will make such trading more difficult. The increased difficulty of margin trading through accounts with brokers may result in traders going to banks to secure funds. 60. Evidence of Thnmnn norcoran. Senate Hearings. Part 15_n. 5494 dams NO. I. N. L' s. E. menses TOTAL BORRowINGs on 00me Billions of Dollars 44. can t t It IF It it 3|: * L fl at a a / at we a a a a '7 as a k] V a a a a a 6 a at / a a: a e a a * 6 JL ' l u_ as fat] ' a [It A as at e a a 4 V */a a a: \at a a a 3 f in e at at a \a a a a at 2 hf? a a a at *\/\ a: a a a 1 an a a» a a W O __ w I927 1928 1929 1950 1933 1934 1955 CHART N0. 11. N. Y. S. E. TOTAL MARKET VALUES OF LISTED SHARES Billions of Dollars 100 t at a It! * a at so A g t I! It: / W It * * 60 t III: III M It It \III/\/\\ It It 40 M a a a: \:\ so [\«W a at It at It It V a 0 1925 ' 1936 1928 1929 1930 1931 1932 1933 45. CHART N0. III. N. Y. s. E. MONEY DESKICALL LOAN RENEWAL RATES Per dent (Monthly Averages) 10 a e a * a a a e a a a a a a 8 T26 '27 '28 '29 '30 '31 '3 '33 '34 '35 '36 '3 CHART NO. IV. ALL FEDERAL RESERVE MEMBER BANKS ELOANS To CUSTOMERStExchpt Banks) 0N SECURITIES Call Date Loans on Securities (In.millions of Dollars) 1928-00t. 3 6, 796 Dec. 31 6, 373 1929-Mar. 27 6,526 Junae 29 6,813 Sept. 29 7,170 Dec. 31 8,685 1930-March 27 7,024 June 30 7,242 ‘Dec. 31 3,288 19310Mar. 25 6,848 June 30 6,602 Sept. 29 6,321 DeOe 31 5,899 1932-June 30 5,009 Sept. 30 4,828 Dec. 31 4,608 1933-June 30 3, 752 Oct. 25 3, 631 Dec. 30 3, 606 1934-M8re 5 3, ’480 June 30 3,309 Dec. 31 3,110 1935-June 29 2,931 Nov. 1 2,885 Dec. 31 2,881 46. 'CHAPTER III EFFECTIVENESS OF HIGH MARGIHS AS A DEVICE FOR FEDERAL CONTROL OF SECURITY CREDIT In the preceding chapter the evils of excessive security speculation were discussed. As a result of these evils the need for adopting a public policy of federal regulation was indicated. One of the means for such regulation is the granting of additional federal control over security credit. It has been asserted that too free use of credit has been a major cause of excessive security specu- lation. The existing means of federal credit control have not proved effective in regulating such speculation. The Fletcher-Rayburn.bill provides for additional powers of regulation through the use of higher margins as a device for federal control of security credit. The question of the effectiveness of such control provides the issue with which this chapter is concerned. THE PLAN FOR MARGIN CONTROL OF SECURITY-CREDIT The Fletcher-Rayburn bill provides a plan for the regulation of security speculation by means of federal credit control. The bill limits the use of security credit through the federal control of margin requirements. The power to fix margins makes it possible to limit the collateral value of securities for margin trading by regulating the size of margin requirements. It differs from other means of credit control in that it affects directly the effective demand for credit rather thanavailable supply or cost. It is the purpose of the bill to fix.margin requirements which will exert a restraining influence on the use of credit for speculation in the stock market so that the business and credit structure will not be 47. unfavorably affected. The proposed bill contained a statutory formula on which margin requirements would be based.1 It was provided that a commis- sion might prescribe higher requirements if conditions made it nece essary to do so.“ The statutory formula would profide in effect that a loan on a security must not be greater than whichever is the higher of: (l) 80 per centum of the lowest price at which such security has sold during the preceding three years;2or (2) 40 per centum of the current market price. The theory on which the statutory margin formula was based was to provide a constant increase of restraining influences as the price of stock advanced above their lows. The operation of this formula will be discussed in greater detail in the next chapter. . The bill provides for the selection of collateral which may be used in margin trading. In order to be eligible as collateral in a margin purchase a security would have to be registered on a nationally registered securities exchange.5 The registration of securities and exchanges was a necessary measure for the administra- tion of the margin formula. Securities which were not registered would not be eligible as collateral in margin trading. The problem of these unlisted securities will be dealt with in a later chapter. Ohjggtiong to Relating Margins to Market Price An objection to the computing of margins on the basis of market price was raised by Alfred L. Bernheim, director of the secu- rities markets survey of the Twentieth Century Fund.4 mhig organ- ization had undertaken an exhaustive survey of the securities markets t2 dgtermine what evils were present and how they should be eliminat- 1. Fletcher-Rayburn bill, Section 6 b . 2. I id. 3. Ibid, Section 6(a). 4. Senate Hearings, Past 15, p. 6936. 48. ed.6 They agreed that minimum margins should be set sufficiently high to discourage excessive speculation but they were of the opinion that the earnings of a security rather than its market price should be used as a means of determining margins. I}. Bernheim stated that "the principle of relating collateral loans solely to market values is essentially unsound, no matter at what point the margin is set. This margin permits a pyramiding process. It makes pos- sible higher loans as prices are rising and accelerates liquida- tion when prices are dropping. This is particularly true under the alternative devices provided in the bill which will serve to permit pyramiding during the later stages of a 'bull-market' when it is most dangerous, while it will impede the flow of credit in- to the market during the early stages of recovery when, if ever, speculation in stock is helpful. Only by relating collateral loan values to the eargings of a security can these unfortunate results be prevented." A table was submitted to illustrate the fallacy of relating the loan value of a security to the market price of the security.7 The table shows the loan values of four common stocks compared with the market values. A comparison of loan values of the stocks is made as they would be computed under the proposal made by the Twentieth Century Fund committee, by the proposed bill, and by the New York Stock Ex- change margin requirements. The prices and loan values for September 3, 1929, June 1, 1932, and February 1, 1934 are shown. It was suggested by Mr. Bernheim that the maximum loan.va1ue of a share of stock be twice the aggregate net earnings applicable to it over the five years preceding the date of the loan.8 The qualifi- cation was added, however, that the collateral value should never exceed sixty per cent of the current market value of a security. Sevegal objections to the plan were pointed out by Roland 5. Senate ’earings, Part 15, p. 6936. 6. Senate Hearings, fart 15, p. 6941. 7. Table incduded at end of chapter» Chart No. VII. 8. Senate Hearings, Part 15, p. 6941. 49. Redmand, attorney for the New York Stock Exchange.9 The plan could not be put into operation without considerable delay due to the ‘Jnecessity of determining a securitgss earnings. In operation the plan would involve much detail and expense. The fact that earnings of many securities fluctuate greatly would further invalidate the plan. He provssion is included in the plan for figuring the margin on secu- rities of new enterprises. Opposition of Market Authorities to Federal Margin Control The market interests were opposed to the use of margins as a device for the federal control of security credit as contemplated in the Fletcher-Rayburn bill. They favored, rather, the indirect control of the volume of credit. It was contended, in this connec- tion, that.the Federal Reserve Board have sufficient powers to enable them to properly regulate security speculation.10 It was agreed that the Board had not succeeded in regulating security speculation previous to 1929. However, it was asserted, bankers had learned by that experience.11 Likewise, the enacting of the Banking Act of 1933 has greatly increased the power of the Board for the express purpose of preventing the undue diversion of funds into speculative operations The theory followed in the proposed legislation for the use of margins to prevent excessive security speculation seemed to be that permanent margins should be fixed sufficiently high to keep any great amount of borrowed funds from entering the market. This in turn would prevent the development of any speculative 'boom'. Exper- ience has shown that the time to check such a 'boom! is before i: e hate 081.1 8 , 3r , Pa 4- e 10. Evidence ofngoward Butcheg, Vice-President, Phila. Stock Exchange, Senate Hearings, Part 15, p. 6969, and of John.C. L088. broker-dealerss firm in Baltimore, Part 15, p. 6919. 11. Evidence of Richard Whitney, President of the New York Stock Exchange, Senate Hearings, Part 15, p. 7033. i so. gets under way. If this is not done, it will gain such force, after it gets under way, that raising margins will not be an effed- tive measure to stop the speculative movement. In opposition to the above plan for the use of margins, it was contended that low margins do not cause security speculation. Margin requirements should be low enough to allow the use of credit in security transactions. These margin requirements should not be permanently fixed but should be determined according to current conditions. If it appears that security speculation is becoming excessive, raising margins will exercise some restraint. The market authorities and brokers have followed this procedure and since they are best acquainted with market conditions they are well- qualified to determine when margins should be raised. EFFECTIVENESS OF HIGH.HARGINS 1H PREVENTING SPECULATION There was a difference of opinions concerning the effec- tiveness of high margins in regulating security speculation. The supporting arguments of those who were oppossed and of those who were favorable to the statutory plan for the regulation of secu- rity speculation through the use of high margins will now be 6 discussed. A The argument that low margins,are not a cause of security speculation was advanced by Frank Altschul, chairman of the committee on stock list of the New York Stock Exchange. 13 He asserted that ”normal margin requirements do not unduly foment speculation." He felt that the temptationuto speculate is or is not ”inherent" in the situation. Low mar in re uirements are not in themselves 12. Senafe Hearings, Part 15, p. 5705. \ 51. a temptation to speculate. It was his Opinion that high margins should not be permanently fixed but they should be tightened as speculative waves develop. ~ It was argued by Richard Whitney, President of the New York Stock.Exchange, that the history of the use of high margins on the New York Stock Exchange does not seem to indicate that they will be effective in curbing security speculation.13 The use of high margins did not prove effective in 1929. The New York Stock Ex- change had minimum margin requirements and brokers raised their margin requirements as security prices began to soar in 1929. “.Statistics taken from the members questionnaires'over the first , six months of 1929 showed margins in customershaccounts averaging forty per cent on their debit balances with brokers. In a speech, January 25, 1930, Mr. Simmons, who was at that time president of the New York Stock Exchange stated: "I need scarcely point out how enormous these margins 2323hefi°3§efiiigmfiiéniutfi fithI‘E‘igEiiifiififm“ ”“1“” The history of high margins, then, does not seem to indicate that high margins will stop speculation just at those times when it should be checked. The history of the use of margins, previous to 1929, as a means of controlling security speculation was interpreted in a different light by Ferdinand Pecora.u‘ It was his opinion that the reason why increased margins proved ineffective to reduce or control the excessive speculation that went on prior to 1929, was that margins had not been raised soon enough. The speculative movement was well under way before margins were increased. The s eculative movement should not be allowed to develop. The desir- 13. Senate Hearings, Part I5, p. 6708. 14. Ibid. 15. Senate Hearings, Part 15, p. 6710. 52. able thing would be "not to let the economic machinery to reach that dangerous rate of speed where the sudde application of brakes would be ineffectual...and dangerous."l The situation which developed in the market previous to 1929 was ccmpared by Senator Fletcher to the situation which developed in business during the same time.17 The proposed use of margins was compared to the use of the discount rate as a means of controlling business credit., In this connection, it was admit- ted, by the Federal Reserve Board, that they were late in raising the rediscount rate in order to check the undue inflation of business credit. It was Senator Fletcheris opinion that if the Board had raised the discount rate earlier they might have pre- vented the inflation of credit.18 The implication of Senator Fletcher's comparison seems to be that undue use of security credit may be checked by fixing margins permanently high. P t f the nvest r The use of high.margins as a means of limiting credit for security speculation will protect the investor. Considerable difference is made by requiring a sixty per cent rather than a twenty per cent margin. When the market price of a security drops below the required level the investor must put up more funds or be sold out. This can be shown.best by an illustration. If an investor held ten theusand dollars worth of a listed security on which he had borrowed four thousand dollars in a margin transaction, unless a drop of sixty per cent occurred, he would not be 'wiped out'. In case it became necessary to put u more mar in and he found it inconvenient to raise the necessar i9. Eviggnge of Ferdinand Pecora, Senate Hearings, Pas? I5, 17. Senate Hearings, Part 15, p. 6710. 18. Ibid. . 53. funds, it would bejpossible to sell a part of his holdings of the security, and with the funds, it would then be possible to bring his margin on the remainder up to the required level. If the investor had borrowed seven thousand dollars on the ten thousand dollar purchase of the security, a dr0p of thirty per cent in the market price of his security would make adjustment difficult by causing the loss of the entire sum invested.19 WW For the purpose of indicating the extent to which margin requirements would be raised by the proposed bill, a tabulation was submitted by Thomas G. Corccre.n.2o The tabulation shows the comparative operation of the margin rules prescribed by the New York Stock Exchange, and those embodied in the Fletcher-Rayburn bill. The tabulation shows that, in general, margin requirements would be raised by the proposed act.“3l As a result of this, credit for security speculation would be decreased and the small investor would be better protected against the loss of his investment. The aim of the drafters of the proposed bill in providing minimum.margin requirements was to set margins high enough to prohibit excessive security speculation and to provide protection for investors. If the increase in margins provided for was to have any material influence in limiting the amount of credit for security speculation and in protecting the investors, a small increase in.margin requirements, such as five perccent, would be insufficient. Margins must be increased sufficiently to limit secugitS credit materially or the: will not be effective. I . ee tabulation at end of this chapter. “CHEFT—fi 20. Senate nearings, Part 15, p. 6474. 21. See tabulation at end of this chapter. Chart V. 54. The attacks on the margin provisions of thewletcher-Rayburn bill resulted in the margin requirements being softened in the form in which it was finally adopted in the Securities Exchange dot of 1934. The extent of this change is revealed by Chart VI at the end of this chapter. During the summer of 1934 a survey of the position of margin accounts showed that under the 1933 rules of the New York Stock Exchange the average margin requirement was about twenty- _five per cent of the current market price of the security.38 The average margin required at that time in accordance with the statutory formula approximated twenty-eight per cent.23 This may seem to be a very small increase.- It must be remembered, however, that security prices were not high at this time. Also, margins had been raised by the New York Stock Exchange. In the future, if securities advance in price the automatic feature of the statutory provisions of the bill will operate to increase margins. The major question of controversy in regard to the use of -~margins as a device for controlhfing security credit is whether that control will be effective in prohibiting excessive security specu- lation. The answer to this question is, at present, largely a matter of opinion. Conclusions concerning the effectiveness of such control can be formed from an observatinn of their effective- ~ ness inbperaticn. Such conclusions must not be too hastily drawn. The.Act was instituted when there was little speculation of any kind. For more final conclusions, a period when there is specu- ~.lation in other fields an an increase in business activiey is needed. This question.will be considered further in the final cha ter.__ _I 22. The Federal Reserve Bulletin for October, 1934. 25. Ibid. 55. Chart No. V. MARGINS. (l) n es la Present New York stock Exchange rules: maintain margin.of 50% 0f debit balance-equivalent of per- miting broker to lend 66 2/375 of value of securities; applies to all accounts where customer "puts up" less than $8,600. (:7) 0n accounts with debit balance of more than $5,000, custom- er must maintain.margin of 30%iof debit balance-equivalent of permitting broker to lend 7T% of value of securities: applies to all accounts where customer puts "up” $8,500( or mores ' (3) Rule proposed by Fletcher-Rayburn bill; The broker may not lend more than whichever is the higher of- (a) 40% of the current value of securities-equivalent to the customer's putting up 60% of the market value of secu- rities purchased or 150% of the debit balance (1. 8., the broker's loan of 00% of the market value); or (B) 80% of lowest price within.three years-equivalent to cus- tomer putting up £0% of the market value of the securities purchased or 26% of the debit balance (i.e., the broker's loan of 80%iof the market value). (2) Comparative Table Illustrating Operation of mar in Rules r n s. r. s. E.-debit of less than $5,000..-- 55 2/395 33 1/3% 3 50% s. v. s. R.-debit of more than $5,000--- 77% 25% c 1/3 as % - Iletcher-Rayburn-40% loan value on specu- lative securities-- --------- - -------- ---- 40% 60% 1 2/3% 160% Iletcher-Rayburn-80% loan.va1ue on stable securities- ------ ---- ----- --------------- 80% 20% 0% 26% I. fiImum 3 0? value of securities broker may find. B. Minimum % of value of securities customer must put up as margin. O..Maximum number of times his deposit customer can buy in market value of securities. D..Minimum %uof debit balance customer must put up as margin. (5) How Much Stock Can a Customer 3 With a Given Deposit? Iith a $2,555 deposit a customer can buy the IEIIBwing vEIues of securities: (a) 7,500-under present New York Stock Exchange rule. (b) ,100-under ‘letcher-Rayburn 40% speculative loan rule. (0) 12,500-under iletcher-Rayburn 80% stable loan rule. Iith a 10,000deposit: (a) 43,333-under present New York Stock Exchange rule. (b) 16,666-under Eletcher-Rayburn 40% speculative loan rule. to) 60,000-F1etcher-Rsyburn 80% stable. loan value rule. 55. Chart NOe Ve (Continued) (d) P t ti Afforded Mar in.Treder b Lar er Bar in lei Suppose a trader without resources to meet additional margin buys 100 shares X stock at 100 on Now York Stock Exch margin-putting up $2,300 on $10,000 market value of securities .Lccount reeds: larket value long position, $10,000; debit, $7,700. ' If stock drops suddenly to 77 where market value equals debit customer's margin is wiped out. - (b) Suppose the trader buys the same 100 shares cf.X's stock at $100 on the Fletcher-Rayburn 40-percent loandvelue margin. He will have to deposit $6,000 on $10,000 market value of Securities and his account will stand: :Market‘value long position, $10,000; debit, $4,000 if the stock drops to 77 the trader can still readjust the account to the required margin on a smaller number of shares without additional cash. By selling 20 shares at 77 for $1,540 and applying the proceeds to the debit balance, the trader wan reestablish his account on the following basis: Market value long position, $6,160; debit, $2,460 By the drop in the market the trader will have lost pert _ of his investment, but not all. (0) Suppose that with the same down payment of $8,300 referred to in the first case above, the trader buys the maximum number of shares of the same stock at the same price which the broker will be permitted to carry for him.under the Fletcher-Rayburn 40% loan-value margin rule. Eb will be able to buy 38 shares of a market value of $3,800 and his account will stand: flarket value long position, $3,800; debit, $1,600. If the stock drops to 77, the trader can still readjust the account to the required margin.on a smaller number of shares without additional cash. By selling B shares without additional cash, by applying the $616 proceeds to the debit balance, the trader can reestablish his account on.the following basis: clarket value long position, $2,310: debit, 308‘. By the drop in the market the trader will have lost. approximately 1/3 of his original investment but he will still have an equity in an account and may be able to recoup with a rise in the market. 67. Chart H0. VI. SUMMARY OF MARGIN PROVISIONS, ORIGINAL BILL AND ENACTED SECURITIES EXCHANGE ACT OF 1934. V Qriginal Bil; got gassed 1. Maximum loans, when based on "‘ % * % lowest price: (a) Initial loan(percentage * * of low)------------------ so 100 (But not more than(percentage* * of market%- ---------------- 80 76 (b) Maintained loan(percentag‘ * of 10 )-- .......... ----- so 100 But not more than(percentage* * of market)-------- ----- -----* 80 * 85 2. Maximum loans, when based on current market price: (3) Initial loan(percentage * * of market)--- ---------- 1* 40 * 65 (b) Maintained loan(percentage of market)---------------* 40 * 60 5. Period from which lowest pric‘ * is to be selected: (a) Until July 1, 1936-------* 3 years * Since July 1, 1953 (b) After July 1, 1956 ------- * 3 years * “3 years 4. Exemption for existing accounts None * Exemption to ‘6. Power to exempt securities---* Limited *‘Descretionary CHART NO. VII. 58. LOAN VALUES Or FOUR COMmOH STOCKS COMPARED WITH MARKEI VALUES E. W. WOOLWORTH COMfibN §ept. 3 June I Feb. I ill 1929 1932 1934 fisrket price (average)-- ------------ "“399766"'"326?26“"$BTT26" .. Loan values: Twentieth Century Fund ....... E 29.44 b§ 15.15 b£30.75 Fletcher-Rayburn Bill -------- b 8. 40 $18.18 20.20 New York Stock Exchange: (debits under 6000)------- 66. 00 'Tl6.82 33.63 ldebits over ------- 77.00 19.44 8.89 ‘—— U. S. ' I .Market price (EverageI ------- --------$259§00 b326.82 $57. 50 Loan values: Twentieth Century Fund ....... : 90.68 a 15.97 :323.84 Fletcher-Rayburn B111 -------- 103.00 20.20 22 80 New York Stock Exchange. (debits under 6000)-------%l72.49 7.96 (debits over ; ' 43.89 __ ’r J . ' e . “ l‘ : : ' . a: V fibrket price (average) ---------------- $3 .0 8. 0 2 .2 Loan values: b Twentieth Century Fund ...... .g 89.54 b 62.80 72.15 Fletcher-Rayburn Bill ------ -- 120.00 ° 68.00 ° 66.19 New York Stock Exchange: ‘ ‘ (debits under $6000)------ 200.00 69.00 80.00 (debits over @5000) ------ 9231.00 8.00 92.00 Iv GENERAL MOTORS COMMON " ' fiv— Market price'TaverageI‘ ----- ~~~~~~~~~~~$72.00 $9.00 $40.62 Loan Values: , Twentieth Century Fund ....... 7. 74 b 5.43 b 24.38 Fletcher-Rayburn Bill -------- § 28. 80 ° 6.80 b 15.25 New York Stock Exchange: (debits under “6000) ------- 48 00 6.00 27.06 6.93 31.28 a. on earn ngs a uste or c anges n cap ization. b. Based on current market price. c. Based on lowest price for preceding three years, adjusted for capitalization. 69. CHAPTER IV STATUTORY VERSUS DISCRETIONARY CONTROL OF MARGIN REQUIREMENTS There are three possible plans which might have been adopt- ed for government regulation of margin requirements. Margins might have been fixed by rigid statutory provisions. Such.margins would be permanent and would need to be relatively high. Less rigid statutory provisions for determining margins might be provided for lower margins and granting to a government agency the power to prescribe higher margin requirements according to circumstances. Finally, the whole responsibility for determining marginsrequirements might be left to some government commission. This plan would pro- vide a more flexible means of’determining margin requirements. Under the terms of the proposed bill, margin requirements would be determined by means of a statutory formula and a govern- ment agency would be granted authority to prescribe higher require- ments. The market interests contended that too high margins would be required under the terms of a statutory formula. Also, this plan for determining margin requirements would be rigid and inflex- ible. It was their desire that federal control of margin require- ments, if such control was to be adopted, should be placed in the hands of a commission. The commission should not be unnecessarily hampered by statutory limitations. This plan would provide flex- ibility and would make it possible to regulate margin requirements according to current conditions. A further description of these two plans and their relative merits and limitations will be the subject of this chapter. 50. OBJECTIVES AND OPERATION 017 THE (STATUTORY PLAN The objectives and operation of the statutory plan for determining margin requirements, which was provided for in the proposed bill, will now be considered. The standard of margin requirements stated in the bill was designed to exert a restraining . influence on speculative trading. By imposing higher margin require- ments on securities that have had a rapid rise than on more stable securities the prescribed requirements would make credit less freely abailable for trading in speculative stocks. By limiting the extent to which Speculative profits might be used as margins for further speculation thee practice of pyramiding would be prohibited. ,If securities advance in price to a point where pyramiding of profits becomes possible, higher margin requirements might be prescribed by the commission.1 'Under the plan for statutory fixing of margins the market price over a base period of three years prior to the date of pur- chase of a security would be used to determine the amount which could be borrowed on the security.2 If the market price of s secu- rity showed little variation over the base period its loan value would be correspondingly high, but if there was a wide fluctuation in the price of a security its loan balue would be correspondingly low. This condition would be brought about by the margin.formula Ipuhvided in the proposed bill.3 The margin requirements, imposed by the statutory formula, were drafted in collaboration with officials of the Federal Reserve System, with a view to placing a pregium.fop margin purposes on securities that keep stable pver p 1. Fletcher-Rayburn bill, Section 6 b . 20 Ibide ' 3. Ibid, Sections 8(a) and 6(b). 4. See page 47. 61. period of time.4 The bill relates to minimum margin requirements only, and a broker may, of course, have an arrangement with his customer to refuse to carry the account unless securities are more heavily margined. Securities would naturally fall into two classes under the terms of the bill. If the loan value of a stock was greater under the eighty per cent rule the margin for it would be computed on that basis. Such stocks would be those which had had little rise in price or had declined in price during the preceding three years.' Secu- rities which would be included in this category are termed stable securities. 0n the other hand, securities which had appreciated considerably in price, or had declined greatly and then climbed back again, would naturally be computed under the forty per cent rule as it would give them greater collateral value. The implication of the bill seems to be that great fluctuation in the price of a securitins an indication of speculative activity in that particular security. Since the avowed purpose of the bill is to curb excessive Speculation by limiting credit on the more specu- lative issues the collateral value should, legically, be comparatively lower on such an issue. In periods of low or declining prices liberal hanginsnmaynbghallcwed while in times of high or rising prices pro- hibitively high margins are fixed. This is, according to Thomas G. Corcoran, counsel for the Reconstruction.Finance Corporation, the "correct result to keep the market from running away on the upside."5 An example to show the application of the stable security and the volatile security feature of the bill will serve to clarify its interpretation. To illustrate the eighty per cent provision of the a end which has a ar value of one the and dollars ma 4. Evidence of Thomas G. Corcoran, counsel for the econstruction Finance Corporation, Senate Hearings, Part 16, p. 6472. so Ibid, p. 6481. 62. be taken. The bond declines in price to eight hundred dollars and then.rises to par at one thousand dollars. Computed in.the eighty per cent rule six hundred and forty dollars could be leaned on this security, whereas; only four hundred dollars could he leaned under the forty per cent rule. It will be observed that the amount which can be borrowed is not eighty per cent of the current market value but eighty per cent of the lowest value in.three years previous to the date of the transaction. In the case of a stable security the percentage of the current market price which is reached on the eighty per cent computation will be higher than forty per cent of the current market price. O The forty per cent rule is applied to volatile stocks which would have a lower loan value under the eighty per cent provision due to wide price fluctuations. A stock which, it is assumed, is of a speculative nature drops during a three year period from forty- nine dollars per share to seven dollars a share and then rises again to a market value of forty dollars a share. Under the provisions of the bill the allowable loan could be computed on the basis of eighty per cent of seven dollars or forty per cent of forty dollars. Obviously, the forty per cent provision would provide a higher loan value, so a broker would loan sixteen dollars a share. That means that the customer would have to provide the difference between six- teen dollars and forty dollars of twenty-four dollars a share. OBJECTIONS TO THE STATUTORY PLAN The statutory formula provides a mechanical means of deter- mining margins for restraining security speculation. The market authorities asserted that this rule would not work and that it id and i 1 xible.6 The did not feel that it would be 6. Published Statement of the New York Stock Exchange, Senate Hearings, )art 16, p. 6627. 63. possible to hake a hard and fast rule for determining margin require- ments. The fixed minimum margin requirements, it was asserted, would operate in such a way as to be detrimental to the public. In periods of low and declining prices margins would be extremely generous and in times of high or rising prices margins would prove prohibitive.7 The stock exchange authorities were of the opindnncthat the "margins, which would be fixed by the preposed bill, would be too high. It was pointed out that considerable confusion has arisen because of the different methods used in computing margins by lay- men and brokers.8 Laymen compute margins by using the market price and the amount put up, thereby arriving at a percentage. Brokers use the debit balance or amount unpaid and the amount put up. The result is that margins as computed by brokers are higher than.margins as computed by the method used in the bill. 0n the basis by which brokers compute margins one hundred and fifty per cent margins, would,,in some instances, be required by the bill. Richard Whitney, .President of the New York Stock Exchange, asserted that this “would not be a margin requirement at all" but that it would "totally pro- hibit what is known as margin trading."9 The following example was given to illustrate the brokerfs method of computing margins: ”If a security like General Motors, which has within 3 years sold at 87 a share and is today selling at $40 a share, should be presented to the broker as margin after the effective date of the proposed act, the broker could only lend $16 a share upon the stock because the 80 per cent provision would humor nugatory by the low price which General Motors reached at the worst period of the depression. In this case the broker would have 160 per cent margin, ile. he would advance $16 against a stock selling at 840, and the difference between these two, or 424, would represeat one and one half times the amount owed him b his customer."1 .I. Published Statement of the New Ybrk Stock Exchange, Sinate Hearings, Part 16, p. 6627. 8. lbid. I0 Ezédenoe of Richard Whitney, Senate Hearings, Kart 16, p. 6601. O ids 64. It was further contended by Richard Whitney, that the power given the commission to raise margins would not go far enough to permit real flexibility.11 There is no power given to the commission to provide that any one security should have a lower loan value than the rest of the class. In actual practice banks and otherlenders of money always judge each loan according to its individual mirits. In.addition, the objection was raised by A. W. Wetsel, of the Wetsel Advisory Service, New Yerk City, that the power of the commission to raise margin requirements would inject an element of continuing uncertainty into all loans against collateral in the 12 In a declining market Mr. Wetsel form of listed securities. felt that two influence would operate: Brokers and bankers hold- ing listed securities as collateral would be compelled to dmmp them as soon as the loan was in.sxcess of the marginal ratios: and the disposition to exercise discretionary power to lower loan values would probably be greater in a declining than a rising market. The fear of such action would be a further depressing influecne, and t0gether with the other influence might precipitate a panic. RESULTS OF THE STATUTORY PLAN There was a marked difference of opinion as to the results 'which would be brought about by the statutory fixing of margins un~ der the terms of the bill. In general, it can be stated that the drafgers of the proposed legislation.believed that the bill would disturb the market but little in its functions. Those who were . Senate Hearings, art 16, p. 66 . 12. Senate Hearings, Part 16, p. 7142. .5. opposed to the legislation took the extreme view that the bill would destroy the market. A.much debated point was the extent to which security specu- lation would be eliminated. The stated purpose of the bill was the elimination of excessive speculation. It was held that the bsll would not stop speculation entirely but only decrease it. In this connec- tion Thomas G. Corcoran declared that as a result of the suggested margins ”only a diminuation and not an entire strangulation of specu- lation "would take place."13 Opponents of the preposed statutory margin requirements contended that as a result of their adoption speculation in secu- rities would be intirely eliminated.14 Without speculation the markets would be ruined from the point of view of liquidity. This was the opinion of Richard Whitney, who stated: "If the bill is enacted it will result in panic and a complete breakdown of the security markets of this country, naturally to the great detriment of these investors holding listed securities.”15 Thomas Corcoran did not agree that the decrease in secu- rity speculation would have a very serious effect upon the liquidity of the market.16 Although there might be a broader element between the bid and the asked in securities, the market would not be seriously upset. The margin trading business, however, would be cut in half by the proposed statutory limitations of margins and this would result in fewer commissions for brokers or the so-called 'flight of commissions:l_ This was held to be the real cause of the market authorities' antagonism toward the re osed legislation.17 . SenateIfigarings, fart INT—3723753. 14. Dean Witter, of Dean Witter & 00., San.Pranisco, Senate.Hear- ings, Part 16, p. 6766. Roland Redmand, Senate Hearings, Part 16, p. 6486. 16. Senate Hearings, Part 16, p. 6601 and 6734. 16. Senate Hearings, Part 16, p. 6499. 17. Ibid. 66. The attempt to regulate the flow of credit by a fixed law :‘broughmforth the criticism of business representatives. It was. felt that the bill would go beyond its purpose of regulating the national securities exchanges and that, taken with the Securities Act of 1933, it would effectually bar the flow of pribate capital in to American business.18 It was believed that it would be a mistake to forbid a free flow of credit into brokers' loans by "arbitrarily imposing a heavy restriction on margins."19 THE CONTROL OF MARGINS BY A COMMISSION The possible detrimental results of the statutory fixing of minimum margin requirements have been set forth as seen by the opponents of the proposed legislation. The market authorities believed that these detrimental results could be avoided without endangering the operation of the public policy of the Fletcher- Rayburn bill.2o They were of the Opinion that a middle course 9 should be taken which would grand something to both sides. An authority for determining margin requirements should be set up. This authority or commission should not be hampered by placing too little power in its hands through the fixing of rigid statutory margin requirements. The commission should have the power to fix the amount of margins which exchanges must require and maintain: they should have thepower to adopt rules to prevent dishonest practices which unduly foment speculation; and they should be given the power to regulate listing requirements.21 In order to bring this condition about an amendment was offered by Roland George H. Rusted, Vice-President, aticnal Manufacturerss Association, Senate Hearings, Part 16, p.7263. 19. Evidence of Robert owen, American Telegraph and Telephone 00,, . Senate Hearings, Part 16,p. 7278. 20. Evidence of Richard Whitney. Part 15, p. 6745. 21. Ibid. 67. determining margin requirements and place the whole matter in the hands of a commission.22 The chief criticism which was advanced against the statutory plan for determining margin requirements was that it would not be flexible. It was felt that rigid and inflexible rules for margins could not be drawn without destroying the functions of the exchanges?8 It would be impossible to set a line which would not need to be changed in the future.24 The real margin requirements will nee- essarily be shifted from day-to-day.26 Rules of law which would be effective today would be worse than worthless tomarrow, and the harm that would be done before Congress could assemble and amend 26 them would be beyond repair. .A commission, if it found the established margins to be unwise, could meet with little delay and fix margins according to the need.27 The attempt to control security credit under the statutory plan was further attacked on the grounds that it would be most unfortunate to write in law specific rules as to credit because credit condtions are fluid and laws are stetic.‘?'8 It was argued . by Frank Altschul,thhairman of the committee on stock list, New york Stock Exchange, that no law provides rigidly that the Peddral Reserve Banks should establish a certain discount rate and that that rate should be maintained.29 The discount rate deachanged from time to time in accordance with conditions. In the same way, it would seem to be quite reasonable to have a provision that me n uirem nt h uld not be made ri id but 18 t ca able 0 22. Senate earings, art 16, p. 646. ‘ 23. Evidence of Dean Witter, Senate Hearings, Part 16, p. 6778. 24. Evidence of W. G. Paul, Sec. of the Los Angeles Stock Exchange, Senate Hearings, Part 16, p. 6778. 26. Saml;el Untermyer, attorney, N.Y. 0. Senate Hearings, Part 16, p. 726. ° 26. Evidence of Richard Whitney, Senate Hearings, Part 16,p.6634. 27. Ibid. 28. Ibid. 29. Senate Hearings, Part 16, p. 6703. 68. being adjusted from time to time in order to accommodate themselves to the day-toeday or month-to-month developments in the speculative market. It was asserted by Richard Whitney, that it would not be humanly possible to adopt any law which would operate fairly in all possible circumstances for determdning margins?O Many factory deter- mine the amount of a sound margin. The nature of a security: the securities activity in.thqmarket; the degree to which it is held on margin or as a collateral for loans: and whether it is stable or volatile; all these are important criteria by which the safe and proper margin should be computed.31 The determination of what constitutes a sound margin, then, involves questions of opinion as to the evolution of actual and potential values and therefore requires the exercising of experienced and trained judgement in the appraisal of conditions which change from dayeto-day.zz It was the opinion of Frank R. Hope, President of the Associated Stock ExchangeiFirms of New York City, that a legislative formula could not be used "as a subsitute for such a judgement and Appraisal?34 The problem of fixing the loan.ba1ue of any particular secu- rity is a local one and must be dealt with by persons who are familiar with the local market conditions. The people who are best qualified to determine the loan values of securities are the people who are in constant daily touch with all the factors on which loan values depend. For these reasons stock exchange authorities were opposed to any plan whereby the loan balues of of securities in margin tradipg would be fixed by statute.34 30. Senate Hearings, art 16, p. 6627. 31. Ibid. 32. Ibid. ' 33. Senate Hearings, Part 15, p. 6907. 34. Published Statement of The New York Stock Exchange, Senate Hearings, Part 16, p. 6630. 69. OBJECTIONS TO THE COEMISSION PLAN It was held gy the drafters of the bill that placing large powers of regulation over margins in the hands of a commission would not prove satisfactory. A government commission that was empowered to fix margins at anyopoint that seemed to be desirable would be under terrific pressure all of the time to make these margins more liberal.55 Senator Gore declared in this connection that ”when there is a general movement(of the market) downward, Senators will find themselves under a good deal of pressure to try to exercise their influence with the commission tagget them to liberalize margin requirements. This is politics. This condition would be afoided by adapting the statutory formula for determining margin requirements. The public policy, embodied in the bill, would be assured by ”placing a bright red line” for the fixing of margins, beyond which "discretion could not go."37 Furthermore, despite the assertions of the market authorities to the contrary, it was believed that the statutory margin require- ments provided in the bill would prove workable.38 Another argument which might be advanced against the commission plan for determining margin requirements is that the commdssion might allow a speculative movement to get under way before deeming it necessary to increase margin requirements. After a speculative movement has gathered force, raising the margin requirements might prove ineffective as a brake on the further development 0f the movement.‘ If statutory margin requirements are fixed, however, no great amount of credit would be allowed to eptgr phg gppket apd a speculatipe movement could npt get fipder 2:. Ezigence of Senator Gore, art 16, p. 6763. Senate earings 37. Evigigge of Thomas G. Corcoran, Senate Hearings, Part 16, Pa 0 38. Evidence of Eugene Black, G Board. Senntn eaernsa e overnor of the Federal Reserve 70. way. It was felt that since there would be but little credit in I the securities market at the time of adoption of the margin require- ments there would be little danger of disturbing the market. It will be seen from the discussions concerning the two plans that both the statutory and the commission plan for deter- {mingnmg margin requirements would be open to certain criticisms. The determination of margin requirements under the statutory plan would tend to be rigid and inflexible. On the other hand, if the power of determining margin riquirements was to be granted to a commission unhampered by statutory llmitations, margin require- ments would be subject to change according to current needs. The commission would be subject to political pressure, however, and might be too slow to act. The plan which was incorporated in the Securities Exchange Act of 1934 may be considered as a compromise. THE PLAN ADOPTED FOR FIXING MARGINS For the purpose of determining margin requirements a statutory formula was provided in the Securities Exchange Act of 1934. The Federal Reserve Board was granted the power to prescribe higher margin requirements and in certain circwmstance to decrease margin requirements. The Act instructs the Board to use broad con- sideration of credit control as criteria for judgement in deter- mining margin requirements. Under this arrangement the formula provided in the statute will have the effect of preventing a secu- rity speculative movement, based on credit, from getting under way. The power of the Board will make it possible to change margin require ments according to current needs. This power should serve to make the margin requirements less rigid and inflexible. In prescribing margin requirements the Federal Reserve 71. Board adopted the formula stated in the Securities Exchange Act. It was ruled that, with certain exceptions, a member of a national securities exchange or a broker or a dealer subject to the regula-‘ tion shall not make any initial extension of credit to any customer on any registered security (other than an exempted security) for . the purpose of purchasing or carrying any security, in an amount which causes the total credit extended on such registered security to exceed which ever is the higher of: (l) 66 per cent of the current market value of the security; or (2) 100 per cent of the lowest market value of the security computed at the lowest price thereof during the period of 36 calendar months immediately prior to the first day of the current calendar month bps not more than 76 per cent of the current market value. As a result of a general increase in security prices, by 1936, the Eederal Reserve Board passed a regulation which had the effect of increasing the highest required margin from forty-five to fifty-five per cent of the current market price.40 This was done because pyramiding in quite a number of securities had become possible due to an increase of over one hundred and eighty-two per cent in market price above the 10w.. The increased margin require- ment had the effect of preventing pyramiding up to a two hundred and twenty-two per cent rise above the lowest market price for the t rt -s on hs eriod. * 39. Regulation T of the Federal Reserve Board. 40n Amendment to Regulation T of the Federal Reserve Board. 72. CHAPTER V. THE LOCATION or DISCRETIONARY CONTROL or moms In the preceding chapter the statutory versus the discretion- ary control of margins was discussed. It was noted, in theis con- nection, that the granting of wide powers of margin control to a commission, unhampered by statutory requirements, would make it possible to change margin requirements to suit current conditions. This was the plan desired by the market authorities. The representatives of the organised exchanges were Opposed to federal control. If such control was inevitable, however, it would be to their advantage to prevent the enacting of a statute which would not allow market representatives to influence control. The fixing of margin requirements by law would remove the matter from the influence of market representatives. It was the desire of the market authorities to have margins subject to the discretionary control of a commission. If this could be accomplished,.it might then be possible to secure market representation on the commission or to influence the commission set up for regulating margins. This would greatly mitigate the objec- tions of the market representatives to federal control of security credit. The importance, then, of the location of the discretionary powers of control over margins is evident. The powers which should be placed in the hands of a com- znission was a cOntroversial subject, as has been observed. Wt will :now indicate the authority which was granted to the commission by the terms of the prOposed bill. The summary of these powers will 75. be followed by a discussion of the stand taken by various groups concerning the selection of a commission to wield these powers. POWERS OE THE COMMISSION IN MMRGIN CONTROL In the bill as originally drafted, a statutory formula for determining margins was provided.1 The power to raise margin requirements above the statutory requirement, but not to decrease them below it, was granted to a commission.2 The section of the bill containing this authority reads in part: ”The commission may by rules and regulations prescribe lower loan values as may be deemed appropriate in the public interest or for the protection of investors duringm metatgd period or in respect to any specified class of securities. " Additional power in regard to the calculating of values, the time of payments by security purchasers, the notice to be given, and the method to be followed in closing out accounts wasjplaced in the hands of the commission.4 The power of the commission was increased in the enacted Securities Exchange Act by providing that the commission might prescribe margin requirements below the statutory margin require- .ments as well as to increase them above the statutory requirements.5 It was recommended that the commission adopt the statutory formula for‘the initial determination of margin requirements but the com- mission.was instructed "to use broad consideration of credit con- trol as criteria for mudgement as to margin requirements."6 Thus, it will be seen, that a great amount of power is granted to the commission. This adds importance to the selection of the commission which is to wield that power. I. FletcherQRayburn bill: Section El lb) 2. Ibid. 3. Ibid. 4. Ibid. 5. Securities Exchange Act of 1954, Section 7(c). 6. Ibid. 7.. THE SELECTION OF A COMMISSION FOR MARGIN REGULATION There were many Opinions in regard to the selection of a commission for controlling margin requirements. The intention of the drafters of the original bill was that this power should be allocated to the Federal Trade Commission. The marketeinterests favored the creation of a special commission. This commission would be made up of the representatives of the government, the organized exchanges, and federal credit control bodies. There was much support for the location of discretionaryrcontrol over mar- gins in the hands of the Federal Reserve Board. This was approved by stock market authorities as a less desirable alternative to the special representative commission suggested by them. It would be, however, more desirable than the Feddral Trade Commission. The Federal Reserve Board was favored in another prpposal but it was suggested that the Board be reconstructed by adding more members to administer the new duties. There were various opinions concerning the desirable features to be considered in the establishing of a regulatory commission. It would be possible for a governmental body already in existence to assume the additional duties, or a special body for the express purpose of regulating margins could be established. The co-ordination of various interests might be brought about by a commission composed of ex-officio members. The discretionary power of regulating margins might be considered as additional powers of regulation of credit by the federal government or such power might be considered as police power for protectivepurposes. The headquarters of the commission was considered important i" _ . . 75. by some. The commdssion might, logically, be required to establish headquarters in Ndw York City or in Washington. These questions willnbe kept in mind in the discussion of the various proposals for the selection of a commission to have discretionary control of margin requirements. The various commissions,for the regulation of margin requirements, which were puggested will now be discussed. The nggrg; Tgadg Commission The commission to be empowered with the discretionary con- trol over margins is net explicitly designated in the original ‘ draft of the Fletcher-Rayburn bill. It was evident, however, that the drafters of the bill intended that this power would be granted to the Federal Trade Commission.7 This commission has served as an administrative body for the enforcing of federal trade regula- tions. It appears that it was the intention that the power to regulate margins be considered as police power. This is indicated by the purpose and history of that organization. The Federal Trade Commission was first established to enforce fair trade prac- tices. The additional power which would be given to the Federal Trade Commission in the regulation of margins might be considered as police power for protective purposes. The selection of the Federal Trade Commission as the regula- tory body in charge of determining and regulating margin.require- ments within the scape of the law met with almost universal criti- cism. Onsof the chief objections was that the proposed legislation would be in the nature of credit control and it was asserted that the Federal Trade Commission should not have anyting to do with credit control. It was contended by Frank R. Hope, President of the Associated Stock Exchange Firms of New York City, that this —r_7. FNidence of Thomas G. Corcoran, in office of counsel for the— §£F%§§%£g0t1°n Finance Corporation- Sanatn We * g g 76. would be "without reference to other governmental departments and agencies having concurrent Jurisdictionfi8 This would result in "confusion and conflict" in the policy and regulation of credit.9 The "broad" powers over the entire "credit and financial system of the country" which are given by the provisions of the ’bill should be placed in the hands of a commission "familiar with the credit conditions throughout the country.10 Another objection to the selection of the federal Trade Commission was that it has many other responsibilities. It was asserted that because of this the Comamission‘would not be able to give "sufficient and immediate" attention to the regulation of margin requirements.11 Senator Carey felt that this would be true .because the Federal Trade Commission has been given various addition- al duties from time to time since it was created over twenty years ago. The many duties imposed by the Securities Act of 1955 are among these new duties. It was stated by Louis K. Comstock, Presi- dent of the Merchant's Association of New York, that these duties would require "all of the time and ability which the members of the Federal Trade Commission possess without adding thereto the task of supervising and preparing regulations for the conduct of an extremely technical, delicately adjusted bugingss with manifold ramifications into every part of the world. The Federal Trade Commission is not given the power of discretionary control over margins in the Securities Exchange Act of 1954 as finally enacted. Although it might act as a protective ‘bgdy, it gguld hardly be expected to act efficiently in the control 8. Senate Hearings, Part 15, p. 6904. 9. Ibid. 10. Evidence of Richard Whitney, President of the New York Stock Exchange, Senate Hearings, Part 15, p. 6627. 11. Senate Hearings, Part 15, p. 6984. 12. Senate Hearings, Part 15, p. 7051. A . .12. of credit. Likewise, the many other duties of the Federal Trade Commission would not permit it to give sufficient time to the new duties. As a result of these objections the Federal Trade Commissior was not given much support as the margin regulatory body. TEE Qpflssigg Propoggd by the New Ygrk Stgck Exchagge ‘We will now turn our attention to the proposals of the New York Stock Exchange representatives concerning the selection of a commission for regulating margin requirements. In this connection, Richard Whitney stated that: "The most important question in regard to any regulatory legislation is the detffimination of what body shall exercise the regulatory power. The reason for the tremendous importance which the representatives of the securities exchanges placed on the selection of a regulatory commission has been inferred in the early part of this chapter. The oOmmission which they proposed would permit the exerting of 'considerable market influence in the determination of margins as will he seen.by an examination of their proposals. The desirable qualities which the regulatory commission for determining margins should have are described in the published statement of the New York Stock Exchange.14 According to this statement the authority should include persons who are "familiar with credit conditions throughout the United States" and persons who are "fully conversant with the technical problems connected with the operations of the stock exchanges.“16 The commission should include, in addition, "outstanding individuals" who would "represent .thg Eggnog“ with thege idgas in mind a special 15. Senate Hearings, Part 16, 6641. . 14. Senate Hearings, Part 15, p. 6641. 16. Ibid. 16. Ibid. 78o co-ordinating authority was suggested. The committee suggested in the published statement of the “ew York Stock Exchange and backed by other market interests would 17 The seven members in the commission be composed of seven.mmmbers. would consist of two members appointed by the President; two cabinet officers, who might well be the Secretary of Treasury and the Secre- tary of Commerce; one person appointed by the Openpmarket Committee of the Federal Reserve System; and two persons representing stock exchanges, one to be designated by the New York Stock Exchange and the other to be elected by the members of those exchanges in the United States other than the New York Stock Exchange.18 It will be seen that the proposed commission would represent several interests. The public and the government would be repre- sented by the presidential appointees and the two cabinet officers. The members appointed through the Federal Reserve System would serve as credit representatives. The securities exchanges would be repre- sented by two members who would be competent to advise the commission in matters concerning the operation of the exchanges. The commission described above was criticized by Senator Carey.19 It was his opinion that it should be a full time rather than an ex-officio body. A full time body would be better because a commission.made up of officers who have other duties usually does not meet very often or pay very much attention to its new duties. Senator carey cited the Federal Power Commission as an example. This commission was at first an Ix-officio commission but afterward sab e to create a full t me commission. Senator 17. Senate Hearings, art 15, p. 6641. 18. Ibid. 19. Senate Hearings, Part 15, p. 6785. 17 9.. Carey believed that a full time commission would be better because it would be in position to act immediately, whereas the suggested commission would be too slow to act. The regulatory commission suggested above was approved.by exchanges throughout the country. It failed to receive any great amount of consideration during the hearings, however. This was probably due to the fact that it was recognized as an attempt to .make the federal regulation of margin reading ineffective. This would probably have taken place if the commission had been adopted because the governmental representatives on the commission would not possess any common unity. Therefore, the suggested commission was not adopted in the enacted Securities Exchange Act of 1954. Th. Sglggtign of the Federal Resegvg Board Considerable preponderance of opinion was expressed whihh favored the grant of the regulatory powers of a commission, under Section Six of the proposed bill, to the Federal Reserve Board.‘°‘o It was felt that this would be justified since the Board is respon- sible for the federal control of credit and the regulation of margin: as a special form of credit control should be placed in their handd. The Federal Reserve Board, furthermore, would be in touch with market conditions and the general credit conditions throughout the United States. They would, also, provide a cc-ordinated and f d ntrol. 20.Evidence of the following: Samuel Untermyer, Attorney at law, New York, Senate Hearings Part 16, p. 7546. Trcwbridge Galloway, chairman of an investment-house group of seventeen companies, Senate Hearings, Part 16, p. 7586. Roland Redmand, Attorney for the New York Stock Exchange, Senate Hearings, Part 16, p. 7546. Eugene Black, Governor of the Federal Reserve Board, Senate Hearings, Part 16, p. 7418. Senator HoAdoo, Senate Hearings, Part 16, p. 7547. 21. lbid. 80. The question of placing margin control in the hands of the Federal Reserve Board was discussed by its GoVernor, Eugene Black. Speaking for the Board, he stated that "the power to regulate margins under the bill should be given to it because it is credit control."za He felt that the Board could "keep itself informed of current market prices" in order to fix margin requirements. in order to take care of this a separate department in the Federal Reserve Board would be set upfi'3 In regard to the regulation of security speculation Eugene Black further stated that the Board "has great authority in restrict- .ing speculation” under the Banking Act of 1955 but the power grant- ed under the proposed bill would be "additional authority."24 Thus, we see that the Board felt capable and willing to undertake the new duties in connection with the regulation of margins under the terms of the bill. Although the New York stock Exchange authorities had pro- posed a special representative commission for the regulation of margins they did not dissapprove of the grant of this authority to' the Federal Reserve Board. It is likely that they felt that control by the Board would be less objectionable than control by the Federal Trade Commission. An amendment was offered on the behalf of the New York Stock Exchange the purpose of which was to entirely do away with Section Six of the prOpOsed bill.25 This amendment which was substantially followed inthe Securities Exchange Act of 1954, placed the entire matter of the regulation of margin requirements inithg hagds of the Federal Reserve Boagd. - 22. Evidence of Eugene Black, Senate earings, Part I6, pp.741 -E 25. Ibid. 24. Ibid. _ 25. Evidence of Roland demand, benate nearings, Part 16, p. 7654. , ‘81. The question arose as to whether the power granted to the Board by the amendment proposed by the market authorities would be premissive or mandatory. Senator Adams contended that the provisions would be mandatory.35 The intention of the market authorities was that it the Federal Reserve Board did not consider that there was an excessive use of credit they could allow the existing condition to go along, and after that, if the Board felt it was excessive, .they would have the power to act.27 In regard to the initiation of margin changes it was_anticipated by the market authoritiesIV' ' that the Board would express the idea that margins should be, raised, and the exchanges would voluntarily raise the margins thereby avoid- ing the necessity of the Board issuing a rule or regulation evenn though they would have the power to do so if they felt it necessary?8 Senator Gore favored the initiation of margin rules by the securities exchanges because he felt that they could be held responsible for resultsrather than the Board or Congress.29 'The making of any further connections between the securities exchanges and the Federal Reserve Board was decidedly apposed by Benator Carter Glass.30 Inasmuch as Senator Glass had had much to do with the founding of the Federal Reserve System and is considered an authority on credit and banking, his opinion is of considerable interest. It was his decided. opinion that the Board should not be Inixed up in the regulation of the securities exchanges. Senator Glass stated that the "Federal Reserve law excluded the system from 26. Evidence of Senator Adams, art 6, Senate Hearings, p. 7554. 27. Ewidsnde of Roland Redmand, Senate Hearings, fart 16, p. 7554. 28. Ibid. 29. Evidence of Senator Gore, Senate Hearings, Part 16, pl 7556. 50. Evidence of Senator Glass, Senate nearings, Part 15, p. 7555. 82. single member of the present Board of eight members who knows any- thing about stock market transactions."51 III his opium-133333;": Boardr ought not to have control of credit and that they were not set up ~for that purpose. The Board was set up to respond to the recuire- ments of credit. The conversation between Senator Glass and Richard Whitney in regard to this point is of interest ind will be reproduced here. ' ‘ EFT-Whitney: IrWiare Very *Iaa to leave ourselves in the—hands of'— , the Federal eserve Board. We believe they can acquire that knowledge(of the stock market) because of theég -present connection with the conditions of credit." Senator Glass:"Do you mean, Mr. Whitney, or I guess you mean that you can tell the Federal Reserve people what to do, as you have been telling them.what to do for a lo time,and maybe you could not tell somebody else." It was suggested by Samuel Untermyer that the Federal Reserve Board be empowered to regulate margins, but he further suggested that the Boarddbe reorganized in such a way as tommake the adequate performance of its new duties possible.34 He proposed that the Eresident should appoint three new members to the Board for the purpose of the administration of regulation of.margins. He stated that ”while it might be true that the present Board are closely allied with high finance it gguld not be true of the new members appointed by the President.” . . It may be noted here that the enacting of the Bank Act of 1955 has .changed the Federal Reserve Board considerably by granting addition- al powers and by adding members. The name of the Federal Reserve Bgagd was also changgd t9 Board of Governors. __ _fi ___ 51. Evidence of Senator Glass, Senate Hearings, Part 15, p. 7555. 52. Senate Hearings, Part 16, p. 7556. 55.'Senate Hearings, Part 16, p. 7556. 54. Senate Hearings, Part 16, p. 7751. 55. Ibid. _ 85. LOCATION OF THE REGULATORY BODY The location of the body in charge of regulating'margins is ’ important. It might well be argued that it should be located in New York City or that it should be located in Washington. The market interests would, of course, favor its location in New York City. Louis K. Comstock felt that the regulatory body should establish its headquarters in Hes York City because most security business is transacted in the financial capital of the United States? He stated that this ”would relieve business men of the expense and delay which would be inseparable from tragsacting business with a regulatory body located in Washington." The best interests of federal regulation would probably be served, however, by the location of the regulatory body in file nagidnes capital. This was favored by Samuel Untermyer who "feared that the regulatory commission might come under the domination of high finance in New York City? 38 This procedure has been followed. The selection of the Federal Reserve Board as the commission for regulating margin trading may be considered as a compromise. The market interests who were opposed to regulation, had favored the selection of a commission on which they would have representation. The selection of the Federal Trade Commission as the commission.would have put emphasis on protection of the investors, rather than on the control of credit. The selection of the Board is a compromise betwee those who favored rigid control for protective purposes and those who desired that the markets be less rigidly regulated. It may be expected that the Board will apply the same principles of erodit regglation which they have apylied to business. {_. ena e earings, ar , p. . 57. Senate Hearings, Part 15, . 7054. 58. Senate Hearings, Part 16, p. 7746. 84. CHAPTER VI. THE PROBLEM OF UNLISTED SECURITIES The problem of the unlisted securities was brought about by the provisions of the Fletcher-Rayburn bill which would prohibit the use of unlisted securities as collateral for loans. The bill provided that in order to be eligible as collateral a security would have to be registered with a nationally registered securities exchange. The registration requirementcwould result in many securities not being eligible as collateral for loans and because of their nature it could not be expected that they would be able to meet the listing requirements. The destruction of the collateral value of unlisted securities for loan purposes would greatly impair the value of these securities. Because of this, much criticism was directed toward the enactment of such protisicns. These criticisms were substantiated by pointing out the harm that would'be done and by indicating remedies which would make the preposed measures less objectionable. The provisions of the bill which require listing of securities for margin trading, the expected results of these provisions, and the memedies which were indicated, will be discussed in this chapter. The Securities Exchange Act of 1954 did not initiate list- ing requirements for securities. “It had been the practice for exchanges throughout the country to require the listing of certain information and conformation to a certain standard before secu- rities would be admitted to trading on that particular exchange. There was little uniformity in the listing requirements of the ... various exchanges, however. For example, the security listing requirements of the “ew York Stock Exchange had led to the creation of the New York Curb Exchange which was organised for the purpose of trading in securities which did not meet the more severe require- ments.1 ‘ ‘ The general effect, then, of the provisions of the Fletcher- Rayburn bill which had to do with security listing requirements would be to locate control of these requirements with the federal government rather than with the exchanges. In addition, the federal listing provisions would institute uniform requirements for secu- rities throughout the country. 111 a previous chapter the federal provisions for the gegulat- ing of margin trading in securities has been detailed. The provis- ions cf the bill requiring the listing of securities on a nationally registered exchange in order to make them eligible as collateral for margin trading are a practical necessity for the regulation of such trading. If the margin requirementsare to be properly super- vised the government must have a record of the various securities and exchanges to be supervised. The logical step, then, would seem to be to refuse margin trading privileges to these securities which are not listed in compliance with the bill; Such a restric- tion, with certain limitations, is made in the Securities Exchange Act of 1954. The bill did not prepcse to make the listing of securities compulsory. The privilege of margin trading is an incentive for listing, however, and the prohibition of margin trading in.unlisted securities penalizes such securities. It was contended, in this connection, that the not creates a hardship on issuers and holders of many securities which cannot be listed because of their nature. 1° sermon Eu0"» Survey ofEEHtemporary EconomicS. article by .._... 86. There was considerable agitation, because of this, to have the listing provisions changed, or to have its provisions modified. The problem, then, seemed to be to provide listing require- ments which would protect the investor and make the administration of margin regulations effective. If some penality was not provided for the failure to register securities the bet would fail in its purpose. A flight of securities from listing on the nationally registered exchanges, in order to escape regulation, had to be pre- vented. With due consideration to these problems, the position of securities which could not be listed because.of their nature re- “ quired consideration. PROVISIONS OF THE BILL REQUIRING LISTING The provisions of the Fletcher-Rayburn bill which had to do with listing requirements on nationally registered exchanges will now be considered. The use of interstate media of transports- tion and communication in connection with security transactions is denied te all security exchanges and brokers unless such exchanges are registered with the commission as national securities exchanges? The members of a registered exchange or dealers and brokers oper- ating through such an exchange are forbidden to effect a transaction in any security unless such security had been registered for that exchange with the commission in accordance with the regulations prescribed by it.5 An application for registration of a security must contain information which by specification is substantially the same as that required in connection with the issue of a secu- rity under the Securities Act of 1955.‘ E. FIetcEsr-Rayburn‘bIIIT—Scction II(a). 5. Ibid, Section 11(b). 4. Ibid. 87. OBJECTION TO LISTING REQUIREMENTS It was asserted that because of the stringent listing requirements the securities of many corporations would not be listed? The oorpoarations which would undertake to comply with the listing requirements would,2necessarily, be put to a considerable expense.6 The officers and directors would, also, make themselves legally liable for any misstatement of facts unless they could show that the statement had been made in.good faith.’ Alfred L. Bernheim, director of the Twentieth Century Fund market survey, stated that 'it should be borne in mind that many unlisted issues are for one reason or another unsuitable for listing on any exchange."8 For these reasons it might be presumed that many corporations would not take the necessary steps to secure listing under the terms of the hot. It has been pointed out that it‘would be difficult to regis- ter certain securities in order to make them eligible as collateral. This would be true in cases in which the issuing corporation is small and the distribution of the issue is limited. The securities which would be most likely to be affected under the registration requirements would include many public utility bonds and common and preferred stocks, bank and insurance company stocks, guaranteed railroad stocks, industrial stocks and bonds, and State, county, and municipal bonds.9 . It was asserted by A1fred L. Bernheim.that the penalizing of these securities would be without regard to their value.10 Many securities that could not be listed, he further asserted, are sounder and have a better record than many securities that could Evidence of Frank R. Hope, Free. 0 Assoc. Stock Exchange Firms, law York. Senate Hearings, Part 15, p. 6905. 6. Ibid. 7. Ibid. 8. Senate Hearings, Part 15, p. 6941. I. gQEE»L%§ , member of the New York ,§%14£m°£9’Raft-“38h18€t1°n 88. cent bonds of 1944 "which enjoy the highest rating" yet they would not be eligible for a loan because they are not listed, while, on 'the other hand, "many bonds of railroads in receivership can be used as collateral because they are listed."11 The volume of securities which would not be listed ctnnot be/ accurately determined. It was believed however that it would be huge.12 Richard Whitney, President of the New York Stock Exchange stated that "there are hundreds of thousands of corporations which dornot have their securities listed on any exchange at present."13 Eighty-two per cent of the securities dealt in upon the New York Curb Exchange, which has a larger business than any exchange ex- cept the New York Stock Exchange, come under their "unlisted" c classification.14 3. Burd Grubb, President of the New york Curb Exchange, asserted that the present bill, if enacted, "would throw the great majority of trading in these securities off the exchange and into the over-the-counter market."15 The difficulty or impossibility of listing the securities described above would have a detrimental effect upon certamn individuals and institutions. The various small, local industries, the securities of which are not large in volume or widely distribu- ted would be adversely affected.16 The various local units and institutions of government borrow money by issuing bonds. Since these could not be listed they would not be used as collateral for loans.17 The small securities exchanges would be vitally interes- II. Senate Hearings, Part 16, p. 6940. 12. 1bid. 13. Senate Hearings, Part 15, p. 6626. 14. Evidence of E. lurd Grubb, Senate Hearings, Part 15, pp. 7099-7100. 15. Ibid. 16. Evidence of Eugene E. Thompson, Pres. of Assoc. Stock Exchang. , lirms,‘lashington. Senate Hearings, Part 16, p. 7676. - 17. Evidence of George B. Gibbons, municipal Bond Dealer, New York City, Senate Hearings, Part 16, p. 7443. 89. ted because they deal, largely, in securities which would not be listed.18 Lastly, investors in the types of securities described ' above would be concerned, It was pointed out in this connection that these securities are largely held by public institutions, insurance companies, savings banks, and trust companies.19 Thus, it will be seen, that because of the volume of securities and the institutions and individuals which would'be affected by the list- ing requirements, the problem concerning unlisted securities was of considerable consequence. POSSIBLE RESULTS OF LISTING REQUIREMENTS The various securities, the volume of thesessecurities, and the institutions, which would be chiefly concerned with the provisions of the proposed Fletcher-Rayburn bill have been in- dicated. The detrimental effect,which the failure to list, would ' have upon security issuers and holders will now be discussed. Under the proposed bill unlisted securities would be ineligible as collateral for loans. It was asserted, by interested parties, that this would have the undesirable result of deflating the market value of such securities. This,in.turn, might cause . forced liquidation of security holdings. is a result of such unfair discrimination against unlisted securities business recovery would be retarded. It was contended that the effect of making unregistered securities ineligible as collateral would greatly reduce the .market value of such securities.20 This would be brought about 18. Evidence of Frank Hope, Senate aearings, Part 16,p. 6906. 19. Evidence of Alfred L. Bernheim, Senate Hearings, Part 16, p. 6941c 20. Evidence of Frank Hope, Senate Hearings, Part 15,p. 6906. 90. by the destruction of their collateral value which would tend to m make such securities less desirable for investment purposes. To that extent, securities worth billions of dollars would suffer a decrease in price.‘?'1 Samuel Untermyer, Attorney of New York City, took the extreme view that the marketability of these securities would be "welln;l.g‘13‘destroyed."‘2‘a Another criticism of the listing provisions that was ad- vanced was that their effect would be extremely deflaticnary.23 The higher margins which would be required if the Fletcher-Rayburn bill is enacted will necessitate more collateral or funds. In cases where margin.accounts are backed partly by registered and partly by unregistered securities, additional funds or registered secu- .rities would have to be put up. In.many cases this could not be done and this would result in forced liquidation of accounts.8‘ The result of this would be to deflate security prices. The retarding of business recovery was foreseen as another undesirable result of making unlisted securities ineligible as collateral for loans. In this connection, it was contended that the raising of capital, which business needs for prosperity, would be greatly impeded. There would be many corporations which would find it difficult te issue and distribute their securities in order to raise the necessary capital. In this connection George H. Huston, Vice-Pres. of the National Manufacturers Association, stated that: "It is in the public interest to not burden the secu- rities issued by business for the procurement of such capital with suchptrigent regulations with respect to their use as HI. Evidence of Frank HSpe, Senate Hearings, fart IE, p. 6906. 22. Senate Hearings, Part 16, p. 7720. , ~ 23. Senate Hearings, Evidence of Eugene Thompson, Part 15, Pa 6985s , 24. Ibid. 91. capital as to interfere with their free issuance, distribution, and retention."35 It was his opinion that the present method of fixing the collateral availiability of such securities through the Federal Reserve System appears to be entirely adequate for the protection of the public interests.26 CHANGES IN LISTING PROVISIONS OF THE BILL The detrimental results which, it was asserted, would result from the destruction of the collateral values of unlisted securities have b can discussed. Certain suggestions were made, by those who” would be affected by the registration provisions, which would, mitigate the expected evils. As a result of these suggestions a number of changes were made in the bill. These changes provided that unlisted securities might be used as collateral for bank loans. The act further specifically exempts certain securities and pro- vides that the Securities and Exchange Commission and the Secretary of the Treasury may grant unlisted trading privileges to other secu- rities at their discretion. Thus, it was hoped that the evils of the registration requirements would be eliminated without impairing the enforcement of margin regulations The changes which were made in regard to the registration requirements were as follows. The Fletcher-Rayburn bill, as originally drafted, was widely interpreted to prohibit the use of unlisted securities as collateral for bank lows?" It was asserted that this would still further disturb the credit mechanism of the country. The opinion p. nate Hearings, PartIIHT_ET_7344. 26. Ibid. 27. Evidence of the following; before Senate Hearings: George B. Gibbons, Municipal Bond Dealer, New York, Part 16, pEuZEESOThcmpson, Part 15, p. 6984. Lyle Wilson, Secretary, Washington State Securities Dealers rdssociaticn, “art 15, p. 6753.- 92. was expressed that the bill should be more clearly defined or re- written so as to allow the making of bank loans on unlisted secu- rities.23_ Thomas G. Corcoran, counsel for the Heconstruction Finance Corporation, stated that the drafters of the bill did not intend ' that its provisions would prohibit bank loans on unlisted secu- rities.:a9 It was his opinion that it would be better to put such loans in the banks where they will be dealt with as a commercial proposition. Likewise, they will have the further check of the examination of bank examiners. Accordingly, bank loans, subunitst- ed securities, subject to the regulations of the Federal Reserve Board, are permited under the terms of the Securities Exchange Act of 1934.50 L It was argued by George B. Gibbons, that bonds of States and the political subdivisions and agencies thereof should be eliminated from the registration provisions of the Fletcher-Rayburn bill.31 He further argued that speculative abuses do not exist in such securities because of their more stable value. These securities "have no rightful place in the bill" and no useful purpose would be served by including them in the bill.32 iotion Taken in the securities Exchange get in Regard is Odo; , 8 The Securities Exchange Act of 1934 specifically exempts from its provisions all obligations of the United States Govern- ment, of any State or minicipal or other political subdivision, 28. Evidence of Eugene Thompson, Senate Hearings, Part 15, p. 6984. 29. Senate Hearings, Part 15, p. 6473. 50. Securities Exchange Act, Section 7, Sub-section c, part 1(d) 31. Senate Hearings, Part 15, p. 7445. 52. Ibid. 931 and of agencies or instrumentalities of a State or local government.3' Obligations guarranteed as to principal or interest by the Federal .or local governments are also exempted?4 In addition, the Secu- rities and Exchange Commission has authority to exempt other secu- rities either unconditionally or upon specified conditions, and , the Sanctum of the Treasury to exempt such securities issued or guaranteed by corporations in which the United States has a direct or indirect interest as may be necessary or appropriate in thepub- lic interest.35 Under thes authority the Secretary of the Treasury has designated as exempted securities, farm loan bonds\issued by the Federal intermediate credit banks under the authority of the Federal Farm Loan Act? 5 Obligations of the Federal Farm Mortgage Corporation and of the Home Owners' Loan Corporation, being guar- anteed by the United States Government, are also emempted.37 The Securities Exchange Act fixes certain margin require- ments on listed securities for margin trading. 'Unlisted, non-ex- empted securities are forbidden the privilege of margin trading. The Act must do this in order to make margin regulations effective. Likewise, listed securities are given a frank premium for the pur- pose of brokers' loans, as an inducement to keep listed securities on the exchanges. It was recOgnized, however, that certain harm- ful results would occur. To a certain degree the harmful provis- ions are mitigated by exempttng certain securities and by permit- ting loans by banks, subJect to Federal Reserve regulations, on , unlisted securities. 6 . Securities Exchange Act, Section 3(a) 34. Ibid. 35. Ibid. 36. Federal Reserve Bulletin, October 1934, pp. 630-631. 37. bid. 94. CHAPTER VIII. EXPERIENCE IN GOVERNMENT REGULATION OF NARGIN REQUIREMENTS The problem confronting legislative control of security speculation by regulation of margin trading simmers down to two questions. These are the discouraging of speculative trading that verges on gambling and preventing such trading from disrupting the credit which should fhbw to industry. It is not merely a problem of making bank loans on securities safer. It is more the need of preventing bank deposit funds from feeding a speculative orgy on the market. Low margin requirements draw into the speculative market people with little money. These people can not afford to lose. They become the victimsfof stock market manipulation more than others because of their inability to provide additional margins when a slight disturbance in prices wipes out their equities. When a large volume of stock is held on margin, a decline in prices brings forced selling, thus causing prices to sink still lower. This frequently brings about important financial disturbances. The aim then of the margin.requirements fixed by the Securities .Exchange Act of 1934 is to protect the business and credit struc- ture and to protect the small investor from the evil effects of excessive security speculation. It will be the purpose of this chapter to discuss the effectiveness of the margin requirements of the Securities Exchange .Act in pretecting the public against the harmful effects of exces- sive security speculation. The Act has not been in force long 95. enough to enable the making of definite assertions regarding its success or failure. It will be possible, however, to point out certain results. These observations will be based on current expert opinion and statistics CONTROVERSIAL QUESTIONS OF HIGH MARGINS Many opinions have been advancedconcerning the probable success of the Securities Exchange Act inppreventing excessive security speculation. The sponsors of the bill predicted that it would do away with harmful security speculation. The market author- ities predicted that it would do away with speculation entirely. They forsaw certain evils as a result of this. They predicted that theedct would greatly decrease the volume of trading, deflate security prices, cause a flight of securities from listingon organized exchanges, and make corporate financing difficult. Current statistics give some indication as to the extent to which these predictions of the market authorities have proved to be accurate. The proposals for public regulation of security speculation were discussed in Chapter Two. The decision was made to control security credit by federal regulation of margin requirements. The proposal to entirely eliminate margin trading was not adopted. Under the terms of the Act margin trading is still permitted. The drafters of the bill were of the opinion that the prohibiting of margin trading might eventually be a good thing but that this condition should be brought about gradually. In Chapter Four the question was raised as to whether margins should be fixed by statute or left to discretion of a regulatory body. The Act places discretionary control over margins in the 96. hands of the Federal Reserve Board. The history of the control of margin requirements by that body may be used to Judge the wisdom of placing such control in their hands rather than in statutory form. Finally, the trading in unlisted securities should be considered. This problem was discussed in Chapter Six. There are no availabde statistics concerning the effect of prohibiting margin trading on such securities. The Securities and Exchange Commission have.made studies of the over-the-counter trading in unlisted securities and they have made regulations governing them. SUCCESS OF HIGH NARGINS IN PREVENTING SPECULATION The Securities Exchange Act has been.in force for too short a period to permit passing positive Judgment concerning the effec- tiveness of high margins as a device for preventing excessive secu- rity speculation. In order to properly test the measure, a period of general speculative activity is needed. Furthermore, since there has been no rapid decline in security prices during the time the Act has been in force the effect of high margins in such a contingency can only be predicted. The opinions concerning the probable effectiveness of the margin provisions of the Act will now be discussed. Effgqt 9n Spable Secugitieg The provisions of the Securities Exchaige Act which provides for a higher loan value on less volatile stocks was particularly criticized by John T. Flynn-1 a. felt that the effect of this s w ' t e stable stocks more volatile. This wi l 1. John T. Flynn, quurity Speculation,;ts Economic Effects, Harcourt, Brace, and Company, New or , 1934, pp. 291-297. 97. true because at any time speculative activity may develop in-a security which.was previously stable. As the year progresses first one and then another issue becomes the subject of speculative activity. When this happens the previous stability of the stock will operate to acdentuate the speculative fluctuations under the stable lending rule. It was further asserted by HE. Flynn that because of this the automatic provisions for margin requirements will be unsuccessful in preventing excessive security speculation. Re n f the Us of Cred t in.Preventi Securit 3 eculat on The regulation of the use of credit by speculators is discus- sed by Wilford J. Eiteman.2 He pointed out that there was a general suspicion that borrowed funds were responsible for infla- tion of stock prices in 1929. This led to agitation to regulate brokers' loans by prohibiting loans to brohers by corporations and by limiting lending by banks. It was the opinion of Mr. Eiteman that because this scheme of regulation erroneously assumes that the total of brokers' loans indicates the total amount of credit being used by marginal operators, it will fail in its purpose. Since this theory of the relatiOn of brokers' loans to Security specu- lation has a bearing on the probable success or failure of the secu- rity credit control feature of the Securities Exchange Act, it will be summarized here. According to Mr. Eiteman,the published totals of brokers' loans reveals only a portion of the borrowings that permit traders to operate on margin. The other portion of brokers' loans is com- posed of customers' credit balances. The total of these is unknown even to brbkers. These balances come about when s eculators sell W museum—W American Economic Review, September 1933, pp. 466-465. 98. securities and leave the proceeds with the brokers at interest. Such funds may be loaned by the broker to other traders until; such a time as they may be used by their owner. Shrewd speculators use such funds to take a long or short position in the market according to inside, technical information. This information might consist of knowledge of dividends to be reduced or passed. In such a case the speculator would sell his holdings in the security and leave the proceeds with his broker. After the security had had a price decrees he could use the funds to buy back in again. It was the opinion of Mr. Eiteman that the total of such customers' free credit balances must have constituted a very large sumein 1929. This is an important fact to the success or failure of any scheme to limit the use of bank credit by brokers. A limitation upon.the total of brokers"loans will not pre- vent excdssive marginal speculation nor inflation in stock prices in the opinion of Mr. Eiteman. This is true because speculative trading in a bull market is essentially buying and selling upon cpen account. Banks supply the funds needed to permit the occasion- al retirement of speculators with credit balances. Hence, a law that limits brokers' loans does not limit the credit that supports prices. It only limits the extent to which banks may underwrite that credit. Such a mode of regulation tends to check the specu- lative fever after the real damage has been accomplished. Mr. Eiteman stated a proposal for the regulation of brokers? loans. The regulation of brokers' loans should include loans from customers as well as loans from banks so that brokers will be able at any moment to convert credits in customers' accounts into cash by borrowing from banks. If regulation is to stop short of 99. loans from customers, then the stock exchange should at least 1 uébublighh.g. i semi-monthly report of the total of customers' credit balances so that traders may be warned when the danger zone is approached. Hi h Ma Du ec easin Pr ces The effect of the emplpyment of high marginhequirements on securities markets during a period of decreasing security prices must be considered. The comparatively short time during which such requirements have been in force may not have reaealed, as yet, the full effects of such margin requirements on securities markets. This is true because the current margin requirements have not been called upon to bear the test of aifalfing market. In the dpinion of A. Tate Smith, New York Stock Exchange Economist, much may be learned when "registered securities are subject to a falling as well as a rising market¥3 The effect of high margin requirements during periods of falling security prices in the past may be taken, however, as an indication of the effect of the current margin requirements in a similiar situation. During the securities 'boom"which terminated in 1929, margins on the New Ybrk Dtock Exchange were very high. When security prices begun to decline it was necessary for margin traders to put up more funds. In many cases this could not he done and the trader's securities had to be sold. This resulted in still further depressing the market and causing still more sales. The result of rdgid margin requirements at that time was to accentuate the speed and the extent of the deflation of secu- rity prices. In order to prevent this and to support the market, W'" -l‘- 81‘8": V8 "_— '1': e :e'v ;n:e : e e: e ,, e; e.- 4 -'3. A. Tate Smith, letter in answer to inquiry. 4. Irving Fisher, ShooStock Market Crash and After, unfn‘11‘nm A- _-_ ___ 7 100. may be observed that during a period of decreasing security prices the granting of more liberal margin requirements will have the effect of stabilizing the securities markets. This procedure can not be followed by brokers at present due to the margin provisions of the Securities Exchange Act. HISTORY OF HIGH NARGINS IN PREVENTING SPECULATION Various opinions regarding the effectiveness of the high margin requirements under the Securities Exchange Act have been quoted. It has been noted that because of the short period of time during which the Act has been in force a definite statement concerning its effectiveness is difficult to make at this time. Certain developments have occurred, however, which give some basis for dudgment of the effectiveness of the margin provisions of the' Act in preventing security speculation. These developments will now be considered. The effect of the present high margins upon the technical position in the market may now be considered. The important question is whether, because of the present high margins, future 'bull' markets will be built on a sounder basis than previous out- bursts of speculative enthusiasm. In this connection, George T. Hughes, market observer, points out that in addition to providing a measure of protection 1 n an active market the present high mar- gins will be dangerous.6 This will_be true becausethe market is so strongly margined that it will tend to be obstinate. This will be true because security holders, at the peak of the 'boom' wiII hold on doggedly long after they know that they are wrong in their judgment; l 5. Detroit News, Feb. 5, 1936. 101. The fact that the margin rules provided in the Securities Exchange Act are so difficult to understand tends to defeat their purpose. In the opinion of Hlmer Walser, market observer, the small trader, puzzled by high margin rules, merely asks the broker how- 6 If the much stock he can obtain for a certain amount of money. answer is favorable he will place an order. it is his further opinion that the small traders will do the same thing under higher margins. A disturbing effect of the margin regulations has been the reckless buying of low priced stocks of doubtful merit and value.7 This has occurred because a minimum of capital is necessary. Large blocks of issues selling from one to five dollars have been purchased by uninformed outsiders. These purchasers reason that since other issues once as low priced have risen these will also. This has led to speculation that might be called gambling by small investors. It is one of the objectives of the Securities Exchange Act to pre- vent such speculation. It is doubted that the raising of margin requirements in 1936 by the Board of Governors will halt the present increased activity in the stock markets. Instead of depressing market prices and our- tailing trading, it is asserted that the effect of the raise has 8 been 'bullish'. This was true because purchasers saw the Board's action as an admission of its belief fora more active market. The result of such advertising was to attract more customers to the markets. 6.Detroit New , Fe . 5, 1936? 7.——__T_'fiGeorge . ughes, Detroit News, Feb. 19, 1936. 8. Elmer Walxer, Detroit News, Feb. 26, 1936. 102. EFFECT OF HIGH NARGINLREQUIREMENTS ON THE MARKET During the course of the Pecora Hearings it was predicted that the margin requirements provided for by the proposed Fletcher- Rayburn bill would have an undesirable effect on the securities markets. It was asserted that the organized markets would be des- troyed. This would come about because security speculation would be entirely eliminated. ‘Unlkss there is speculation in the market the volume of trading will be too small to enable the market to function properly. As a result securities would lose their liquidity and the price would be greatly deflated. Trade in securities, under these conditions would be carried on better on the over-the-counter markets. This would cause a flight of securities from listing on the organized exchanges. Furthermore, as a result of the disruption of the organized markets, the sdcuring of new corporate funds By floating new issues would be made difficult. The drafters of the Act took an opposit view. They felt that the markets would be disturbed but little by the margin provisions of the Act. Instead of being sntirely eliminated, only excessive security speculation would be done away with. As a result there would be a wider gap between the bid and the asked price and the volume of trading would be decreased. This would result in fewer commissions for brokers but security prices would not be greatly deflated. It was predicted that the regulation of the over-the- counter market by the Securities and Exchange Commission.wculd prevent a flight of securities from the organized exchanges. The effect of the margin provisions of the Securities Exchange Act on the organized markets may now be considered. Certain observations can be made. These observations willLbe based on statistics of the New York Stock Exchange concerning the volume 103. of trading in securities, the trend of security prices, the price of exchange seats, and the raising of new corporate capital by the flotation of new issues on the New York Stock Exchange. [plume 9f Trgdipg on the New Ygrk Spock Exchgpge The stock exchange authorities predicted that the margin provisions of the Securities Exchange Act would decrease greatly the volume of trading in securities on organized exchanges. This prediction may now be examined. In the diagram of Chart VIII the solid line represents year by year the turnover of shares on the New York Stock Exchange.9 The rate of turnover has been determined by dividing monthly reported sales of stock bytthe number of shares listed. An average of the volume of trading for the 1928-25 period is taken to equal one hundred. It will be noticed that during June 1934, when the Securities Exchange Act became effective, the tolume of trading decreased con- siderably. There was little increase in the volume of trading until the middle of 1935. This decline in volume of trading might be attributed to the effect of the Act. Other factors should be con- sidered, however. During the year 1933 a minor 'boom’ occurred in the New York Stock Exchange. Whenthe Securities Exchange Act became effective security prices and the volume of trading were already declining. After the Act had been in force for some time the vomume of trading began, in l936,to increase considerably. An examination of theaaverage monthly volume of trading dur- ing 1934 reveals more accurately the effect of the Act on the volume The Securities Ex ha 9. N w Y r took Exchan 6 Bulletin, New Capital an Market Activity , November, 1936. Chart included at end of chapter. 104. Act became effective June 1, 1934. The New York Stock Exchange monthly averages show a decline in trading during June of 1934 follow ed by a rise in July. In Deptem‘ber, when the margin provisions of the Act became effective, the volume of trading reached a low for the year. The volume of trading began to increase in October and in.December was a little less than half of the volume of trading of the preceding January. The volume of trading continued to in- crease during the early part of 1935. During the latter part of I 1935 the volume of trading fell off but it began to increase again in 1936. it may be concluded from the statistics available that the margin provisions of the Securities Exchange Act will not permanent- ly reduce the volume of security trading greatly. The reduction which occurred may be accounted for, in part, by the psychological factor and by the need of traders to familiarize themselves with the new regulations. Th: Epigg 9f Secggitigs The effect of the margin provisions of the Act on the prices of securities listed on the New York Stock Exhhange may now be con- sidered. Chart II shows the total market values of shares listed on the New York Stock Exchange from 1927 to 1936.10 The dotted line showing the total market values of listed shares in the chart moves in harmony with the solid line in Chart VIII which shows the volume of trading. Likewise, the average monthly price of secu- rities during 1934 shows a similiar variation to the average monthly volume of trading during 1934. In June of 1934 the average price of stocks dropped two dollars a share and in August a drop of two dollars and eighty-four cents occurred for a new 1934 low. It may 10- N- Y- s- E- Ballerinas“ §¥°°¥".T°f§1.5.ht£d° states. Q‘.-_\_-L -...---- ...- 1... be inferred that the sag in security prices at the time the Secu- rities Exchange Act became effective was caused by forces simulsr‘ to those which caused a decline in the volume of trading on the New York Stock Exchange during the same time. laggin Rgguirgments and the Flight of Securities . Statistics do not show that the inauguration of the Secu- rities Exchange Act has resulted in a flight of securities from listing on the New York Stock Exchange as was predicted by market authorities. Chart IX, aththe end of the chapter, shows a slight decline in listing during 1933. In 1936, however, the number of shares listed increased to reach a new high. Margin Reggirements and New Corporate Capital The effect of the Securities Exchange Act on the securing of new corporate capital is difficult to predict because of the short time during which the act has been in force. The New York Stock Exchange have statistics indicating the amount of new corporate capital raised by listing of new issues on the Exchange. The broken line in Chart VIII represents corporate capital flotations, excluding those of investment trusts and those for refunding purposes Beginning in 1929 and continuing until 1931 stock market activity decreased more regularly and presistently than capital flotations. Since 1931 and until quite recently capital flotations have been relatively smaller than market activity. Capital flotations began to increase in 1935, however, and during 1936 they were a little less than fortyper cent of what they were in the 1923-26 period. This may indicate that the Securities Exchange Act will not impede new capital flotations, - I. 106. Trig; 9; N1! Ygrk Stock Exchangg meberships It may be assumed that if the Securities Exchange Act has had the evil effects predicted it would result in decreasing greatly the value of exchange memberships. This decrease would be due to the inability of brokers to make a prefit. Statistics taken from the New York Stock Exchange indicate the relationship of the Seen-g rities Exchange Act to the price of memberships. Chart III, at the end of the chapter, reveals the high and low prices for such member- ships from 192? to 1936, inclusive. The trend in the price of memberships moves in sympathy with the volume of ttading and the aharage price of securities listed on the Exchange. The highest price paid for a membership was $625,000 in 1929. In 1932, after the market collapse, the highest price paid for a membership was $185,000. During the minor 'boom' in 1933 the highest membership price rose to $250,000. This was followed by a drop in 1934 to $190,000 and in 1935 to $140,000. In 1936, the highest membership price rose to $174,000. ‘ The decrease in exchange membership prices in 1934 and 1935 may be partly accounted for by the fact that the volume of trading in the New York Stock Exchange was declining following the collapse of the minor 'boom’ in 1933. With all due allowance to other causes, the