Lombard Street: A Description of the Money Market

It is painful to have to doubt of the continuance of such a class, and yet, I fear, we must doubt of it. The evidence of figures is against it. In 1810 there were 40 private banks in Lombard Street admitted to the clearing-house: there now are only 3. Though the business of banking has increased so much since 1810, this species of banks is fewer in number than it was then. Nor is this the worst. The race is not renewed. There are not many recognised impossibilities in business, but everybody admits 'that you cannot found a new private bank.' No such has been founded in London, or, as far as I know, in the country, for many years. The old ones merge or die, and so the number is lessened; but no new ones begin so as to increase that number again.

The truth is that the circumstances which originally favoured the establishment of private banks have now almost passed away. The world has become so large and complicated that it is not easy to ascertain who is rich and who is poor. No doubt there are some enormously wealthy men in England whose means everybody has heard of, and has no doubt of. But these are not the men to incur the vast liabilities of private banking. If they were bred in it they might stay in it; but they would never begin it for themselves. And if they did, I expect people would begin to doubt even of their wealth. It would be said, 'What does A B go into banking for? he cannot be as rich as we thought.' A millionaire commonly shrinks from liability, and the essence of great banking is great liability. No doubt there are many 'second-rate' rich men, as we now count riches, who would be quite ready to add to their income the profit of a private bank if only they could manage it. But unluckily they cannot manage it. Their wealth is not sufficiently familiar to the world; they cannot obtain the necessary confidence. No new private bank is founded in England because men of first-rate wealth will not found one, and men not of absolutely first-rate wealth cannot.

In the present day, also, private banking is exposed to a competition against which in its origin it had not to struggle. Owing to the changes of which I have before spoken, joint stock banking has begun to compete with it. In old times this was impossible; the Bank of England had a monopoly in banking of the principle of association. But now large joint stock banks of deposit are among the most conspicuous banks in Lombard Street. They have a large paid-up capital and intelligible published accounts; they use these as an incessant advertisement, in a manner in which no individual can use his own wealth. By their increasing progress they effectually prevent the foundation of any new private bank.

The amount of the present business of private banks is perfectly unknown. Their balance sheets are effective secrets—rigidly guarded. But none of them, except a few of the largest, are believed at all to gain business. The common repute of Lombard Street might be wrong in a particular case, but upon the general doctrine it is almost sure to be right. There are a few well-known exceptions, but according to universal belief the deposits of most private bankers in London tend rather to diminish than to increase.

As to the smaller banks, this naturally would be so. A large bank always tends to become larger, and a small one tends to become smaller. People naturally choose for their banker the banker who has most present credit, and the one who has most money in hand is the one who possesses such credit. This is what is meant by saying that a long established and rich bank has a 'privileged opportunity'; it is in a better position to do its business than any one else is; it has a great advantage over old competitors and an overwhelming superiority over new comers. New people coming into Lombard Street judge by results; they give to those who have: they take their money to the biggest bank because it is the biggest. I confess I cannot, looking far forward into the future, expect that the smaller private banks will maintain their ground. Their old connections will not leave them; there will be no fatal ruin, no sudden mortality. But the tide will gently ebb, and the course of business will be carried elsewhere.

Sooner or later, appearances indicate, and principle suggests, that the business of Lombard Street will be divided between the joint stock banks and a few large private banks. And then we have to ask ourselves the question, can those large private banks be permanent? I am sure I should be very sorry to say that they certainly cannot, but at the same time I cannot be blind to the grave difficulties which they must surmount.

In the first place, an hereditary business of great magnitude is dangerous. The management of such a business needs more than common industry and more than common ability. But there is no security at all that these will be regularly continued in each generation. The case of Overend, Gurney and Co., the model instance of all evil in business, is a most alarming example of this evil. No cleverer men of business probably (cleverer I mean for the purposes of their particular calling) could well be found than the founders and first managers of that house. But in a very few years the rule in it passed to a generation whose folly surpassed the usual limit of imaginable incapacity. In a short time they substituted ruin for prosperity and changed opulence into insolvency. Such great folly is happily rare; and the business of a bank is not nearly as difficult as the business of a discount company. Still much folly is common, and the business of a great bank requires a great deal of ability, and an even rarer degree of trained and sober judgment. That which happened so marvelously in the green tree may happen also in the dry. A great private bank might easily become very rotten by a change from discretion to foolishness in those who conduct it.

We have had as yet in London, happily, no example of this; indeed, we have hardly as yet had the opportunity. Till now private banks have been small; small as we now reckon banks. For their exigencies a moderate degree of ability and an anxious caution will suffice. But if the size of the banks is augmented and greater ability is required, the constant difficulty of an hereditary government will begin to be felt. 'The father had great brains and created the business: but the son had less brains and lost or lessened it.' This is the history of all great monarchies, and it may be the history of great private banks. The peculiarity in the case of Overend, Gurney and Co. at least, one peculiarity is that the evil was soon discovered. The richest partners had least concern in the management; and when they found that incredible losses were ruining them, they stopped the concern and turned it into a company. But they had done nothing; if at least they had only prevented farther losses, the firm might have been in existence and in the highest credit now. It was the publicity of their losses which ruined them. But if they had continued to be a private partnership they need not have disclosed those losses: they might have written them off quietly out of the immense profits they could have accumulated. They had some ten millions of other people's money in their hands which no one thought of disturbing. The perturbation through the country which their failure caused in the end, shows how diffused and how unimpaired their popular reputation was. No one in the rural districts (as I know by experience) would ever believe a word against them, say what you might. The catastrophe came because at the change the partners in the old private firm—the Gurney family especially—had guaranteed the new company against the previous losses: those losses turned out to be much greater than was expected. To pay what was necessary the 'Gurneys' had to sell their estates, and their visible ruin destroyed the credit of the concern. But if there had been no such guarantee, and no sale of estates, if the great losses had slept a quiet sleep in a hidden ledger, no one would have been alarmed, and the credit and the business of 'Overends' might have existed till now, and their name still continued to be one of our first names. The difficulty of propagating a good management by inheritance for generations is greatest in private banks and discount firms because of their essential secrecy.

The danger may indeed be surmounted by the continual infusion of new and able partners. The deterioration of the old blood may be compensated by the excellent quality of the fresh blood. But to this again there is an objection, of little value perhaps in seeming, but of much real influence in practice. The infusion of new partners requires from the old partners a considerable sacrifice of income; the old must give up that which the new receive, and the old will not like this. The effectual remedy is so painful that I fear it often may be postponed too long.

I cannot, therefore, expect with certainty the continuance of our system of private banking. I am sure that the days of small banks will before many years come to an end, and that the difficulties of large private banks are very important. In the mean time it is very important that large private banks should be well managed. And the present state of banking makes this peculiarly difficult. The detail of the business is augmenting with an overwhelming rapidity. More cheques are drawn year by year; not only more absolutely, but more by each person, and more in proportion to his income. The payments in, and payments out of a common account are very much more numerous than they formerly were. And this causes an enormous growth of detail. And besides, bankers have of late begun almost a new business. They now not only keep people's money, but also collect their incomes for them. Many persons live entirely on the income of shares, or debentures, or foreign bonds, which is paid in coupons, and these are handed in for the bank to collect. Often enough the debenture, or the certificate, or the bond is in the custody of the banker, and he is expected to see when the coupon is due, and to cut it off and transmit it for payment. And the detail of all this is incredible, and it needs a special machinery to cope with it.

A large joint stock bank, if well-worked, has that machinery. It has at the head of the executive a general manager who was tried in the detail of banking, who is devoted to it, and who is content to live almost wholly in it. He thinks of little else, and ought to think of little else. One of his first duties is to form a hierarchy of inferior officers, whose respective duties are defined, and to see that they can perform and do perform those duties. But a private bank of the type usual in London has no such officer. It is managed by the partners; now these are generally rich men, are seldom able to grapple with great business of detail, and are not disposed to spend their whole lives and devote their entire minds to it if they were able. A person with the accumulated wealth, the education and the social place of a great London banker would be a 'fool so to devote himself. He would sacrifice a suitable and a pleasant life for an unpleasant and an unsuitable life. But still the detail must be well done; and some one must be specially chosen to watch it and to preside over it, or it will not be well done. Until now, or until lately, this difficulty has not been fully felt. The detail of the business of a small private bank was moderate enough to be superintended effectually by the partners. But, as has been said, the detail of banking—the proportion of detail to the size of the bank—is everywhere increasing. The size of the private banks will have to augment if private banks are not to cease; and therefore the necessity of a good organisation for detail is urgent. If the bank grows, and simultaneously the detail grows in proportion to the bank, a frightful confusion is near unless care be taken.

The only organisation which I can imagine to be effectual is that which exists in the antagonistic establishments. The great private banks will have, I believe, to appoint in some form or other, and under some name or other, some species of general manager who will watch, contrive, and arrange the detail for them. The precise shape of the organisation is immaterial; each bank may have its own shape, but the man must be there. The true business of the private partners in such a bank is much that of the directors in a joint stock bank. They should form a permanent committee to consult with their general manager, to watch him, and to attend to large loans and points of principle. They should not themselves be responsible for detail; if they do there will be two evils at once: the detail will be done badly, and the minds of those who ought to decide principal things will be distracted from those principal things. There will be a continual worry in the bank, and in a worry bad loans are apt to be made and money is apt to be lost.

A subsidiary advantage of this organisation is that it would render the transition from private banking to joint stock banking easier, if that transition should be necessary. The one might merge in the other as convenience suggested and as events required. There is nothing intrusive in discussing this subject. The organisation of the private is just like that of the joint stock banks; all the public are interested that it should be good. The want of a good organisation may cause the failure of one or more of these banks; and such failure of such banks may intensify a panic, even if it should not cause one.

CHAPTER XI

The Bill-Brokers.

Under every system of banking, whether that in which the reserve is kept in many banks, or one in which it is kept in a single bank only, there will always be a class of persons who examine more carefully than busy bankers can the nature of different securities; and who, by attending only to one class, come to be particularly well acquainted with that class. And as these specially qualified dealers can for the most part lend much more than their own capital, they will always be ready to borrow largely from bankers and others, and to deposit the securities which they know to be good as a pledge for the loan. They act thus as intermediaries between the borrowing public and the less qualified capitalist; knowing better than the ordinary capitalist which loans are better and which are worse, they borrow from him, and gain a profit by charging to the public more than they pay to him.

Many stock brokers transact such business upon a great scale. They lend large sums on foreign bonds or railway shares or other such securities, and borrow those sums from bankers, depositing the securities with the bankers, and generally, though not always, giving their guarantee. But by far the greatest of these intermediate dealers are the bill-brokers. Mercantile bills are an exceedingly difficult kind of security to understand. The relative credit of different merchants is a great 'tradition'; it is a large mass of most valuable knowledge which has never been described in books and is probably incapable of being so described. The subject matter of it, too, is shifting and changing daily; an accurate representation of the trustworthiness of houses at the beginning of a year might easily be a most fatal representation at the end of it. In all years there are great changes; some houses rise a good deal and some fall. And in some particular years the changes are immense; in years like 1871 many active men make so much money that at the end of the year they are worthy of altogether greater credit than anyone would have dreamed of giving to them at the beginning. On the other hand, in years like 1866 a contagious ruin destroys the trustworthiness of very many firms and persons, and often, especially, of many who stood highest immediately before. Such years alter altogether an important part of the mercantile world: the final question of bill-brokers, 'which bills will be paid and which will not? which bills are second-rate and which first-rate?' would be answered very differently at the beginning of the year and at the end. No one can be a good bill-broker who has not learnt the great mercantile tradition of what is called 'the standing of parties' and who does not watch personally and incessantly the inevitable changes which from hour to hour impair the truth of that tradition. The 'credit' of a person—that is, the reliance which may be placed on his pecuniary fidelity—is a different thing from his property. No doubt, other things being equal, a rich man is more likely to pay than a poor man. But on the other hand, there are many men not of much wealth who are trusted in the market, 'as a matter of business,' for sums much exceeding the wealth of those who are many times richer. A firm or a person who have been long known to 'meet their engagements,' inspire a degree of confidence not dependent on the quantity of his or their property. Persons who buy to sell again soon are often liable for amounts altogether much greater than their own capital; and the power of obtaining those sums depends upon their 'respectability,' their 'standing,' and their 'credit,' as the technical terms express it, and more simply upon the opinion which those who deal with them have formed of them. The principal mode in which money is raised by traders is by 'bills of exchange;' the estimated certainty of their paying those bills on the day they fall due is the measure of their credit; and those who estimate that liability best, the only persons indeed who can estimate it exceedingly well, are the bill-brokers. And these dealers, taking advantage of their peculiar knowledge, borrow immense sums from bankers and others; they generally deposit the bills as a security; and they generally give their own guarantee of the goodness of the bill: but neither of such practices indeed is essential, though both are the ordinary rule. When Overends failed, as I have said before, they had borrowed in this way very largely. There are others now in the trade who have borrowed quite as much.

As is usually the case, this kind of business has grown up only gradually. In the year 1810 there was no such business precisely answering to what we now call bill-broking in London. Mr. Richardson, the principal 'bill-broker' of the time, as the term was then understood, thus described his business to the 'Bullion Committee:'

'What is the nature of the agency for country banks?—It is twofold: in the first place to procure money for country bankers on bills when they have occasion to borrow on discount, which is not often the case; and in the next place, to lend the money for the country bankers on bills on discount. The sums of money which I lend for country bankers on discount are fifty times more than the sums borrowed for country bankers.

'Do you send London bills into the country for discount?—Yes.

'Do you receive bills from the country upon London in return, at a date, to be discounted?—Yes, to a very considerable amount, from particular parts of the country.

'Are not both sets of bills by this means under discount?—No, the bills received from one part of the country are sent down to another part for discount.

'And they are not discounted in London?—No. In some parts of the country there is but little circulation of bills drawn upon London, as in Norfolk, Suffolk, Essex, Sussex, &c.; but there is there a considerable circulation in country bank-notes, principally optional notes. In Lancashire there is little or no circulation of country bank-notes; but there is a great circulation of bills drawn upon London at two or three months' date. I receive bills to a considerable amount from Lancashire in particular, and remit them to Norfolk, Suffolk, &c., where the bankers have large lodgments, and much surplus money to advance on bills for discount.'

Mr. Richardson was only a broker who found money for bills and bills for money. He is further asked:

'Do you guarantee the bills you discount, and what is your charge per cent?—No, we do not guarantee them; our charge is one-eighth per cent brokerage upon the bill discounted, but we make no charge to the lender of the money.

'Do you consider that brokerage as a compensation for the skill which you exercise in selecting the bills which you thus get discounted?—Yes, for selecting of the bills, writing letters, and other trouble.

'Does the party who furnishes the money give you any kind of compensation?—None at all.

'Does he not consider you as his agent, and in some degree responsible for the safety of the bills which you give him?—Not at all.

'Does he not prefer you on the score of his judging that you will give him good intelligence upon that subject?—Yes, he relies upon us.

'Do you then exercise a discretion as to the probable safety of the bills?—Yes; if a bill comes to us which we conceive not to be safe, we return it.

'Do you not then conceive yourselves to depend in a great measure for the quantity of business which you can perform on the favour of the party lending the money?—Yes, very much so. If we manage our business well, we retain our friends; if we do not, we lose them.'

It was natural enough that the owners of the money should not pay, though the owner of the bill did, for in almost all ages the borrower has been a seeker more or less anxious; he has always been ready to pay for those who will find him the money he is in search of. But the possessor of money has rarely been willing to pay anything; he has usually and rightly believed that the borrower would discover him soon.

Notwithstanding other changes, the distribution of the customers of the bill-brokers in different parts of the country still remains much as Mr. Richardson described it sixty years ago. For the most part, agricultural counties do not employ as much money as they save; manufacturing counties, on the other hand, can employ much more than they save; and therefore the money of Norfolk or of Somersetshire is deposited with the London bill-brokers, who use it to discount the bills of Lancashire and Yorkshire.

The old practice of bill-broking, which Mr. Richardson describes, also still exists. There are many brokers to be seen about Lombard Street with bills which they wish to discount but which they do not guarantee. They have sometimes discounted these bills with their own capital, and if they can re-discount them at a slightly lower rate they gain a difference which at first seems but trifling, but with which they are quite content, because this system of lending first and borrowing again immediately enables them to turn their capital very frequently, and on a few thousand pounds of capital to discount hundreds of thousands of bills; as the transactions are so many, they can be content with a smaller profit on each. In other cases, these non-guaranteeing brokers are only agents who are seeking money for bills which they have undertaken to get discounted. But in either case, as far as the banker or other ultimate capitalist is concerned, the transaction is essentially that which Mr. Richardson describes. The loan by such banker is a re-discount of the bill; that banker cannot obtain repayment of that loan, except by the payment of the bill at maturity. He has no claim upon the agent who brought him the bill. Bill-broking, in this which we may call its archaic form, is simply one of the modes in which bankers obtain bills which are acceptable to them and which they re-discount. No reference is made in it to the credit of the bill-broker; the bills being discounted 'without recourse' to him are as good if taken from a pauper as if taken from a millionaire. The lender exercises his own judgment on the goodness of the bill.

But in modern bill-broking the credit of the bill-broker is a vital element. The lender considers that the bill-broker—no matter whether an individual, a company, or a firm—has considerable wealth, and he takes the 'bills,' relying that the broker would not venture that wealth by guaranteeing them unless he thought them good. The lender thinks, too, that the bill-broker being daily conversant with bills and bills only, knows probably all about bills: he lends partly in reliance on the wealth of the broker and partly in reliance on his skill. He does not exercise much judgment of his own on the bills deposited with him: he often does not watch them very closely. Probably not one-thousandth part of the creditors on security of Overend, Gurney and Co., had ever expected to have to rely on that security, or had ever given much real attention to it. Sometimes, indeed, the confidence in the bill-brokers goes farther. A considerable number of persons lend to them, not only without much looking at the security but even without taking any security. This is the exact reverse of the practice which Mr. Richardson described in 1810; then the lender relied wholly on the goodness of the bill, now, in these particular cases, he relies solely on the bill-broker, and does not take a bill in any shape. Nothing can be more natural or more inevitable than this change. It was certain that the bill-broker, being supposed to understand bills well, would be asked by the lenders to evince his reliance on the bills he offered by giving a guarantee for them. It was also most natural that the bill-brokers, having by the constant practice of this lucrative trade obtained high standing and acquired great wealth, should become, more or less, bankers too, and should receive money on deposit without giving any security for it.