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CREDITSand

COLLECTIONSby

Richard P. EttingerPresident and Chairman of the BoordPrentice-Hall, Inc.

Member of the New York Barand

David E. GoliebChairman of the Boord, J. A. Deknatel andSon, Inc.; Member of the Boord of Directors,Patchogue-Plymouth Mills Corporation; Chairman of the Boord of Governors, Notional Instituteof Credit, New York Chapter; and Post Pres-ident of the New York Credit Men's Association

THIRD EDITION

NEW YORKPRENTICE-HALL, INC.

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2 WHAT IS CREDIT?and money is very slight in practical business affairs. We speakof money as ordinarily being more generally acceptable thancredit, but if we consider that this money is turned into creditas soon as it is received (by depositing it in a bank to preventloss by fire or theft), we immediately realize that in everydaylife credit is in some forms at least th e equal of money. Yet thisis not always so. Let us, therefore, understand at the very outsetthat credit is only as good an d as strong as the person or insti-tution upon whom it places the obligation to make the futurepayment in money. .

The word "credit" is used to apply to (1) the credit trans-action, (2) the credit standing of the borrower or buyer, an d (3)the credit instruments that are part of th e transaction. To avoidconfusion in understanding what credit is, the student mustdistinguish among these three terms. The credit transaction isthe actual exchange of money or goods for the promise to pa y inthe future. A borrower's or buyer's credit standing is th e busi-ness world's judgment of his ability and willingness to fulfill hispromise to pay. Credit instruments are the evidence of the

("' credit transaction. For example, a dollar l l l l l and a promissorynote are both forms of credit instruments, for both are promisesto pay. Thus, we speak of buying goods on "credit"; of a mer-chant's "credit"; an d of making a payment by a "credit.".) Nature of credit. Is credit wealth? Weare certain that many()..'('f: people believe it is. Herein lies a great difficulty, for it is this'oJ\:h +OY'V' conception of credit that leads to undue expansion of credit,,.[ cre11' \; speculative business, collapse, and consequent misery. I t is easy

Vj I to demonstrate that credit is not wealth. Three men, A, B, and\fl C, can give one another credit, which, if wealth, would fill thecoffers of the world. With this credit they could gain control ofone another 's property, but soon this would be exhausted insupplying their wants, and then their credit would be as uselessas a kettle with nothing to put in it. "No more wealth, no morecapital, no more goods exist after credit is given than before.Nevertheless, the use of credit does lead to an increase of wealth,for it brings the productive agents of a country into the posses-sion of those men who are most competent to utilize them. Justas the railroad has rendered the rich prairies of Nebraska an dKansas available to the farmer, so does credit render available

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WHAT IS CREDIT? 7Government today usually exercises its control of credit. TheFederal Reserve Act is the principal law that delegates power tocontrol credit.

The Federal Reserve Act. This Act instituted a system ofbanks known as the Federal Reserve System. Under the systemtwelve Federal reserve banks have been established. All national banks are required to belong to the system; state banksmay belong if they meet the requirements of the Federal Re-serve Act. Banks that belong to the system are "member" banks. 1\ IIThe twelve Federal reserve banks are bankers' banks-their pri- ~ \ . ) ~ ~ 7\mary purpose is to supply credit to member banks. The memberere \ .. 1\banks, in turn, distribute the credit to their customers. Federal 't1i ~ \ ; r ) o u . - \ ireserve banks are operated under the management of local offi- Cl enrt.cers and boards of directors, but they are all subject to the au- (In. (Are..thority of the Board of Governors of the Federal Reserve S Y S - \ \ ~ ~ I ~ e . Stern. IIOne of the powers of the Federal Reserve System is the au- vathority to advance money to member banks on notes that they ~ \ A , ? ? \ ~ ~have accepted from their customers. This power is one of severa \ ~ t ~ \ b Wthat the Federal Reserve System may use to control credit E)Since it is the one that most directly affects the businessmanwe shall show how it operates. But first the student must under \ l c : ~ h ~ \ J , ~ \ \stand what is meant by the term "discount."Suppose A accepts a note from B, to whom he has sold goodon credit. A needs cash. He goes to his bank and arranges for aadvance by the bank on B's note. A endorses the note and Awell as B are then responsible for the payment of the note whedue. The bank then makes available to A the face amount of thnote less interest. This process is called "discounting"; the ratof interest deducted is the "discount rate."When the Federal reserve banks advance money to member (-tHt*)banks on notes that they have discounted for their customers, -the member bank endorses t e note an is Ia Ie or Its payment.The Federal reserve banks deduct interest in advance. ThIS ~ o wb ~process of advancing money to a bank on notes that it has dis- -I::he.f'{J"bcounted is called "rediscounting"; the rate of interest deductedd' sU::Uvtt tLis the "rediscount rate." The plan means that, even in times of 1..\' L _ \ . ~. h b . f d f \,V\e. { X A ' f \ ~ I .... ,pamc, t e usmessman can secure necessary un s rom a mem- e.rdor \ . ' \ ~ e . . ( ) - b e . v . ~ \ 9 J \ = - I ~ ~ O I ' \ e f\ \ w i ~ e u t f u . o u ~ e . . n o..\\tSwld \-t,W v - e . c . o ~ - b " ' e . -\:xi t.'(' ~ _ ' Thl"::.\ ~ l\()werl ' o ~ ff\c2o"LA. .

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CHAPTER 2Credit Instruments

CREDIT transactions involve the use of credit instruments.These instruments show definitely that credit has been ex-tended. Credit instruments may be divided broadly into those ofgeneral acceptability and those of limited acceptability. A creditinstrument that is universally acceptable is properly calledmoney or currency. Federal reserve notes, banknotes, and silvercertificates, all of which are mere promises to pay, belong to thisgroup. Much has been written about this kind of credit and theeffect of an increase or decrease in the supply or demand formoney upon prices, interest, and business in general-mattersof the most vital significance to the successful businessman. I tis not our purpose to treat these matters here. I t is sufficient tonote that credit instruments of general or unlimited accepta-bility serve as a substitute for money in the country that issuesthem.--credit instruments of limited acceptability include all otherforms of evidence that credit has been extended. These may bedivided into promises to pay and orders to pay. The chief prom-ises to pay are: open or book accounts (known as book credit),!promissory notes, and bonds. The chief orders to pay are:checks, trade acceptances, drafts, bills of exchange, and moneyorders.

Negotiable instrument. The term "negotiable" is frequentlyused in connection with credit instruments. I t is, therefore,necessary for the student to understand what is meant by anegotiable instrument. Negotiability means that the instrumentcan be passed freely from one person to another in such a man-ner as to constitute the transferee the holder. I f payable to

1 Some authors use the term credit instrument in the strict sense that it isa written promise, or order, to pay a definite or determinable sum of money tobearer, or to a specified person or his order. They do not, then, consider bookaccounts as credit instruments since these, strictly speaking, do not involve anywritten promise or order to pay.9