Commercial Paper Market
THE DEVELOPMENT OF THE U.S. COMMERCIAL PAPER MARKET 1800-1900
The Period 1800-1850
In colonial America, and then on into the 1800s, the nation's
currency consisted of notes issued by private banks, along with
the First and Second Bank of the United States, the notes of private
banks purportedly being backed by gold or silver. Over time, and
in many cases, such a backstop didn't exist, and banks' assets
began to be comprised of various types of loans and securities.
As such, the credit standing and value of the notes of different
banks varied widely. As such, bank notes were not a very reliable
medium of exchange. Gold and silver coins were in circulation
but really only useful in small, consumer transactions. Bartering
was a known and reliable method of exchange, but in many cases
clumsy and impractical.
Most businesses in America even well up into the 19th century
were small, single person, or family, owned operations -- "proprietorships"
or "partnerships"-- often encompassing family members,
with names like "George Smith, Tailor," "Smith
& Wesson," "John E. Jones & Bros.," or
"Ian MacLachan & Son." The names in the business
title followed by a trade description reflected the very personal
nature of many businesses. The nature of each business, the character
and competence of the owners, and the business' general success,
were quite often generally known within the local community, but
not outside it. Business-to-business relationships between suppliers
and customers were also personal and generally not conducted over
long distances. A merchant vendor could feel secure and comfortable
selling goods on credit to merchant customer known and evaluated
personally, and operating a business with which the vendor was
somewhat familiar and even perhaps had physically visited and
observed. Such a merchant could have in selling goods to such
a customer and take in return a note providing for payment on
a specified future date. The note might have expressed a stated
interest rate, but usually not, the vendor thus absorbing the
"time cost of money" in his gross profit. The vendor
would typically then "carry" the note and be paid the
face amount by the customer/drawer at maturity, often with acceptable
bank notes, all as part of an ongoing business relationship. The
merchant vendor would often, in turn, be the customer of another
merchant vendor doing business the same way and thus have both
trade notes receivable and trade notes payable entries in his
book of accounts.
Apparently commencing in the late 1700s and carrying over into
the early 1800s --especially in Boston, Philadelphia, and New
York, America's then main trade centers -- merchant vendors began
to realize that banks, or in some cases non-bank individuals or
partnerships who took on the name "bankers" or "capitalists,"
would purchase customer trade notes, essentially "for investment,"
at a discount from face value, providing working capital to the
vendor and a good return to the note purchaser/investor. In most
cases, the investor or "holder" of a note would know
very little if anything about the customer ("drawer")
of the note and thus would require the vendor to "endorse"
the note (by signing his name on the note's back side), thereby
guaranteeing payment at maturity. Also, such an endorsement was
a guaranty of the note's "authenticity" in the event
at maturity the investor had to claim payment directly from the
It is not surprising that interest of vendors to sell, and the
interest of investors to purchase, such "business paper"
created the opportunity for "go between" middle men.
Thus the business of "note broking" was born. It is
also likely that once a few note broking proprietorships or partnerships
came into being and showed success, others soon followed. As this
intermediary business grew and more vendors and investors availed
themselves of the services provided, the more there became a "market
for business paper." Comments on the availability of and
rates for "business paper" became a regular part of
the daily "money market reports" in the major city newspapers.
It also appears that some note brokers were already handling in
parallel the short dated borrowings ("notes" and "warranties")
of cities and towns, and began to broker business paper as an
extension and diversification of municipal paper dealing.
Simultaneous with the growth of the short term note brokerage
business in the 1800-1850 period there was a significant expansion
in the number of state chartered and non-chartered private banks
taking deposits in the main cities and in the countryside throughout
New England, New York State, Pennsylvania, and in the South. These
organizations needed to put their deposit funds to work and as
time went on they became the main investors in discounted business
Although the early "note brokers" were often referred
to as "bankers" - a title they often used in their advertisements
-- they in fact dealt in trade notes on a "consignment"
basis. They did not lend funds to a merchant vendor, taking his
customers' trade notes as collateral, nor did they purchase and
own such notes outright. They were "agents, not "principals.
They took no credit or market rate risk in merchandising the trade
notes owned by a vendor. Usually the broker would take on consignment
all of a notes of a vendor with whom he had established a relationship
(usually exclusive), but might even "select" from a
vendor's cache of notes those which he believed he could particularly
market and provide the vendor with the cash he needed at that
time. The note broker would visit the vendor, pick up or otherwise
receive the notes to be sold, provide a receipt for them, and
then in turn visit local bankers and other investors to complete
sales. Some dealers prepared offering sheets mailed or otherwise
regularly delivered to investors, listing the notes they held
for sale, including maturities, rates of discounts, and the endorser's
name, all subject to prior purchase. When a note was sold, the
broker would remit to his vendor client the proceeds of sale (face
value less the agreed market rate and time discount) and after
deducting a small "commission" for broking services,
usually also expressed as a percent discount per annum, such as
1/4%. For instance, for a trade note in the face amount $4,567
payable in 4 months at a 10% discount, the discount to be earned
by the investor would be $152.23, the commission to the broker
would be $3.81, and the proceeds to the vendor would thus be $4,410.96.
These numbers seem small today, but were rather typical for transactions
around 1850. The practice of buying and selling discounted trade
notes as principal/dealer rather than taking them on consignment
as agent did not develop generally until in the 1890s, although
possibly somewhat earlier in eastern cities.
The Period 1850-1873
Business records clearly suggest that "discounting trade
notes" through brokers and their sale primarily to banks,
became the principal form of short term working capital financing
for many American businesses by the 1850s up into about 1900.
This method of financing was especially associated with the textile
and leather industries in New York and Boston which industries
involved many "tiers" of fabrication and distribution
by business entities operating in disparate locations before the
finished goods reached ultimate, widely dispersed consumers. Later,
the discounting of trade paper spread to most all industries,
as the nation's economic development moved westward, and as "multi-level"
manufacturing and distribution activities grew substantially and
broadly in many industrial sectors. At each layer of business
activity, vendors and customers depended on the "discount
market" to augment and replenish their working capital. Each
merchant had to incorporate in the pricing of his goods the discount
he would give up on the trade notes he would consign for sale
in order to convert these notes into cash. Also, such a merchant
vendor, as guarantor/endorser, would need to take into account
the character and apparent business success -- and thus credit
-- of each customer and note drawer to whom he sold goods. And,
finally, the merchant vendor would need to run his own business
successfully and be sensitive to how he and his business were
perceived in his local business community, particularly within
the local banks. These perceptions, along with hints or reports
of financial condition and operating results over time, would
influence his credit standing, the weight given his endorsement
of his customers' notes, which, in turn, would be a primary factor
in the discount he would incur to market his trade paper, and
thus determine his "cost of money."
The maturities of early business paper were usually in the three
to six month range and quite often were for four months. As time
went along, maturities of notes being created in some industries
began to conform to the seasonal pattern of a drawer's business
and industry. For instance, an original maturity of eight months
was established on the notes of certain industries because that
amount of time was generally required for end-use customers to
convert purchased goods into cash sufficient to meet their trade
note obligations. Of course, generally, the longer the maturity
date on a note ("long dated notes") the higher the market
discount rate, and the deeper the amount of the discount a vendor
would have to absorb if the note were sold in the market.
As the banking industry grew and expanded in the last half of
the 19th century, and as sectional and regional banking and money
markets coalesced, the form of trade notes used by drawers began
to include -- on their face, either printed or as a blank to fill
in -- the name of a bank (or other specified office) at which
payment would be made at maturity, upon presentment. Also, banks
in towns and smaller cities in eastern region began to look to
larger, central city banks for services, such as the presentment
of drafts or notes into their city's clearing house system, or
for forwarding to and collection by banks in other cities. These
central city bankers also began to handle a wide range of other
agency and service functions, and to provide advice, including
increasingly an opinion about the endorsers of paper being offered
to a country bank by a note broker. In due course, these central
city banks became paying agents and custodians of paper purchased
and owned by country bank clients and became responsible for collecting
such paper at maturity and crediting the country banks' account.
This emerging bankers' communication and service network began
to be known as "correspondent banking." The emergence
of these networks gave a great boost to the widespread marketing,
purchase, and sale of what was now commonly called "open
market commercial paper" in the later part of 1800s and into
the 1900s, especially in the Midwest, southern, and western states.
The Period 1873-1900
For various reasons, the panic of 1873 was a turning point in
the national commercial paper market. During mid-1873, business
paper discount rates were rising, and in the month of September,
reached a rate of 1 1/2% per month for top rated, shorter term
paper. Much paper could not therefore be sold at any rate, or
certainly not at one which most businesses could afford, even
for a short time period. A number of banks and railroads went
bankrupt. Many other businesses went bankrupt, or suspended operations,
but many survived and paid their trade notes on a timely basis.
Overall, trade note payment experience was quite favorable.
Business activity was depressed for some six years through 1879,
followed generally by a small boom and then decline in 1880-6,
and then more-or-less steady expansion through to the mid-1893
panic. All during this almost 20 year period, commercial paper
rates for well established businesses -- but also for businesses
which were strong and growing but still young -- were relatively
steady in the 6-8% per annum range. On the other hand, loans by
banks to a much more select group of businesses carried generally
higher rates. For the first time, the banking industry was feeling
the competition of lower cost "open market borrowing."
At the same time, banks were encouraging the development of the
"open commercial paper market" as a source of diversified
and liquid short term investment increasingly reflecting in rates
and terms the wide spread and objective judgments of many investors
as to credit worthiness. By this state, commercial paper became
an established and integral part of the nation's money markets.
As illustrated in the offering lists of note brokers at the time,
it was apparently during this period that two-name paper began
to be created in even denominations. This probably was the result
of vendors requesting and obtaining multiple notes from customers,
at least for larger sales of goods, with only one of the notes
having an odd denomination to reconcile with the total odd amount
of an invoice. All such notes might be dated the same, or even
perhaps have somewhat different maturity dates, to improve their
marketability, perhaps on the advice of the note broker, and as
acceptable to the customer. Also, it was during this period, perhaps
in the 1880-90s, when the owner of a single proprietorship business
might create (draw) obligations in the name of his business, and
then endorse the paper with his own signature, such that technically
the paper was "two-name," but essentially depended on
the creditworthiness of a single person or family.
Until late in the 1890s, but perhaps not even until into the
1900s --with the possible exception of a few very large publicly
owned companies -- there were no financial statements readily
available for vendors/endorsers, and certainly not for most vendors'
customers, the originators and signers of the underlying trade
notes. Such documents were just not expected to be available to
creditors. In many cases, even owners and managers had poor and
delayed financial information about their own business. Word of
mouth existed about a business' general operating results and
financial condition, but even many bankers did not have such privileged,
close-to-the-vest financial information about their customers.
Some business historians have suggested that the culture of the
times (however irrational it might appear today) was such that
the availability, or even the request, of a business' financial
statement was a prima facie indicator of that business' weak credit.
However, it appears that by the mid-1890s and into the early 1900s,
perhaps as a result of the 1893 panic and subsequent poor business
conditions, bankruptcies, and large credit losses, the expectation
and analysis of financial statements became rapidly prevalent,
even for smaller businesses. In this regard, it might be noted
that starting in the early 1900s advertisements by business firms
offering "accounting service and financial statement preparation"
began to appear in the classified sections of major newspapers.
This period apparently witnessed the emergence of the American
"accounting and auditing firm."
It is not clear when vendors first began to offer discounts to
customers for early payment rather than taking payment via a trade
note of, say, 3-4 months maturity. Also, it is not clear whether
this development took place in connection with selling some or
all goods on an "open receivables" basis versus a dated
trade note basis. Perhaps these practices began to emerge as early
as the 1870s when money was very tight and, if available, only
at the prevailing very high discount basis of 1 1/2% per month.
Perhaps, too, some vendors realized that such a practice reduced
or eliminated the risk of being contingently liable on 3-4 month
endorsements of customers' trade notes sold in the open market.
A common discount for early payment might have been 2% if paid
in 30 days, or perhaps even "2%/10." Here again, some
vendors probably began to build into their pricing the cost of
offering these early payment discounts.
However or whenever the "discount for early payment"
practice emerged, it became very attractive for many businesses
to take advantage of the high return on capital realized in taking
such discounts, if at all possible, including borrowing money
to do so. Such borrowing might be from the business' bank or banks,
or perhaps in the "open market." By this time, open
market investors were beginning to be accustomed to what was,
in fact, single name paper, and were beginning to prefer round
amount denominations and maturity dates that fitted into their
own cash flow needs as well as those of the issuer. It was thus
a "small step" -- as A. G. Becker later said -- for
credit worthy issuers -- especially if they were willing to disclose
their financial condition -- to issue unsecured short term promissory
notes on their own credit, fashioning terms to suit their needs
as well as those of purchasers, and generally financing inventories
and receivables, particularly short term assets which experienced
large seasonal fluctuations.
Commensurate with all these developments was the transition of
the "note broker" into a "commercial paper dealer."
The practice of a note brokers purchasing some very high quality,
short dated trade or simple promissory notes directly from vendors
or issuers, using his own and borrowed funds, may have started
in New York or Boston sometime before 1893, as suggested in some
business history literature. However, it is reasonably clear that
A. G. Becker pioneered this practice in Chicago and the western
commercial paper market in his first year in the business, 1893-1894.
It is interesting to note that A. G. Becker literally "grew
up" in the two name trade note and then commercial paper
business as it blossomed, evolved, became institutionalized, and
matured after 1873. It will be remembered that A. G. Becker joined
the Greenebaum banking businesses in that year at about the same
time as Herman Schaffner. As mentioned elsewhere in this chronicle,
the Greenebaum business was quite prominent in size and reputation,
but still a small organization by modern standards, and in all
likelihood handled business paper. Schaffner and Becker must have
worked relatively closely together especially at the German National
Bank. A. G. Becker must have observed, from the inside, the growth
and apparent prosperity of the Greenebaum enterprises, including,
however, very loose banking practices, regulatory scrutiny, and
then suspension in late 1877. In 1878, while launching the Herman
Schaffner bank with his brother-in-law, Mr. Becker must have been
dismayed and pained to see Henry Greenebaum, accused of embezzlement.
And then during the whole of the 1880s, and into the 1890s, the
commercial paper business of the Shaffner bank, presumably under
A. G. Becker's management, grew significantly, participating in
the expanding national market. By 1893, it was variously reported
that the Herman Schaffner bank had become the largest commercial
paper broker outside of New York, Boston, and Philadelphia, with
a with particularly large market share among bank investors in
Chicago, the Midwest, west, and South.
A. G. Becker reminisced about many of these developments in a
speech he prepared for a group of Cook County bankers in 1923.
We providing this complete paper at this point in our chronicle
since it includes a review of developments in the commercial paper
market over time. But also, the speech conveys the thinking of
A. G. Becker about the commercial paper business as it was being
operated in the early 1920s, just a few years before Mr. Becker's
death in 1925. In particular, the presentation outlines three
closely related policies of A. G. Becker & Co. which endured
for the next 80 years: comprehensive, diligent, and sustained
credit analysis of client issuers; initiating issuer relationships
which would be sound and mutually valuable in the longer term;
and accepting a moral responsibility for the indebtedness of any
commercial paper handled by the firm.
A. G. Becker Speech (This
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