Readings in Money and Banking Part 70

The farmer, on the other hand, must be educated by the banker, the press, and the agricultural school and college, to the advantages of credit as a mean to the more efficient working of his farm. This should be done with caution, for credit is a two-edged sword. The farmer should be encouraged to borrow only when it is very clear that he can use additional capital so productively that it will pay. But what industrious farmer could not use profitably some additional capital every year, could he obtain it at as reasonable rates as does the merchant? The farmer must learn to keep careful accounts. He must be made to realize that the banks are open to him as to other business men, and that the bulk of the country's short-time commercial loans, as likewise of the agricultural loans of Europe, are made on the very same security he is capable of giving, _i.e._, two-name paper of honest, industrious business men.

FARM CREDIT IN A NORTHWESTERN STATE[225]

LONG-TIME LOANS

In North Dakota the average farm mortgage runs for 4.94 years; and the average interest rate is approximately 8 per cent. (accurately 7.88 per cent.). This 8 per cent. does not include the expense of abstracting t.i.tles, examining the property, and the recording of the mortgage. These fees are invariably paid by the borrower. Nor does this interest rate of 8 per cent. take account of the bonus that is frequently exacted, in the newer regions, from the borrower for the privilege of securing a loan; nor does it allow for the sum the borrower loses in paying his yearly interest in advance, which is deducted from the princ.i.p.al. While the practice of exacting a bonus is not common, it is generally the custom to deduct the entire year's interest in advance; a.s.suming an 8 per cent.

rate, the farmer therefore pays $80 interest not on $1,000 but on $920, which brings the rate up to 8.7 per cent.

While the average prevailing rate, according to our returns, is approximately 8 per cent., the rate varies in different parts of the state, depending upon the local conditions. The rates are lowest in the eastern tier of counties, and rise gradually towards the western part of the state, where the rate runs up to 10 and 12 per cent., which is also the rate in the eastern part of Montana. That the 8 per cent. rate is quite general for a large part of the state is evidenced from the fact that 25 of the 45 counties report an average rate of 8 per cent. or more. In only 4 counties is the rate less than 7 per cent., and in no county does the average fall below 6 per cent.

The above figures are conservative. They are based on returns submitted by bankers who would naturally understate rather than overstate the rate of interest charged in their respective localities. Furthermore, we have a check on these bank returns in the replies received from farmers. As a rule the rates reported by bankers and farmers are nearly identical in their respective counties. It is safe to conclude, therefore, that the average rate on farm mortgages for the entire state is about 8 per cent.

SHORT-TIME LOANS

Short-time loans are of two kinds, bank loans and book credit advanced by retail stores. The bank loan is made on the farmer's note, generally unsecured, though often secured by a chattel mortgage. According to the reports received from 125 banks, the average length of time for these short-time loans is 8-1/2 months; and the average rate of interest is 10.75 per cent. The average rate reported by farmers residing in 22 different counties was 11.07 per cent.

An effort was made to compare rates paid by farmers with those paid by business men on short-time loans in the same locality. The same banks that reported an average of 10.75 per cent. to farmers averaged only 9.18 per cent. on loans made to merchants and manufacturers. Fully 95 out of the 125 reporting banks stated that the rate was higher for agricultural short-time loans than for commercial loans; 26 reported the rate to be the same for both cla.s.ses; and only 4 reported a lower rate for the farmer. As North Dakota, however, is not a manufacturing nor a jobbing state, commercial paper is scarce, and consequently comparisons of the above nature are apt to be misleading. The significant fact remains that the farmer pays from 10 to 11 per cent. on small loans, for short periods of time.

Store or book credit is a form of short-time loan which is perhaps more important than bank credit. In a state where the bank charges a high rate of interest, the farmer is more likely to buy merchandise on credit than to borrow from the bank and pay cash. The North Dakota farmer is rarely denied credit at a country store. To secure information on this form of credit, questionnaires were mailed to implement and hardware dealers, as well as to farmers. One question asked of implement dealers was: "What percentage of farmers pay cash in buying farm machinery?" The answer from 54 firms, located in 35 counties, was that only 13 per cent.

of the farmers pay cash, 87 per cent. buying on time. Out of 29 farmers reporting only 6 pay cash in buying machinery and supplies. These book accounts run anywhere from three months to two years; the average account is carried about one year (12.37 months). The farmer contemplates making payment immediately after his prospective crop is marketed. In case of crop failure the retailer will carry the account over until the next harvest season.

It is quite common for the dealer to obtain a note from the farmer--the note generally bearing a 10 per cent. interest rate from the date of issue. Often, however, the note does not begin to bear interest until the farmer has failed to make payment at the expected time, that is, immediately following the harvesting season. The 54 implement and hardware dealers reported an average of 10.26 per cent. interest per year on these notes.

It is more difficult to secure uniform information from dealers on the subject of book credits, especially with reference to the interest rates charged on such accounts. The practice varies. Usually an interest rate is added to the credit price depending on the duration of the account.

There is no common discount rate for cash purchases, though 7 per cent.

is most common, that is, 7 per cent. of the credit price. This brings the credit price of a $160 binder down to $150 for cash. As a matter of fact all dealers quote two prices, the cash and the credit price, the difference between the two depending upon the reputation of the buyer, the shrewdness of the seller, and the degree of compet.i.tion in the particular locality.

On this point, replies from farmers do not differ materially from the replies of the implement dealers. The difference between the cash price and the credit price of a binder is usually given as $5 to $10, and a wagon or plough, as $3 to $5. The general discount rate is 7 per cent.

off the credit price.

The implement dealers and the farmers are all agreed that cash payments would be preferable if rates on bank loans were reduced. The farmer, however, is often afraid to approach the banker for a loan. On the other hand, the farmer does not always see that the book credit is quite as expensive as bank credit, if not more so. The prevailing high bank rate, however, from 10 per cent. to 12 per cent. on short-time loans, does not encourage cash payments.

Are the foregoing rates too high as compared with rates in other communities? The _Crop Reporter_ for April, 1913, shows interest rates on short-time loans in every state in the Union. In 1913, the North Dakota rate exceeded that of all other States; in 1912, it exceeded all but Oklahoma.

Farmers as a rule think that rates are fixed arbitrarily by the bankers and other money lenders in the community. That fundamental laws of supply and demand have any controlling influence is apt to be overlooked. Without attempting to justify the high rates let us state some of the conditions which help to explain them. The demand for capital in a growing state is always greater than can be met by the local supply. In 1890, North Dakota farms were mortgaged for $11,168,854; in 1910, for $47,841,587; in 1920 it will doubtless reach $150,000,000. Outside capital is attracted into the state by high rates of interest. Two life insurance companies, the Union Central of Cincinnati and the Northwestern Mutual of Milwaukee, loan heavily in the state. In 1910 the Union Central Life Insurance Company reported a total investment of $5,489,087.33 in North Dakota real estate. Local banks use farm mortgages in borrowing money from banks in large cities outside of the state. Every town and village has its money-lender who acts as agent for foreign investors in farm mortgages. Banks within the state compete for capital by offering high rates of interest on time deposits, and pay all the way from 4-1/2 to 7 per cent. interest on deposits. The rate on loans must necessarily be higher under these circ.u.mstances than where banks are paying 2-1/2 and 3 per cent. interest. The high interest rate paid on bank deposits is evidence of the lack of local capital to satisfy the local demand.

The inability to attract foreign capital on lower terms is due primarily to the character of the investment. The newness of the state, the instability of its population, the character of its agriculture, all make for uncertainty. Hence the speculative character of the farm mortgage as security for a loan. In the eastern counties where the land has long been under cultivation, where the population is more stable, and where mixed farming has in a large measure supplanted the bonanza wheat farm, rates are correspondingly lower than in the newer portions of the state. As the element of risk is eliminated from investments, interest rates will come down. At least this seems to be the consensus of opinion among bankers.

The character of the farming is frequently mentioned as a prominent factor in the credit situation. A crop failure under a single crop system, such as is practised in North Dakota, is likely to find the farmer in bad straits. The payment of interest on the mortgage is delayed or deferred. The local bank or loan company is obliged either to carry the farmer along for a year or to foreclose. Since many farm mortgages are held by outside investors, the annoyance is sufficient to reflect itself in an increased rate of interest. Because of this fact many bankers are urging mixed farming as a means of reducing rates. This aspect of the question is well expressed in a communication from a banker in Stark County who says:

It is our belief that the scarcity of money and the high interest rates are largely due to poor farming. The people having money to loan know well that our farmers here have a very uncertain income according to their present methods of farming, and would expect a much higher rate commensurate with the risk taken when they can find people where money can be placed more safely. As conditions are here now, some people have not paid all their interest, for at least three or sometimes four years. In the older slates, like Iowa for example, where people farm well, interest rates are much lower. As soon as our farmers can show that they are safe and will take care of their obligations promptly, they can command the lowest interest rates that may exist. We believe it more necessary to work on better farming methods, encouraging them, than on better interest rates, for the lower interest rates are a natural consequence of better farming.

Another factor is the character of the population. One prominent banker says of North Dakota farmers: "They lack a sense of responsibility. Farm loans require constant care, hence high rates." Another complaint is: "Farmers are careless in not making prompt payment or renewals of obligations." Some bankers think the high rates due to too much borrowing; that is, too much liberality in the loaning of money.

Injudicious loaning leads to extravagance, and naturally calls for high rates to offset the risks involved. One banker in a.n.a.lyzing the situation claims that the legal restrictions placed on the loaning power of banks is responsible for unduly high rates. In support of this view it might be stated that while the total farm mortgages in the state in 1910 reached the $50,000,000 mark, the power to loan on real estate by all banks, state and national, was less than $5,000,000. Banks are forced to loan on the personal note of the farmer, secured by a mortgage, instead of taking a direct mortgage on the property. Other banks turn these mortgage loans over to trust companies, and collect a commission from the farmer for placing the mortgage.

Commissions are responsible for at least from one to two per cent. of the rate when loans are handled by real estate agents and loan companies. In the case of loans by life insurance companies, the state agent generally receives one per cent. and the local agent, at interior points, receives one per cent. Two per cent. could be saved by the farmer if the money could be borrowed directly from the investor, without the aid of an agent.

Allowing, however, for all these local conditions--the great demand for capital in a new and developing country, the inability to attract sufficient outside capital because of the risky character of investments, the irresponsible character of some elements in the population, the character of farming methods, the commission agent, and the legal restrictions handicapping banks--allowing for all these conditions, and because of some of them, it is believed that the farmers by organizing co-operative credit a.s.sociations could reduce the rate of interest on both long- and short-time loans; and, furthermore, that such co-operative credit facilities would be a means of improving the methods of farming, would encourage stability in population, and would make the farmer feel that he is not being discriminated against in the borrowing and employment of capital.

CATTLE LOAN BANKS[226]

Consumers desiring a reduction in the cost of food supplies will be interested in a study of the operations of cattle loan companies and in the development which these may reasonably attain as a result of the provision in the Federal Reserve Act for the rediscounting of agricultural paper.

The cattle loan company, commonly referred to as "cattle bank," is a middleman between borrowing cattle-owners and lending bank-managers. Its business methods and forms closely parallel those of real estate mortgage loan companies except for the fact that cattle loans are of shorter duration and secured by mortgages of the chattel variety. Cattle loan companies, incorporated under state charters, have been operating in such cities as Fort Worth, Denver, East St. Louis, St. Joseph, Portland, South St. Paul, Omaha (2), and Kansas City (3), some of them for over twelve years; and one is now being organized in Chicago. These companies have a paid-in capital stock ranging from $50,000 to $300,000, and are usually closely affiliated with a national or state bank, as are trust companies in the larger cities.

These companies are informed of desired loans through country bankers, or by receipt of direct applications, the latter usually from the larger "cattle-growers." In some cases the company on its own initiative urges cattlemen in whom it has particular confidence to undertake feeding operations at a time when the beef market offers a favorable opportunity for such production. In every case a salaried examiner of the company inspects the plant and herd of the cattle-grower and his personal capacity and integrity before the granting of a loan. And thereafter the examiner, on his regular circuit, maintains a continuous inspection and volunteers advice designed to protect the value of the security given for the loan. When a loan application has been acted upon favorably, a promissory note and chattel mortgage are taken. The funds of the company then advanced to the borrowers may be utilized to buy more cattle, to pay outstanding debts such as those for feeding expense, or, as is often the case, to buy the very cattle which are pledged as security for the loan. In a few cases where the cattle-grower enjoys an exceptional credit, funds will be advanced for the full purchase price of a herd for seasonal feeding purposes, or to develop two-year-olds into finished four-year-old beef cattle. The loans granted are seldom less than 60 per cent. of the known value of the cattle.

To secure a buyer for the note and mortgage is the second primary function of the cattle loan company. If the loan is a small one, usually $10,000, it may be sold entire, the chattel mortgage a.s.signed and the note indorsed to the buyer. If the loan is a larger one, of $50,000 to $100,000, it is necessary to subdivide it in order to provide a ready sale. The mortgage and note are a.s.signed in parts of $5,000, $20,000, or other denominations, to suit the convenience of the buyers of the paper.

In this case the a.s.signed parts, since they are indorsed by the loan company, are equivalent to a "debenture" issue secured by a pledge of specified a.s.sets held by the company for the protection of the note-holders. The size of mortgage loan most frequently made is $10,000, while loans of $100,000 are exceptional.

The business of cattle loan companies approaches closely to the functions of the commercial paper broker. The cattle loan company has an advantage over the commercial paper broker in that the favorable location of the company--always at the receiving cattle-market of the district in which its loans are exclusively placed--enables it fully to protect its interest by claiming the proceeds of sales of mortgaged cattle. This is particularly true in the case of range cattle, which can be readily identified by the mortgaged brands.

To cover expenses of administration the cattle loan company secures for itself a part of the interest paid on the loan. The rate charged the borrower is usually determined by conditions in the locality where it is made, sometimes running as high as 10 per cent., and again, influenced by general rates for capital, falling as low as 7 per cent. From this gross interest charge a commission has to be given to the local banker who makes the loan, expenses of examination and management must be met, and an appropriation made to a contingency reserve fund to cover occasional losses incurred from the circ.u.mstance that the companies usually become surety, by indors.e.m.e.nt, for the final payment of all the loans which they have placed with lenders. These deductions determine what may be safely paid to eastern purchasers of the paper, usually 5 or 6 per cent.

Holders of cattle paper have never suffered in times of financial panic from failure to pay at maturity. Cattle, like grain, are a cash commodity purchased by retailers and sold by them, largely for cash, to satisfy a relatively constant consuming demand. This characteristic is retained even in time of panic.

Maturities are usually six months for feeding purposes; and less often of two and one-half years for developing two-year-olds for market. This two and one-half year paper is occasionally converted into the six-month variety by the sale of notes running for six months, based upon the two-and-one-half year mortgage. These notes are taken up at maturity by the loan company and reissued or renewed for like succeeding periods until the original loan is repaid.

In the past this form of loan has not been so desirable as it will be in the near future. It has been a relatively long-term investment; and while perfectly liquid at maturity and enjoying a good rate of return, it has not possessed a sufficiently wide market to insure salability at those times when the demands of depositors and local customers for accommodation press in upon the investing bank. This difficulty will be fully corrected by the expected operations of the Federal Reserve Act.

Eastern bankers possessing these six-month notes will probably find them readily rediscountable with the local federal reserve bank at any time up to maturity. And a considerable amount of two-and-one-half year notes may be held to advantage, since, if properly selected with successive maturities, one-fifth of their total amount will be immediately rediscountable when necessary.

By rendering this form of agricultural paper liquid before maturity the Federal Reserve Act will have become a most important influence for enlarging the amount of capital devoted to this branch of industry.

Already eastern bankers have scouts touring the Western States to study this form of banking with a view to investing several millions of dollars each. Interest rates upon these loans will unquestionably be reduced in time through such increased compet.i.tion of lenders. The loan companies will hardly suffer, however. While charging the cattle-grower less, they will be enjoying a larger turnover and should welcome this new development. The four or five million dollars placed in such loans yearly by the average loan company, as at present const.i.tuted, is but a fraction of the loans that may be placed by them within a few years.

By reducing the interest cost charged to cattle-growers an important service will have been performed for the consumer. Such a reduction will increase, in the first instance, the cattle-man's profit and induce him to increase his holdings. The benefit of increased production at lowered expense should, in time, be pa.s.sed on to the final consumer of beef.

This phase of the operations of the Federal Reserve Act will be of distinct benefit, and possibly also the least dangerous of all forms of legislation designed to a.s.sist American agriculture.

FOOTNOTES:

[197] Adapted from R. B. Van Cortland. _What is Agricultural Credit?

North American Review_, Vol. 199, April, 1914, pp. 585-588.

[198] E. W. Kemmerer, _Agricultural Credit in the United States, The American Economic Review_, Vol. 2, No. 4, December, 1912, pp. 852-872.

[199] New York, Chicago, Philadelphia, St. Louis, Boston, Cleveland, Baltimore, Pittsburgh, Detroit, San Francisco, Milwaukee, and Cincinnati. For Buffalo, the tenth city in population, Cincinnati, the thirteenth city, was subst.i.tuted, since for Buffalo, which is not a reserve city, satisfactory banking figures are not available.

[200] [National banks are now permitted to lend on real estate security by the Federal Reserve Act pa.s.sed in 1913.]

[201] Cf. Testimony before United States Industrial Commission (_Report._ X, under subjects of "Credit System" and "Crop Lien System,"

_pa.s.sim_.)

[202] _Report_. X, p. 161.

[203] In some states farmers themselves own considerable amounts of bank capital. This is said to be particularly true of Iowa.