like, need scarcely be taken up here, although it may be well to keep in mind that these secondary effects are commonly very considerable and farreaching, and that they may in specific instances very materially affect the outcome.
The theoretical result of this summary sketch of loan credit so far seems to be: (a) an extension of loan credit beyond that involved in the transference of productive goods from their owners to more competent users is unavoidable under the regime of competitive business - credit expansion is normally in some degree "abnormal" or "excessive"; (b) such a use of credit does not add to the aggregate of industrially productive equipment nor increase its material output of product, and therefore it does not add materially to the aggregate gross earnings obtained by the body of business men engaged in industry, as counted in material terms of wealth or of permanent values;72 (c) it diminishes the aggregate net profits obtained by the business men engaged in industry, as counted in such terms, in that it requires them to pay interest, to creditors outside the industrial process proper, on funds which, taken as an aggregate, represent no productive goods and have no aggregate productive effect; (d) there results an overrating of the aggregate capital engaged in industry, compared with the value of the industrial equipment at the starting-point, by approximately the amount of the aggregate deposits and loans on collateral; (e) the overrating swells the business capital, thereby raises the valuation of collateral, and gives rise to a further extension of credit, with further results of a like nature; (f) commonly beginning at some point where the extension of credit is exceptionally large in proportion to the material substratum of productive goods, or where the discrepancy between nominal capital and earning-capacity is exceptionally wide, the overrating is presently recognized by the creditor and a settlement ensues; (g) on the consequent withdrawal of credit a forced rerating of the aggregate capital follows, bringing the nominal aggregate into approximate accord with the facts of earning-capacity; (h) the shrinkage which takes place in reducing the aggregate rating of business capital from the basis of capital goods plus loans to the basis of capital goods alone, takes place at the expense of debtors and nominal owners of industrial equipment, in so far as they are solvent; (i) in the period of liquidation the gain represented by the credit inflation goes to the creditors and claimants of funds outside the industrial process proper, except that so much as is cancelled in bad debts is written off; (j) apart from secondary effects, such as heightened efficiency of industry due to inflated values, changes of the rate of interest, insolvency, etc., the main final outcome is a redistribution of the ownership of property whereby the creditor class, including holders and claimants of funds, is benefited.
Since the modern industrial situation began to take form, there have been two principal forms of credit transactions current in the usage of the business community for the purpose of investment: the old-fashioned loan, the usage of which has come down from an earlier, day. and the stock share, whereby funds are invested in a joint stock company or corporation. The latter is a credit instrument, so far as touches the management of the property represented, in that (in earlier usage at least) it effects a transfer of a given body of property from the hands of an owner who resigns discretion in its control to a board of directors who assume the management of it. In addition to these two methods of credit relation there has, during the late-modern industrial period, come into extensive use a third class of expedients, viz. debentures of one form and another - bonds of various tenor, preferred stock, preference shares, etc., ranging, in point of technical character and degree of liability, from something approaching the nature of a bill of sale to something not readily distinguishable in effect from a personal note. The typical (latest and most highly specialized) instrument of this class is the preferred stock. This is in form a deed of ownership and in effect an evidence of debt. It is typical of a somewhat comprehensive class of securities in use in the business community, in the respect that it sets aside the distinction between capital and credit. In this respect, indeed, preferred stock, more adequately perhaps than any other instrument, reflects the nature of the "capital concept" current among the up-to-date business men who are engaged in the larger industrial affairs.
The part which debenture credit, nominal and virtual, plays in the financing of modern industrial corporations is very considerable, and the proportion which it bears in the capitalization of these corporations apparently grows larger as time passes and shrewder methods of business gain ground. In the field of the "industrials" proper, debenture credit has not until lately been employed with full effect. It seems to be from the corporation finance of American railway companies that business men have learned the full use of an exhaustive debenture credit as an expedient for expanding business capital. It is not an expedient newly discovered, but its free use, even in railway finance, is relatively late. Wherever it prevails in an unmitigated form, as with some railway companies, and latterly in many other industrial enterprises, it throws the capitalization of the business concerns affected by it into a peculiar, characteristically modern, position in relation to credit. When carried out thoroughly it places virtually the entire capital, comprising the whole of the material equipment, on a credit basis. Stock being issued by the use of such funds as will pay for printing the instruments, a road will be built or an industrial plant established by the use of funds drawn from the sale of bonds; preferred stock or similar debentures will then be issued, commonly of various denominations, to the full amount that the property will bear, and not infrequently somewhat in excess of what the property will bear. When the latter case occurs, the market quotations of the securities will, of course, roughly adjust the current effective capitalization to the run of the facts, whatever the nominal capitalization may be. The common stock in such a case represents "goodwill," and in the later development it usually represents nothing but "good-will."73 The material equipment is covered by credit instruments debentures. Not infrequently the debentures cover appreciably more than the value of the material equipment, together with such property as useful patent rights or trade secrets; in such a case the good-will is also, to some extent, covered by debentures, and so serves as virtual collateral for a credit extension which is incorporated in the business capital of the company. In the ideal case, where a corporation is financed with due perspicacity, there will be but an inappreciable proportion of the market value of the company's good-will left uncovered by debentures. In the case of a railway company, for instance, no more should be left uncovered by debentures than the value of the "franchise," and probably in most cases not that much actually is uncovered.
Whether capitalized good-will (including "franchise" if necessary) is to be rated as a credit extension is a nice question that can apparently be decided only on a legal technicality. In any case so much seems clear - that good-will is the nucleus of capitalization in modern corporation finance. In a well financed, flourishing corporation, good-will, indeed, constitutes the total remaining assets after liabilities have been met, but the total remaining assets may not nearly equal the total market value of the company's good-will; that is to say, the material equipment (plant, etc.) of a shrewdly managed concern is hypothecated at least once, commonly more than once, and its immaterial properties (good-will), together with the evidences of its indebtedness, may also to some extent be drawn into the hypothecation.74
What has just been said of the part borne by good-will and debentures in the capitalization of corporations should be taken in connection with what was said above (pp. 100-104) as to the nature of the securities offered as collateral in procuring a credit extension. The greatcr part of the securities used as collateral, and so "coined into means of payment," are evidences of debt, at the first remove or farther from their physical basis, instruments of credit recording a previous credit extension.
In the earlier period of growth of this debenture financiering in industry, as, e.g., in the railroad financiering of the third quarter of the nineteenth century, the process of expansion by means of debenture credit, in any given case, was worked out gradually, over a more or less extended period of time. But as the possibilities of this expedient have grown familiar to the business community, the time consumed in perfecting the structure of debentures in each case has been reduced; until it is now not unusual to perfect the whole organizztion, with its load of debentures, at the inception of a corporate enterprise.
