CREDITS

and
COLLECTIONS
by
Richard P. Ettinger
President and Chairman of the Boord
Prentice-Hall, Inc.
Member of the New York Bar
and
David E. Golieb
Chairman of the Boord, J. A. Deknatel and
Son, Inc.; Member of the Boord of Directors,
Patchogue-Plymouth Mills Corporation; Chair-
man of the Boord of Governors, Notional Institute
of Credit, New York Chapter; and Post Pres-
ident of the New York Credit Men's Association
THIRD EDITION
NEW YORK
PRENTICE-HALL, INC.
2 WHAT IS CREDIT?
and money is very slight in practical business affairs. We speak
of money as ordinarily being more generally acceptable than
credit, but if we consider that this money is turned into credit
as soon as it is received (by depositing it in a bank to prevent
loss by fire or theft), we immediately realize that in everyday
life credit is in some forms at least the equal of money. Yet this
is not always so. Let us, therefore, understand at the very outset
that credit is only as good and as strong as the person or insti-
tution upon whom it places the obligation to make the future
payment in money. .
The word "credit" is used to apply to (1) the credit trans-
action, (2) the credit standing of the borrower or buyer, and (3)
the credit instruments that are part of the transaction. To avoid
confusion in understanding what credit is, the student must
distinguish among these three terms. The credit transaction is
the actual exchange of money or goods for the promise to pay in
the future. A borrower's or buyer's credit standing is the busi-
ness world's judgment of his ability and willingness to fulfill his
promise to pay. Credit instruments are the evidence of the
("' credit transaction. For example, a dollar lllll and a promissory
note are both forms of credit instruments, for both are promises
to pay. Thus, we speak of buying goods on "credit"; of a mer-
chant's "credit"; and 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. It 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 the
coffers of the world. With this credit they could gain control of
one another's property, but soon this would be exhausted in
supplying their wants, and then their credit would be as useless
as a kettle with nothing to put in it. "No more wealth, no more
capital, 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. Just
as the railroad has rendered the rich prairies of Nebraska and
Kansas available to the farmer, so does credit render available
WHAT IS CREDIT? 7
Government today usually exercises its control of credit. The
Federal Reserve Act is the principal law that delegates power to
control credit.
The Federal Reserve Act. This Act instituted a system of
banks known as the Federal Reserve System. Under the system
twelve Federal reserve banks have been established. All na-
tional banks are required to belong to the system; state banks
may belong if they meet the requirements of the Federal Re-
serve Act. Banks that belong to the system are "member" banks. 1\ II
The twelve Federal reserve banks are bankers' banks-their pri- 7\
mary purpose is to supply credit to member banks. The member ere \ .. 1\
banks, in turn, distribute the credit to their customers. Federal 't1i
reserve 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
tern. II
One of the powers of the Federal Reserve System is the au- va
thority to advance money to member banks on notes that they
have accepted from their customers. This power is one of severa \ W
that the Federal Reserve System may use to control credit E)
Since it is the one that most directly affects the businessman
we shall show how it operates. But first the student must under
stand what is meant by the term "discount."
Suppose A accepts a note from B, to whom he has sold good
on credit. A needs cash. He goes to his bank and arranges for a
advance by the bank on B's note. A endorses the note and A
well as B are then responsible for the payment of the note whe
due. The bank then makes available to A the face amount of th
note less interest. This process is called "discounting"; the rat
of 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 wb
process of advancing money to a bank on notes that it has dis- -I::he.f'{J"b-
counted is called "rediscounting"; the rate of interest deducted d' sU::Uvtt tL
is the "rediscount rate." The plan means that, even in times of1..\' L _ \ .
. h b . f d f \,V\e. I .... ,
pamc, t e usmessman can secure necessary un s rom a mem- e.rdor<.::ef (
ber bank, for the member bank in turn can rediscount his paper I
l\')
o..\\tSwl
d
\-t,W -\:xi t.'(' _' Thl"::.
l\()werl ff\
c
2o"LA. .
CHAPTER 2
Credit Instruments
C
REDIT 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 of
general acceptability and those of limited acceptability. A credit
instrument that is universally acceptable is properly called
money or currency. Federal reserve notes, banknotes, and silver
certificates, all of which are mere promises to pay, belong to this
group. Much has been written about this kind of credit and the
effect of an increase or decrease in the supply or demand for
money upon prices, interest, and business in general-matters
of the most vital significance to the successful businessman. It
is not our purpose to treat these matters here. It is sufficient to
note that credit instruments of general or unlimited accepta-
bility serve as a substitute for money in the country that issues
them.
--credit instruments of limited acceptability include all other
forms of evidence that credit has been extended. These may be
divided 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 money
orders.
Negotiable instrument. The term "negotiable" is frequently
used in connection with credit instruments. It is, therefore,
necessary for the student to understand what is meant by a
negotiable instrument. Negotiability means that the instrument
can be passed freely from one person to another in such a man-
ner as to constitute the transferee the holder. If payable to
1 Some authors use the term credit instrument in the strict sense that it is
a written promise, or order, to pay a definite or determinable sum of money to
bearer, or to a specified person or his order. They do not, then, consider book
accounts as credit instruments since these, strictly speaking, do not involve any
written promise or order to pay.
9