"accepted" on the contract and pays the seller the amount of the sale. The accepting bank, therefore, advances the money to the seller in expectation of receiving future payment from the buyer's bank. For this service, both banks charge a fee expressed as a percentage of the contract. Thus, the buyer pays a little more than the amount of the sales contract, and the seller receives a little less.
Historically, these contracts have been safe, because the banks are careful to guarantee payment only for financially sound firms.
But, in times of economic panic, even sound firms may be unable to honor their contracts. It was underwriting that kind of business that nearly bankrupted George Peabody and J.P. Morgan in London during the panic of 1857, and would have done so had they not been bailed out by the Bank of England.
Acceptances, like commercial loan contracts, are negotiable instruments that can be traded in the securities market. The accepting banks have a choice of holding them until maturity or selling them. If they hold them, their profit will be realized when the underlying contract is eventually paid off and it will be equal to the amount of its "discount," which is banker language for its fee.
Acceptances are said to be "rediscounted" when they are sold by the original discounter, the underwriter. The advantage of doing that is that they do not have to wait three to six months for their profit. They can acquire immediate capital which can be invested to earn interest.
THE GREAT DUCK DINNER
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The sale price of an acceptance is always less than the value of the underlying contracts; otherwise no one would buy them. The difference represents the potential profit to the buyer. It is expressed as a percentage and is called the "rate" of discount—or, in this case, rediscount. But the rate given by the seller must be lower than what he expects to earn with the money he receives, otherwise he will be better off not selling.
Although bankers' acceptances were commonly traded in
Europe, they were not popular in the United States. Before the Federal Reserve Act was passed, national banks had been prohibited from purchasing them. A market, therefore, had to be created.
The Fed accomplished this by setting the discount rate on acceptances so low that underwriters would have been foolish not to take advantage of it. At a very low discount, they could acquire short-term funds which then could be invested at a higher rate of return. Thus, acceptances quickly became plentiful on the open market in the United States.
But who would want to buy them at a low return? No one, of course. So, to create that market, not only did the Federal Reserve set the discount rate artificially low, it also pledged to buy all of the acceptances that were offered. The Fed, therefore, became the principal buyer of these securities. Banks also came into the market as buyers, but only because they knew that, at any time they wanted to sell, the Fed was pledged to buy.
Since the money was being created out of nothing, the cost did not really matter, nor did the low profit potential. The Fed's goal was not to make a profit on investment. It was to increase the nation's money supply.
WARBURG AND FRIENDS MAKE A LITTLE PROFIT
The man who benefited most from this artificially created market was none other than Paul Warburg, a partner with Kuhn, Loeb and Co. Warburg was in attendance at the Jekyll Island meeting at which the Federal Reserve System was conceived. He was considered by all to have been the master theoretician who led the others in their deliberations. He was one of the most influential voices in the public debates that followed. He had been appointed as one of the first members of the Federal Reserve Board and later became its Vice Governor until outbreak of war, at which time he resigned because of publicity regarding his connections with 482
THE CREATURE FROM JEKYLL ISLAND
German banking. He was a director of American I.G. Chemical Corp. and Agfa Ansco, Inc., firms that were controlled by l.G.
Farben, the infamous German cartel that, only a few years later, would sponsor the rise to power of Adolph Hitler. He was also a director of the CFR (Council on Foreign Relations). It should not be surprising, therefore, to learn that he was able to position himself at the center of the huge cash flow resulting from the Fed's purchase of acceptances.
Warburg was the founder and Chairman of the International Acceptance Bank of New York, the world's largest acceptance bank. He was also a director of several smaller "competitors,"
including the prestigious Westinghouse Acceptance Bank. He was founder and Chairman of the American Acceptance Council.
