Frank Proposal

In Washington last week highdomed SEC Commissioner Jerome Frank lay in bed suffering with pneumonia. But even as he did so he added a chapter to depression economic philosophy. Before a meeting of the National Association of Securities Commissioners in Kansas City, husky SEC Lawyer Chester Lane read a speech that Commissioner Frank had written, a speech that excited comment in financial circles, drew even an approving nod from the arch-Republican New York Herald Tribune.

Mr. Frank's thesis was embodied in a question "Is it perhaps not desirable that the bulk of long-time financing of our major American industries should hereafter be done through the issuance of shares of stock, rather than by borrowings through the issuance of long-term bonds?" Taking the railroads as the classic example of an industry weighed down with fixed charges,* he pointed out that when a railroad fails, bondholders suffer just about as much as preferred stockholders.

Theoretically, bonds are direct obligations and property can be sold to retire them.

Actually a road is reorganized and bondholders not only usually lose interest payments during the reorganization but suffer from write-downs in the formation of the new company.

What is true of railroads, Mr. Frank held, is generally true of other industries.

Not only the company or industry affected, but the whole economic system suffers from the bludgeoning effect of fixed maturities falling due during depressions, and the freezing of capital due to defaults. Even in industries where defaults do not occur, fixed charges exercise a downward leverage on public purchasing power, a leverage that affects not only dividends but wages.

These recognized depression phenomena have already given rise to one New Deal theory, that "Saving makes a rainy day" (because savings are translated into loans to industry, increasing fixed charges). This theory, of which the leading exponent is David Cushman Coyle (a consulting engineer of the National Resources Board), arrives at the inevitable conclusion that the way to prevent depressions is to reduce savings by heavy taxation on the people who save, i.e., the well-to-do. The New Deal is already putting it in practice.

Jerome Frank's theory is another approach to the problem: not to prevent saving but to prevent it from being translated into fixed charges. Emphasizing that his proposal was not officially inspired, he pointed out its major difficulty: the necessity of changes in State laws to allow banks and insurance companies to invest in stocks. Preferred securities he maintained would be just as sound investments for banks if they carried voting control when dividends were in arrears, thereby giving preferred stockholders the right to force a change in management.

* The B. & O. last week announced that its subsidiary, the Alton R. R., would default on its 3% bonds on October 1.

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