TABLE XXXVIII.-Showing purposes of municipal bond issues.

1

Attention is directed to the fact that the proposed bill makes the acceptability of municipal bonds determined by four factors: (1) The population of the municipality; (2), its period of existence as a city or town, which must be not less than 25 years; (3) its good record in the payment of debts, the bonds of no city being acceptable if it has defaulted within 10 years in the payment of any part of either principal or interest of any funded debt authorized to be contracted by it; and (4) its net indebtedness, which must not exceed 5 per cent of the valuation of the city's taxable property in the case of cities or towns of less than 200,000 inhabitants, and must not exceed 7 per cent of the valuation of the taxable property in cases of cities of more than 200,000 inhabitants.

BONDS OF SMALL MUNICIPALITIES.

The last bill introduced during the first session of the Sixtieth Congress (H. R. 21261) limited investments in municipal bonds to cities of 100,000 population and over. A number of financiers consulted advised that the investment provision be changed to include cities of much smaller population, care being taken to preserve the clause as to the time the municipality had been a city. Mr. Louis D. Brandeis, of Boston, author of the savings-bank and annuity law which was recently enacted in Massachusetts, said that, in his opinion, many of the smaller cities are better security than the larger ones, and that it is not in the interest of the people generally or of the employees to discriminate against the smaller municipalities. The proposed bill accordingly limits investments in bonds to bonds of cities having a

population of 25,000 and over. According to the census of 1900, there are 156 cities in the United States which have a population of 25,000 or over.1

In support of the contention that the smaller municipalities are often better security than the larger ones, and that it is not in the interest of the people generally to discriminate against the smaller municipalities, the following quotation is of interest:

While differing only moderately from one another in point of safety and income return, municipal bonds may be divided into two distinct classes in accordance with the degree of convertibility which they possess. Some municipal bonds possess great convertibility; others almost none. The feature which chiefly determines the activity or inactivity of a municipal issue is the size and importance of the municipalty, together with the amount of bonds which it has outstanding. The bonds of large and important cities, whose outstanding debt reaches considerable proportions, usually possess great activity. They are constantly traded in and command a broad market, because dealers are willing to buy or sell in blocks at prices within a fraction of 1 per cent apart.

On the other hand, the bonds of counties, townships, and small cities are usually quite inactive. Transactions rarely occur in them, dealers do not make market in them, and they can be sold only to genuine investors. It is often impossible to have them even quoted.

At first sight it would appear that active municipal bonds would be much more desirable, but inactive municipals possess a special advantage which the active ones do not enjoy. They possess more stability of market price. It is true that their stability of value is due to the fact that they are not traded in or quoted and is therefore largely fictitious, but nevertheless it accomplishes a useful purpose. It enables the investor to carry inactive municipals at cost price upon his books through periods in which active market bonds would require to be marked down in conformity with prevailing market prices. No other class of investment except real-estate mortgages possesses to the same degree this quality of price stability. For many classes of buyers-savings banks, for example-stability of price is a consideration of prime importance. The preservation of the savings bank's surplus and, indeed, the continued solvency of the institution depend upon maintaining the integrity of the principal which it has invested. A savings bank requires, also, great safety of principal and interest, i. e., the certainty that principal and interest installments will be paid at maturity. It needs only a fair, but not high, yield, and it does not need to place emphasis upon convertibility or prospect of appreciation in value. Comparison of these requirements with the characteristics of inactive municipal bonds discloses a striking adaptability on their part to the real needs of the case. As a consequence, it is not surprising to discover that inactive municipals are greatly sought by savings banks.

The desirability of inactive municipals for savings-bank investment was never more forcibly illustrated than on the first of last January, when the savings banks came to make up their annual statements. Broadly speaking, there can be no doubt that they were saved by the large quantity of inactive municipals and real-estate mortgages which they carried. Had any considerable portion of their assets consisted of railroad bonds and active municipals, upon which

1 The number of cities of 25,000 inhabitants has probably increased since 1900. It does not follow, however, that all will come within the provisions of the bill, for the reason that their net indebtedness may be greater in some cases than allowed under the bill.

they should have had to write off a loss of 10 to 15 points, their solvency would almost certainly have been impaired.1

In accordance with the suggestion of Mr. Pierre Jay, former bank commissioner of the Commonwealth of Massachusetts, and others, the proposed bill contains a definition of the term "net indebtedness" similar to that contained in the Massachusetts law relating to investments of savings banks. While it is generally conceded that municipalities can not usually stand a greater "net indebtedness than 5 per cent of the assessed valuation, it is a rule that has some striking exceptions. The assessed valuation is the value fixed upon the property of the municipality by authorized officials for the purpose of taxation, but the rules for fixing the assessments vary in different places. In New York, for instance, property is, assessed at about its true value, whereas in Chicago the assessment of real property is based upon about 75 per cent of its real value. In municipalities where the assessed valuation is only a fraction of the real value of the property, the net indebtedness of the city may safely be more than 5 per cent of the valuation of the city's taxable property. The Massachusetts law for savings banks has been followed in this as in other respects, and the proposed bill therefore fixes the limit of indebtedness allowed on the smaller municipalities those having less than 200,000 inhabitants-at 5 per cent of the assessed valuation, and raises the limit of indebtedness allowed municipalities of more than 200,000 inhabitants to 7 per cent of the valuation of their taxable property. By net indebtedness is meant "the indebtedness of any city or town, omitting debts created for supplying the inhabitants with water and debts created in anticipation of taxes to be paid within one year, and deducting the amount of sinking funds available for the payment of the indebtedness included."

ESSENTIAL POINTS IN CONSIDERING SAFETY OF MUNICIPAL BONDS.

Before dismissing the subject of the safety and desirability of the municipal bond as a form of investment, it may be proper to emphasize the fact that municipalities are not all governed by the same laws nor possessed of the same degree of civilization and material wealth, and that their credit therefore varies like that of different individuals. The statement is made by the manager of a Chicago bond house that "the important elements of security in a municipal bond are the legality of its issue, the moral hazard, the assessed valuation of the property that must be taxed to pay the bond, and the ratio of the debt to real assessment valuation." 2

1 See How to Invest Money, by George Garr Henry, vice president Guaranty Trust Co., of New York (1908).

2 See "Investment Securities," by George B. Caldwell, manager bond department, American Trust and Savings Bank, Chicago, Ill., in American Investments, February, 1906.

The points which should be considered in the investigation of a municipal bond are similarly defined by another bank official as follows:

(1) The proportion which the total debt of the municipality bears to the assessed valuation of the property subject to taxation; (2) the purpose of issue, which must be a proper and suitable one; (3) the proceedings under which the bonds were issued, which must be in full compliance with the law. "If these points are found to be satisfactory, the investor may rest content that no other form of security is so greatly safeguarded and that his bonds rank upon a substantial equality with Government and State obligations.1

RATE OF INTEREST ON MUNICIPAL BONDS.

After the safety of the municipal bond, the most important thing to be considered is the rate of interest which it will yield. Since United States and State bonds are now so high in value, it follows that the Government employees' retirement fund will have to depend mainly on municipal bonds to lift the interest rate above an average of 2 or 3 per cent. Can they be depended on to yield the 3 per cent provided for in the bill, or the 4 per cent recommended as more desirable? In the opinion of savings-bank officials of New York and New England who have been consulted it is safe to guarantee that rate of interest on the employees' savings. According to the statement of a prominent bond house, the yield on the investments in municipal bonds may be said to range between 3 and 41 per cent.2

The vice president of the First National Bank of Chicago, Ill., states that "municipal bonds yield, according to their grade, from 3 to 5 per cent to the investor, and as a class they are one of the best investments in the market." 3

PROBABLE FUTURE COURSE OF RATE OF INTEREST.

The profitable investment of the retirement fund created under the provisions of the proposed bill will depend on the rate of interest which can be obtained on the securities to which it is restricted. Many persons believe that the rate of interest is lower now than it has been in the past and that it is likely to be still lower in the future. The student finds, however, that the interest rate fluctuates constantly, so that it is impossible to know whether the general tendency of the rate is upward or downward unless a long period of years is taken under observation. It may be stated, of course, as a general proposition that the interest rate is always low in an old and settled country in comparison to what it is in a new and undeveloped one, and that

1 See How to Invest Money, by George Garr Henry, vice president Guaranty Trust Co., New York (1908).

2 See Investment Problems, by Fisk & Robinson.

3 See "Investments," by David R. Forgan, vice president First National Bank, Chicago, in American Investments, February, 1906.

money therefore is not likely to bring in future years the large return it has brought here in the past when the Great West was first opened up to industry. The fact, too, that these are days of swift and easy communication between widely distant countries lowers the general rate of interest by making our American securities well known the world over and bringing to us from all points of the compass without much effort the capital desired. Nevertheless, in spite of the fact that these modern conditions might be expected to depress the interest rate and keep it down, there are those who say, not only that the rate of interest is now on the upward trend and has been so for some time, but that it never will stay down for any great length of time.

It is illuminating in connection with this discussion to read what Lester W. Zartman, instructor in insurance at Yale University, has said on this subject:

If we study the rate of interest in the United States from the period of the Civil War, we shall find that there has been one tendency through the whole period, the movement toward lower rates. Much discussion in insurance circles has been based on the showing of this period. The conclusion has been that the tendency of interest is to decline, and investments, especially during the past 15 years, have been made on the assumption that the rate of interest for a long time was to continue to decline. It is a mistake to base conclusions on a study of the period since the Civil War and on this period alone. Valid conclusions must be based on a wider study.

There is a belief widely prevalent that the rate of interest has been high throughout the history of the United States until recent years, and that there has been a gradual decline to what is known as the present low rate. This is not exactly true. It is a fact that in general the rate of interest in the United States has been higher than in Europe, especially in England, but, relatively speaking, the rate was not steadily high during the early history of the country, nor has there been a gradual decline. The real situation is that the rate has been a fluctuating one. During colonial times 6 per cent was altogether a common rate of interest. Before the Revolutionary War loans could be secured on desirable mortgages in New York State at 5 per cent, which can not be considered as a high rate on mortgage loans, for many borrowers are paying more even now.1

Zartman goes on to describe the fluctuations in the rate of interest in succeeding years. He finds that during the thirties the rate fluctuated rapidly, being extremely high in 1836 and then, during the severe depression following the crisis of 1837-1839, going as low as 4 per cent on many loans, the ordinary rate fluctuating around 6 per cent. Life-insurance statistics were not available before 1850, but savingsbank statistics show that for such investments as the savings banks were allowed to make the rate of interest for 50 years was probably under 6 per cent. From 1850 to 1860 the statistics of the income and assets of seven life-insurance companies are available, and show, in a general way, that the rate of interest for the decade 1850-1860 was somewhat below 6 per cent.

1 See The Investments of Life Insurance Companies, by Lester W. Zartman.