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PREPARED STATEMENT OF FRANK CARR, PRESIDENT, JOHN NUVEEN & Co.,
My name is Frank Carr; I am an investment banker from Chicago, Illinois; I am here representing the 700 member firms of the Investment Bankers Association of America. On my left is Mr. Alvin V. Shoemaker, Municipal Director, Investment Bankers Association of America, Washington, D.C.
I am President of John Nuveen & Co., the Nation's oldest and most active firm specializing in State and Municipal Bonds. The firm was founded in 1898 and underwrites more new bond issues of colleges and universities than any other investment banking firm.
As noted in my printed statement, the IBA supports a strong and financially sound national system of higher education. Probably no industry depends more on the Nation's colleges and universities for preparing people for it than the investment banking industry. So I am here to talk about students, not dollars. The IBA believes that a more effective and useful program of Federal loan aid to the Nation's colleges and universities, as far as the individual student is concerned, would result from a flexible rate of interest on Federal loans related to the cost of money to the Government, rather than a fixed sub-market interest rate of 3%. I am not going to read my statement; however, I will comment upon it and request that it be put into the record, along with this supplementary statement which will be furnished to you within the next few days.
The essence of the IBA position is that a 3% fixed interest rate on Federal college loans is inefficient and negative, rather than positive, in its effect. A flexible rate of interest, related to the Government's cost of long-term funds, would overcome this problem. The IBA position is very close to that of the Administration, as recommended by the Departments of Health, Education, and Welfare and Housing and Urban Development, the Treasury Department and the Bureau of the Budget. The IBA feels the fixed 3% Federal loan rate is inefficient and negative in its effect for the following reasons:
First, a 3% interest rate is usually below the interest rate obtainable in the private market. This forces "cash-short" colleges and universities (which is practically all of them) to try to do their borrowing from the Federal Government to save interest charges (or face the alternative of explaining to their trustees, contributors, or legislators why they don't take advantage of "low-cost Federal money").
This includes many large public universities which enjoy excellent credit ratings and are able to borrow in the private market on favorable terms (lower in cost than at which the Government can borrow long-term funds). The demand for Federal loans accordingly far exceeds the amounts available therefore.
a. Many urgently needed college facilities are therefore delayed while awaiting Federal financing.
b. Smaller private schools are sometimes forced into the private market for financing an emergency project at an interest cost penalty substantially in excess of the saving realized by a larger public institution in its utilization of Federal loan funds.
Third, the private market for college loans, which is capable of at least absorbing practically all the requirements of the public schools on favorable terms, is not fully exploited.
And finally, it is self-defeating because:
a. It in effect discriminates against the schools which most need Federal loans (because the private schools don't have the alternative of the nonFederal market when all appropriated Federal funds are loaned).
b. To benefit one student with a minor monetary saving, facilities required to accommodate other students are deferred and delayed.
The proposal to allow a reduction in the Federal loan interest rate by 1% below the Government's average long-term interest rate, as contemplated by the Administration's amendment, should be reduced to not more than 2%-a 1% reduction will continue to force much of this financing into the Government.
It was brought home to me this past week that it is the individual student with whom we must be concerned in assessing the merit of Federal loan aid proposals for colleges and universities. So I asked one of our Chicago IBA members who is
a specialist on college financing to explore the benefits of the 3% fixed interest rate proposal as far as the individual student is concerned.
A. John Kennedy of White, Welde & Co. reported:
1. Using the example of a $4 million college bond issue, lease rentals, taxes, tuition or general income, payable from student fees, amortized over a 40year period, issued by a state university with a student body of 15,000, a differential of 1% in interest rate on the issue (4% vs. 3%) would be equivalent to less than $2 per student per academic year.
2. If all the bonded debt of the University of Illinois, some $71 million in amount, was refinanced from a theoretical average interest rate of 4% to the Federal loan rate of 3% and amortized over a 40-year period, the saving that would be realized by each of the estimated 29,725 students who will enroll in the fall of 1967 would amount to less than $14 for a school year, less than 40¢ a week for a 36-week academic year.
Individual student savings amounting to a few cents per week do not seem significant considering:
The relative insignificance of this saving in relation to the estimated gross cost of schooling at a top private college of $3,000 to $4,000 per year, or even in relation to the estimated $1,500 to $2,500 annual cost of attending one of the large state universities.
That in order to effect such a saving, facilities to accommodate other students are postponed and delayed.
The Federal program is presumably designed to benefit all students in all respects, not just certain students and only from a financial standpoint.
The postponement of significant improvements in facilities (such as libraries, classrooms and laboratories) may result in an impairment in the academic dividends that could be realized by a student as a result of their availability.
Increases in the costs of construction and in the purchase of materials and furnishings during the delay in perfecting a Federal loan is almost sure to outweigh the savings to be realized from a 3% sub-market interest rate, considering that construction costs have historically increased over a long period at an annual rate of 3% on average.
The IBA concurs with the American Council on Education and others who report that it is time to examine the entire Federal program of aid to the Nation's colleges and universities. The financial health of these important educational and research institutions is fundamental to the national welfare; progress in expanding and improving their facilities and programs adequately to serve the national interest requires periodic examination. The IBA will be glad to cooperate in such an investigation to find the most efficient basis for long-term financing of college buildings and facilities. If at all possible, this should be done prior to the convening of the next Congress.
In the meantime, however, the IBA agrees with the Administration that the abandonment of the 3% fixed interest rate on Federal college loans, in favor of a flexible rate tied closely to the Government's cost of borrowing long-term funds, will be to the greatest advantage of the individual college student. This will maximize the participation of the private market in the financing of puble college faclities, will relieve the Treasury from the burden of this financing, will result in savings to college students and will expedite the construction of the multitude of college and university projects that otherwise will get tied up in the Federal loan program, to the disadvantage of the students who need these facilities.
STATEMENT BY THE INVESTMENT BANKERS ASSOCIATION OF AMERICA
I am Frank Carr, President of John Nuveen & Co., Chicago, the Nation's largest firm engaged strictly in the business of underwriting and marketing state and municipal bonds. I am appearing today in behalf of the 700 members of the Investment Bankers Association of America. IBA member firms are located in every state in the Union, with over 2,000 registered branch offices. Collectively, they underwrite, deal in and act as brokers for all types of corporate, Federal Government, and State and local government securities.
The Association believes that continued and increased quality of education is a laudable and necessary national objective which deserves the support of all Americans.
Our testimony, however, will deal only with Title 10, Section 1001, Adjustment of Interest Rates on Loans. This is a subject upon which we believe we are particularly qualified to speak, IBA members being regularly engaged in the business of underwriting and marketing the securities of universities and colleges for expansion of needed academic facilities, dormitories and essential equipment.
It is the understanding of this Association that the ultimate purpose of the legislation before you today is to make an education more available to the Nation's young people, regardless of their individual financial means. However, we submit that this purpose is defeated by provision for a fixed sub-market interest rate on Federal college loans. The establishment of an arbitrarily low interest rate on Federal loans will result in the delay of urgently needed education facilities that could promptly be financed in the private market at a somewhat higher interest rate. This results in delays in the improvement and expansion of already overtaxed facilities and proves a handicap, not a net benefit, to our higher education institutions.
Under the present Office of Education Program of aid to higher education money is available to colleges and universities in the form of grants and/or loans. It is our understanding that the grant program was designed to provide general Federal assistance for higher education while the loan program would finance those schools which cannot obtain funds in the private market at reasonable rates of interest. The Federal loan program could be particularly useful to those colleges which, due to their less favorable credit situation (size, scope, type, location, history, etc.) pay considerably higher than average interest rates on borrowed funds. The vast majority of public institutions of higher learning already are borrowing at costs lower than the U.S. Government, and at interest rates which are considerably below the prime rates charged to private corporations. In order for the Federal loan program to be most effective, its funds should be reserved for those schools with the greatest need.
The Federally subsidized 3 per cent interest rate, as provided for in the Act, forces most college borrowers to abandon the private sector in favor of the Federal program, regardless of their ability to raise funds on reasonable terms in the private market.
There is no logical reason why one school should receive 3 per cent funds and another must pay the going rate of interest in the private market. The choice for a college, regardless of need, between 3 per cent and a higher rate is simple. The real question is how long the construction of a project can be delayed in order to obtain a sub-market rate Federal loan. As long as the Federal government loans money well below the market price, there will likely never be sufficient funds to meet the artificial demands created by the low interest rate. So unless the Federal government is willing to commit itself on this basis to satisfy the total demand for new college facilities, the net overall value of its assistance to colleges is negative rather than positive.
While the 3 per cent interest rate may have been relatively close to the market at the time it was established, there has been considerable disparity between it and the money market during practically all of the last two years. The yield on typical "A" rated municipal bonds, as indicated by the Daily Bond Buyer "20-Bond Index," was 3.07 per cent on January 28, 1965. By March 4, 1966 this yield had increased to 3.83 per cent and by August 1966 was at a modern alltime high of 4.24 per cent. As of April 17, 1967 the yield-index had declined to 3.54 per cent.
Therefore it is our opinion that interest rates on college loans made under the Federal academic facilities and college housing programs should not be established separately from the private market and without regard for its fluctuations. In addition, Federal subsidies to higher education should be provided in such a manner as to supplement the private market, not pre-empt it. It is notable that this opinion has been shared in various degrees by each of the following: Commission on Money and Credit,' U.S. Treasury Department, Bureau of the Budget,
1 Money and Credit, The Report of the Commission on Money and Credit, page 197, Prentice-Hall, Inc., Englewood Cliffs, N.J., 1961.
U.S. Office of Education, and the Department of Housing and Urban Development.
The U.S. Treasury department agrees that direct Federal loan programs should be designed to broaden the private market, not preclude its use; its recent report to Congress 2 states at pages 15 and 16:
"Such fixed statutory interest rates insulate the programs from market influences. In addition, they limit the possibility of converting such direct loans to an insured or guaranteed basis to periods when market rates are unusually low, or to the sale of guaranteed certificates of participations in a pool of loans which the Government subsidizes and continues to service. Thus, the full participation of private lenders in credit programs is frustrated. In the case of college housing loans, for example, enactment of 3 percent ceiling has greatly increased the demand for direct loans, especially by public institutions which formerly could borrw through tax-exempt issues at rates below the Federal lending rate, but more recently have found it advantageous to use the Government program at the 3 percent rate. This has limited private participation and adversely affected the total supply of credit for college housing."
We sincerely believe that it is in the National interest to program Federal subsidies to higher education in such a manner as to supplement the contribution of the private market, not preclude its participation.
Historically, the private capital markets have provided the bulk of financing for our public schools of higher education. With substantially increasing requirements for funds, it is a disservice, not a service, for a Federal loan program of necessarily limited size to be so designed as to force those schools least needing Federal subsidy to abandon the private market in favor of Federal loans, to the disadvantage of those less-forunate schools which most need Federal assistance. For instance, in 1965 over $750 million was raised in the private market by issuance of long-term college bonds. In 1966, in the face of tight credit conditions, state and local governments raised over $1 billion for higher education from the private market sector. The ability of the private market to provide this amount of long-term funds last year, the great majority of which was at interest rates below the yield on outstanding long-term U.S. obligations, is even more significant in view of the inability of the Federal government (because of statutory limitations on interest rates) to borrow any long-term funds.
The static and overloaded condition of the Academic Facilities Program, and particularly the College Housing Program, is faultless evidence of the inefficiency of the present method of providing Federal financing assistance to higher education.
In the academic facilities program administered by Health, Education and Welfare, loan requests at the low interest rate of 3 per cent totaled some $240 million in fiscal 1966, of which over $140 million had to be deferred to fiscal 1967. (Approximately $100 million was available in fiscal 1966 out of an original appropriation of $110 million due to enactment of P.L. 89-429 on May 24, 1966.)
A similar situation exists at the Department of Housing and Urban Development as of January 31, 1966. HUD has had to refuse to accept applications for loans, regardless of need, because it had applications on hand as of that same date for $760 million of loans. This amount of applications included a carryover of $192 million from the previous fiscal year ended June 30, 1965.
HUD was authorized to make loans in the amount of $300 million each for fiscal years 1965, 1966 and 1967. All of the $300 million authorized for fiscal year 1966 was allocated well before the end of the year, leaving an approximately carryover to fiscal year 1967 of $460 million in loan applications. This carry-over is more than double the amount of the previous year's carry-over of $192 million. Therefore, it is obvious that to continue a sub-market rate of interest, 3 per cent, on Federal college loans means less college construction and facilities as a result of abandonment of the private market by those schools able to utilize it, to the detriment of those educational institutions which need Federal assistance and find the funds they need largely appropriated by more affluent schools. In
2 Feasibility, Advantages, and Disadvantages of Direct Loan Programs Compared to Guaranteed or Insured Loan Programs, A Report of the Secretary of the Treasury to the Congress as required by the Participation Sales Act of 1966 (Public Law 89-429, 89th Congress, May 24, 1966), submitted November 24, 1966.
fact, what happens is that much needed construction must stay dormant awaiting funds at the artificially low rate of 3 per cent from the Federal government when many of these projects could and should be financed promptly in the private market at reasonable rates.
Some might say that although the private market has performed admirably in the past, the expected heavy demand for long-term funds for the Nation's colleges in the future will be more than the market can efficiently provide for this and all other public purposes. However, a recent study published by the Joint Economic Committee of Congress' indicates that the private market can be expected to provide an adequate supply of additional funds for college facilities and other public improvements on increasingly favorable terms. In comparing the expected demand and supply of private funds for public university and other facilities, the report reads “during the decade 1966-1975 the demand for municipal securities by various investor groups is expected to be higher than the supply arising from projected public facilities capital requirements."
Further, it is important that the expected increase in required college financing can be handled in the private market without materially increasing interest and other financing costs. From another section of the same study, it is noted that ". a pronounced trend of increasing number of bids exists for all categories (of state and municipal bonds) over the past 9 years. For all categories, the average number of competitive bids was at least 50 per cent higher in 1965 than 1957."5
Investment bankers' compensation for services has markedly declined. "The most noticeable relationship is the decrease in spread in all categories between the time periods 1958-59 and 1963-65 (spread is the price paid by the issuer for the investment banker's underwriting services). Even during the latter time period of increased interest rates the trend remains downward. Thus, in 1958 a community borrowing $250,000 to $500,000 through the bond market would have paid the investment banker (on the average) $4,327 to $8,655 for his services. In 1965 these services would have cost $2,955 to $5,910."
Both the declining cost of investment banking services and the ability of the private market to produce a greater number of bids for new municipal bond issues is particularly significant when it is considered that these accomplishments occurred in a bond market that grew in volume from $7.0 billion in 1957 to $11.1 billion in 1965, and to over $4 billion in the first quarter of 1967.
Under the formula for determining the rate of interest proposed in the Higher Education Amendments of 1967, the Secretary of the Treasury is to take into consideration the current average market yields on outstanding marketable obligations of the United States with redemption periods to maturity comparable to the average maturities of such loans, adjusted to the nearest % of 1 per cent less not to exceed 1 per cent per annum, as determined by the Commissioner.
It is our understanding that at present this formula would produce a rate of interest of 45% per cent, less the option to reduce it to the extent of a maximum one per cent, to 3% per cent. We feel that the Federal borrowing cost as reflected by market yields is not an unreasonable basis for determining the interest rate on Federal loans to colleges and universities, even though it affords the Government no reimbursement for its expense of making, administering and servicing such loans.
An interest rate of 45% per cent is substantially below the borrowing cost of private colleges and is somewhat above the borrowing cost of most public schools. Even this interest rate, however, would be advantageous to many of the public schools.
For instance, in 1966 30 per cent of state and local bond issues to finance higher education were sold in the private market at a cost ranging from 4 of 1 per cent below to more than 4 of 1 per cent above the U.S. long-term bond yield; over 21 per cent of the dollar volume of financing for public schools fell into this category. Thus, in 1966 many schools in addition to those already receiving Federal loan assistance would have benefited from Federal loans even if the loan rate were equal to the yield on outstanding long-term Government obligations.
3 U.S. Congress, Joint Economic Committee, State and Local Public Facility Needs_and Financing: Volume 2, Public Facility Financing, 89th Congress, 2nd Session, Joint Committee Print. (Washington: U.S. Government Printing Office, 1966.)
Ibid., p. 21.
Ibid., p. 196.