ALTERNATIVE METHODS OF FINANCE

Our discussion of the shortcomings of the Environmental Financing Authority should not leave the impression that a vital element of the water pollution control effort would be sacrificed were EFA not enacted. This is not the case. The EFA proposal diverts attention from what most witnesses before this Committee have agreed to be the major gaps in the present program:

(1) the lack of sufficient Federal grant participation through larger appropriations and higher matching ratios;

(2) the lack of a dependable, long-term commitment on the part of the Federal Government;

(3) the lack of an effective priority system so that the money is spent where the pollution control needs are the greatest;

(4) the lack of coordination among existing pollution finance programs.

It has been repeatedly stressed that Federal grants should be made more generous-covering a larger portion of the total project cost-and, above all, made more dependable so that actual appropriations live up to enacted authorizations. The long-term nature of these programs requires that financing and policy decisions upon which they are based be long-term as well.

We believe that those charged with the implementation of the water pollution program on the local level should be skeptical about accepting the possibility of some form of credit assistance as a substitute for a concrete program of cash grants. They do not need nor desire, we believe, proposals to enlarge their ability to go into debt more rapidly. Rather than involving the Federal Government in a new debt financing scheme, it would be preferable to pay the costs of the Federal construction grant program from current tax income. This practice would be less inflationary and would assure the objective of adequate waste treatment facilities. Examinations of such construction indicates that the availability of Federal funds is the major determinant of activity in most States Thus the most urgent need appears to be the need to stabilize and assure adequate Federal financial participation. The response that current revenues are presently insufficient and that the budget cannot be altered to permit more direct Treasury debt is not sufficient nor necessarily true. Congress has just lifted the debt ceiling and has permitted the limited issuance of long-term bonds above the old 44 percent ceiling. Since this is the cheapest way to borrow (if borrow we must), why should not that ceiling be raised to encompass any requirements for funding additional direct loan programs? Even barring that possibility, why further disperse pollution control lending programs among more agencies? At least there could be a more efficient use of resources and manpower by operating such a loan program through currently existing agencies. To the extent that these do not perform optimally or do not reflect changing priorities, they should be altered (a positive step in itself) and then used to lend to the occasional municipal borrower that is considered to be unable to sell his bonds on the open market. We cannot believe that every new financing task-especially one as indefinite and unproven as that intended for EFArequires the assembling of a new staff, a new institution, and the issuance of new security.

Those supporting the creation of EFA have yet to demonstrate that there is a problem which justifies the creation of a new lending authority. Moreover, there is a clear danger that EFA, if devoted to boosting smaller, one-shot projects, could divert the major thrust of the pollution control program.

Nearly all new legislation places emphasis upon funneling Federal funds into the populated areas of the country, primarily metropolitan complexes including industrial dischargers. To the best of our knowledge, these areas are able to raise needed funds if they are not locked in by ceilings on interest rates. Devising a means to encourage the financing of small projects outside the limits of greatest pollution seems to run counter to the pending proposals in other bills before your Committee. In fact, it is our understanding that a major problem in the area of waste treatment facility construction in the past was excessive emphasis on small, isolated projects. The real need lies in more adequate Federal appropriations and a firm commitment of Federal funds, rather than the creation of a new vehicle to help local governments increase their indebted

ness.

In conclusion, the financing of the water pollution program should be soundly grounded on a substantial and clear commitment of public funds. It should not include what we believe are unnecessary and faulty credit mechanisms. It should not be diluted by any notion that somehow budgetary economics may be effected by shifting financing from a visible claim on current revenues to a largely invisible draft on the capital markets. As an economy with limited savings and resources, we cannot make that shift and we can overtax ourselves in the attempt in many ways.

The financing of the water pollution control program should be simple and efficient:

The Federal share should be as large as befits the national priorities of the program. It should consist of grants or, if such a need is determined, of direct loans or advances to recipient communities.

To the extent that they can be, Federal contributions should be funded by current revenues. If these are insufficient, then the remainder-including any justifiable additional assistance to recipient units—should be extended through direct loans funded when necessary and prudent by direct Treasury borrowing. At a minimum, any necessary agency borrowing should be collected under an umbrella authority and fully coordinated through a central entity, responsible to the Treasury. All transactions and their subsidy elements should be clearly reflected in the budget.

There should be no further expansion of indirect Federal borrowing and various forms of Federal credit assistance until more is known of their full impact on the economy and credit markets, until these programs have been successfully integrated into the budget, and until effective methods of Congressional and Executive review and control have been created.

SUMMARY OF THE PRINCIPAL POINTS OF THE TESTIMONY

Technical and administrative problems with EFA

It would create diffusion of responsibility and unnecessary complexity in the water pollution control program. The power to propose loans is vested in one department but the power to lend is left to another.

There is no definition of "reasonable rates." The Administrator of the Environmental Protection Agency is delegated broad latitude in judging eligibility for EFA loans. The intended magnitude of the lending program is not set forth in the legislation.

There is a lack of any real guidance in determining EFA's relending rates and terms. The Secretary of the Treasury has been granted virtually unlimited control over the size of the subsidy and, hence, the size of the lending program. No need has been demonstrated

There is no real evidence that a lending authority such as that embodied in EFA is needed or that, in any event, the authority is the best way to meet such a need. The assertions that governments are unable to sell pollution control bonds in sufficient volume at the going market rate or that this rate is unreasonable have not been substantiated.

Broader policy questions raised by EFA

Agency financing is not an appropriate way to finance Federal assistance to State and local governments. The rapid growth and already broad expanse of many and diverse credit assistance programs has led to many problems. They are largely unbudgeted, uncoordinated, and unresponsive to the overall needs of stabilizing monetary and fiscal policy. Their operation preempts credit, intensifies the demand for funds, forces up interest rates, and creates new margins of unsatisfied borrowing demands. Their final influence on the economy is uncertain and may well be counterproductive.

The EFA credit assistance approach to Federal aid might be extended to other Federal aid programs, marking a major change in our intergovernmental fiscal structure. Such programs give the appearance rather than the substance of substantial Federal assistance and may have perverse effects on the ability of these units to raise funds for their other capital needs.

Alternative approaches to Federal aid

EFA diverts attention from the major gaps in the existing Water Pollution Control Program. Rather than creating a new debt financing scheme, Federal grants should be made more generous to cover a larger portion of project costs, more dependable so that actual appropriations live up to enacted authorizations, and directed to those areas where the pollution problems are the greatest. To the extent possible, grants should be funded by current revenues or by direct Treasury borrowing.

APPENDICES OF RELATED MATERIAL

A. Statutory Interest Rate Ceilings on State and Local Bonds.

B. Remarks by Murray Weidenbaum, Assistant Secretary of the Treasury, before the Municipal Finance Forum of Washington on Federal Credit Programs.

C. Table of Comparison of Municipal and Agency Bond Yield Series.

D. Selected Remarks by Henry Wallich at the Federal Reserve Bank of Boston Monetary Conference, June 14-16, 1970, on Federal Credit Programs. E. Remarks by Former Secretary of the Treasury David Kennedy at the Joint Economic Committee Hearings, Midyear, 1970, on the State of the Economy.

APPENDIX A

STATUTORY INTEREST RATE CEILINGS ON STATE AND LOCAL BONDS, THE BOND, BUYER, NOV. 23, 1970

STATUTORY INTEREST RATE CEILINGS ON STATE AND LOCAL BONDS, THE BOND BUYER, NOV. 23, 1970-Con.

1 Arkansas: School district bonds, about 20 types of bonds for street and parking facilities, public building corporations formed to construct municipal facilities, municipally sponsored bonds for waterworks, sewer, drainage, parks, recreation agencies, convention centers, and construction and refunding bonds for eight State-sponsored colleges and universities, and county and municipal bonds for hospitals, nursing homes, and rest homes may be issued at 8 percent. County and municipal industrial development bonds, airport bonds for larger cities, countywide river port bonds and municipal port authority bonds may be issued at 10 percent.

2 Colorado: Maximum interest rate must be part of proposal submitted to voters along with amount of authorization. 3 Delaware: State agency bond anticipation notes for school districts are limited to 6 percent.

* Louisiana: Most local bond issues have constitutional ceilings of 6 percent, although the statutory ceiling is 8 percent. $ Minnesota: Highway bonds have constitutionally fixed ceiling of 5 percent.

• Nebraska: No State public debt.

New Jersey: 6 percent ceilings suspended through June 30, 1971, for counties, municipalities, school districts, State agencies and other public authorities and agencies.

California: Any rate permitted on specific issue approved by two-thirds vote of each house of Legislature and by the Governor.

New York: 5 percent ceilings suspended until June 30, 1971 except for issues by public authorities on which the ceiling is 8 percent.

10 North Dakota: Municipal refunding improvement bonds have 7 percent ceiling.

11 Oklahoma: Some State agencies such as Boards of Regents for Colleges have no interest rate ceiling.

12 Wisconsin: Local notes can run for 10 years.

13 Pennsylvania: Philadelphia does not come under Municipal Borrowing Act and thus has no ceiling on interest costs, except for 6 percent limitation on port, transit and street bonds. The 7 percent limitation on State revenue, agency and local GO, revenue, agency bonds and notes will be reinstated on July 1, 1971.

14 Illinois: Chicago GO bond limit of 6 percent suspended until July 1, 1971. Park District (city corporation) GOs are imited to 7 percent. Sanitary districts in State and City of Chicago and Chicago Board of Education authorized to issue GO notes of twp-year duration not to exceed 7 percent.

15 Arizona: Maximum interest rate must be specified on ballot.

15 Michigan: The 8 percent ceiling is effective through Jan. 1, 1971, then drops to 7.5 percent until July 1, 1971, and then returns to 6 percent.

17 Virginia: Ceiling reverts to 6 percent after June 30, 1972.

19 Missouri: Bonds must be sold not less than 95 percent of par. Negotiated sales cannot exceed 6 percent, except industrial aid bonds which have 8 percent ceiling.

19 Hawaii: 8 percent limitation for State effective until April, 1971, when it reverts to 6 percent; 8 percent limitation for counties effective until July, 1971, when it reverts to 6 percent.

20 Tennessee: Local utility districts are limited to 8 percent. All others are 10 percent.

REMARKS OF HON. MURRAY L. WEIDENBAUM, ASSISTANT SECRETARY OF THE TREASURY FOR ECONOMIC POLICY, BEFORE THE MUNICIPAL FINANCE FORUM, WASHINGTON, D.C., TUESDAY, OCTOBER 6, 1970

A REEVALUATION OF FEDERAL CREDIT PROGRAMS

I am delighted to have the opportunity to appear before the Municipal Finance Forum to discuss the role of Federal credit programs in governmental budget policy. The current rapid expansion of these Government and Government assisted lending activities raises a number of broad public policy issues-the size of the public sector, the role of the Government, the structure of financial markets, the effectiveness of monetary and fiscal policies, and the relative importance of large sectors of the Nation-agriculture, housing, foreign trade, and so forth.

After trying to piece together a picture of recent and prospective developments in the area of Federal credit programs, I would like to discuss several of the major problems stemming from the current treatment of credit activities in the Federal budget. Finally, I will outline some of the major issues and indicate some promising approaches. When I speak of "us," I refer not only to the

Administration or to Government; these issues have a bearing on all participants in the economic process. But before launching into these matters, it may be helpful to review some of the basic functions of a financial system. We can then think about the Federal credit programs in terms of their impact on these basic functions.

In any assessment of the implications of Federal credit programs, we need to be concerned with their impact on resource allocation and with their effects on the efficiency of the financial system.

When a national government enters financial markets, it possesses advantages not available to private borrowers such as its position as a virtually riskless borrower. To some extent, as we will see, it can transfer some of these governmental attributes to ostensibly private organizations who are empowered to issue obligations backed or otherwise supported by the U.S. Treasury. Thus, even if the Federal Government itself exercises restraint in its direct borrowing, expanded credit operations by these "assisted" agencies may result in increasing portions of available funds being preempted and not available to truly private borrowers.

Against the background of these remarks, I would like now to turn to a description of the present treatment of Federal credit programs in the budget.

Present Treatment of Credit Programs

As recommended by the Budget Concepts Commission, the Federal budget totals cover only direct loans. That is, loans are included in the unified budget only when they are made directly by agencies of the Federal Government, including trust funds and mixed ownership corporations.

The budget does not include what are termed federally assisted loans. For example, loans by agencies which are federally sponsored but are entirely privately owned-such as the Federal National Mortgage Association (FNMA), the Federal Home Loan Banks, and the farm credit agencies-are no longer included in the budget. Similarly, federally guaranteed loans-which include loans financed in the municipal market, e.g., for public housing and urban renewal and nonguaranteed loans made by private lenders with a Federal interest subsidy-such as for college housing and academic facilities are not included in the unified budget.

As it turns out, this particular accounting convention means that the bulk of Federal credit assistance is excluded from the budget. Of the estimated $22 billion net increase in Federal and federally assisted loans for fiscal 1971, only $12 billion are included in the budget.

The funds for federally assisted private credit must come from some place other than the Federal Government. They are borrowed from the public. If the budget forecasts are realized, there will be $20 billion of net borrowing in fiscal 1971-well over 20 percent of the funds advanced and borrowed directly in credit markets, and about one-third greater than in fiscal 1970. Moreover, there is every presumption that federally assisted credit financed outside the budget will continue to grow rapidly after 1971.

Problems in the Current Treatment of Credit Programs

The fact that a Federal program is big and growing does not by itself mean that it is cause for concern. It may simply reflect the success of the program. It may simply be evidence that the program works. What then is all the fuss about?

It strikes me that the federally assisted credit programs pose several important problems that should be faced explicitly. It may be that we would choose to do nothing about these problems. (An old professor of mine once told me that there are two kinds of problems: those about which you can do nothing, and those that go away of their own accord.) Even so, I want to be sure that the problems to which I shall allude are fully recognized and that we do not simply lose ground by default.

At the present time, Government control over the growth of federally assisted credit programs is quite limited. I am sure that some people would view this state of affairs as desirable, and not a problem. However, in light of the way in which these programs have been developing, I believe that we need to take note of some of the problems that have emerged.

1. A major share of the federally assisted loans outstanding in fiscal 1971 will require direct Federal payments of interest or other debt service subsidies.