STATEMENT OF JOHN FOGARTY, CHAIRMAN, MUNICIPAL SECU. RITIES COMMITTEE, INVESTMENT BANKERS ASSOCIATION; ACCOMPANIED BY: THOMAS MASTERSON, UNDERWOOD, NEUHAUS & COMPANY, INC., HOUSTON, TEX., CHAIRMAN OF MUNICIPAL FEDERAL LEGISLATIVE COMMITTEE; ROBERT HARKNESS, PRESIDENT, ADAMS, HARKNESS & HILL, INC., BOSTON, MASS.; AND JOHN PETERSEN, DIRECTOR OF MUNICIPAL FINANCE, INVESTMENT BANKERS ASSOCIATION OF AMERICA

Mr. FOGARTY. My name is John Fogarty, vice president of Stern Brothers & Co., Kansas City, Mo., and chairman of the Municipal Securities Committee of the Investment Bankers Association of America.

Appearing with me so as to expand our capacity to respond to questions are:

On my far left, Mr. Robert Harkness of Adams, Harkness & Hill of Boston.

On my left, Thomas Masterson of Underwood, Neuhaus & Co., of Houston.

On my right, John Petersen, director of Municipal Finance, Investment Bankers Association of America.

We are authorized to testify on behalf of the more than 600 investment firms and banks, members of our association who underwrite and make secondary markets for bonds of the 50 States and their political subdivisions.

Our members daily use their experience and expertise to help finance sewer and water facilities, as well as other municipal improvements. It is our livelihood: we are participants in, not observers of, municipal financial decisions.

Our members also underwrite and make markets in the securities of corporations and the Federal Government, including all of its agencies. Therefore, we believe we can be objective in our appraisal of the effects of proposals to finance Federal programs through the use of credit, whatever its form. Federal or State and local, taxable or nontaxable.

Last year, we testified before this subcommittee on the Environmental Financing Authority, raising numerous questions regarding the technical features of the legislation, the need for such an agency, and the larger policy questions involved in use of such agency financing programs. We suggested at that time, that what was needed was a substantial increase in the current grants to this vital area of pollution.

This year's legislation, S. 1015, does not differ in any material way from that proposed last year, S. 3468.

We again oppose the creation of the Environmental Financing Authority. Our position is fully expressed in the formal statement that has been submitted to the committee.

Although we share the concerns that motivate consideration of this act, we are compelled to oppose the financing vehicle it contains. Our objections may be summarized in three areas:

First, there is no demonstrated need for Federal purchase and subsidy of local government's bond issues. We stated last year and

now repeat, that smaller communities have been able to sell their bonds at competitve market prices-often lower rates than the large metropolitan centers.

I might interject here that there are many communities who do not have a rating on their bonds because they don't owe enough

money.

The drop in volume in 1969 largely resulted from local statutes limiting the maximum rate of interest or from market decisions of the issuers, themselves.

Senator BAKER. Could I interrupt one second?

Did I understand you to say that there is no failure of small communities to sell their revenue bonds?

Mr. FOGARTY. Right.

Senator BAKER. I really wonder about that. I can think of situations in my own experience and I have been told that communities have tried to sell revenue bonds and have been unable to sell them.

Mr. FOGARTY. There have been cases where there is a statutory rate limit. Most States have raised maximum rates where they could not get a bid. Even the Federal Housing bonds could not be sold. because of such limitations.

Senator BAKER. I am thinking of water bonds and sewer bonds in Tennessee.

Mr. FOGARTY. I have talked to Harold Clark of Cherokee Securities Co. and asked whether he knew of any instance where that happened in Tennessee. He sent along a long list of very small communities in Tennessee that had been able to sell their bonds.

Senator BAKER. I have a high regard for Harold Clark and he ought to know, but do you have on do any of your associates have a compilation of revenue obligations that were not taken up or are there such compilation?

Mr. FOGARTY. The Bond Buyer has a list which they have published and kept up to date during 1969 of the issues that came up for sale that did not sell. This list is later reduced as they do sell. There were times in 1969 when communities got bids and they said, "we will wait until the rates go down."

Senator BAKER. Were there also cases where there were no bids at all?

Mr. FOGARTY. I do not know of one. Last year, we asked the National League of Cities to investigate and tell us if they had any existing community which could not get a market bid. My colleagues and I know of no such cases and together we cover a good part of the country. In case you do have questions, Mr. Harkness is largely in New England and the Northeast, and Tom Masterson is in Texas, and my firm runs from Illinois to New Mexico, Colorado, and Nebraska. We represent a large geographical area and I have talked to others such as Mr. Clark about this question.

Senator BAKER. If you will proceed, then, with your testimony. Mr. FOGARTY. In 1970, this market absorbed approximately $18 billion long-term debt and an equal amount of short-term notes. In the first 2 months of 1971, over $4 billion of local bonds have been sold. By more than tripling its capacity during the past 10 years, the municipal market has demonstrated its growth capabilities.

Second, the method proposed of creating another Federal credit program is not in the best interests of the Nation's economy, an opinion supported by public statements of many Treasury officials. Assistant Secretary Murray Weidenbaum has repeatedly pointed out the inherent problems in this area.

Of $22 billion net increase in Federal and federally assisted loans for 1971, only $1.5 billion are included in the budget. In this article, "A Reevaluation of Federal Credit Programs," a copy of which is attached to our formal statement, he points out several problems with loan programs such as EFA. (See p. 837.)

These have led to a rapid increase in Federal Government involvement in private capital flows. They involve borrowing techniques that do not undergo the discipline of the budget or the private capital market. These programs generate higher budget outlays for future interest subsidies and thus increase uncontrollable budget items.

Such credit programs, Mr. Weidenbaum has stated, have contributed to a proliferation in the capital markets of inefficient and inequitable forms of Federal aid, to higher interest rates, and to misleading changes in budget figures.

His suggestions for consideration:

1. A careful review of such programs to see that meeting priorities does not upset economic stability.

2. An improvement in controls over the total volume of federally assisted credit and the impact of the time lag between commitment and takedown.

3. When possible, the program should be budgeted explicitly and its lending should become a part of the normal Treasury financing process.

Former Secretary Kennedy, in his testimony before the Joint Economic Committee last July, admitted such programs for the normal financing of the Treasury, and that changes were being studied.

Senior Advisor to the Treasury, Prof. Henry Wallich, has recently stated he felt such programs as EFA were "a step in the wrong direction."

The Office of Management and Budget has noted the lack of coordination and consistency with overall public debt policy. Furthermore, a special subcommittee of the Cabinet Committee on Economic Policy and the President's Commission on Financial Institutions are currently exploring the implications for the financial markets as well as the overall impact of these programs on the economy. Third, there are specific technical difficulties in the bill:

1. The diffusion of responsibility between the Treasury, the Authority, and the Environmental Protection Agency.

2. The lack of a clearly defined reasonable rate to efficiently determine the scope of EFA.

3. The absence of guidelines in setting the rate at which EFA would land to the community.

With the recognized agreement that such programs are unsatisfactory, we cannot support the creation of another such mechanism. This debt financing technique could easily be extended to other major Federal assistance programs. Therefore, it is important to

bring to your attention that this type of Federal financing would constitute a major change in our governmental fiscal structure.

This could severely limit the political and fiscal flexibility of our local governments and make them subservient to the budgetary and administrative requirements of the Federal Government.

We believe it would be most unfortunate if our examination of EFA were to leave the impression that a vital element in the water pollution control effort would be sacrificed were EFA not enacted. In fact, this bill directs attention away from what many agree to be the many major gaps in the program:

1. The lack of sufficient Federal grant participation through direct annual appropriations.

2. The lack of an effective priority system so that money is earmarked for pollution control where needs are greatest.

3. The lack of dependable and long-term commitment on the part of the Federal Government.

EFA makes no positive contribution in these three areas. However, there does exist an excessive network of departments within the Federal Government structure which is devoted to providing assistance to water and waste treatment facilities.

Rather than create a new Federal debt financing scheme, it would be preferable to fund pollution control needs through existing Federal departments and, inasmuch as possible, by current revenues or, if necessary, by direct Treasury borrowing. This practice would be less inflationary.

In conclusion, I point out that the continual shifting of borrowing in the capital markets to come under the happy umbrella of Federal assistance has increased to the point that estimated direct Government borrowing in fiscal 1972 will be $9.2 billion, while net new borrowing for federally credit assisted programs will be $31.4 billion. As Tilford Gaines, economist for Manufacturers Hanover Trust, states in his February report, the estimated budget deficit in 1972 is $11.6 billion but "is likely to be at least $25 billion", in which case, "the net increase in Federal and agency borrowing from the public is likely to be on the order of $55-60 million. This figure. would be in excess of 40 percent of all demands upon the credit and markets".

At what point does Federal assistance to borrowers lose its impact? Not everyone can get under the umbrella. We therefore respectfully request the committee to reject again the proposed Environmental Financing Authority.

Senator MUSKIE. Mr. Fogarty, I understand this is a summary of your more complete statement.

So, without objection, your complete statement will be made a part of the record following your testimony. (See p. 821.)

Senator BENTSEN (presiding). Mr. Fogarty, as I understand it, one of the recommendations you have made in lieu of EFA is that the Federal Government in effect take over a larger share of the burden and it seems to me this calls for a larger impact on the Federal budget, itself, rather than encouraging the municipalities and local levels of government to carry a substantial part of this burden. Mr. FOGARTY. No; we are talking about municipalities putting up

their share. But the other part, from the Federal Government, should not be financed through an agency which pays a higher interest rate than the Treasury would if it borrowed directly.

Senator BENTSEN. You deal with lack of Federal grants assistance through direct, annual appropriations and call that a major gap in the program. So, it seems to me that what you are advocating is an increased burden on the Federal taxpayer and a further imbalance in the budget problems that we have.

Mr. PETERSEN. Senator, I think a longstanding problem has been appropriations are falling way behind authorizations in this key area. The program's intent has not been carried out.

There is another side of the coin, you are quite correct.

We do believes that since we are funding a national priority program, it should be paid out of increased tax revenue or increased direct Treasury borrowings. The substance of our argument is that the commitment has to be in the budget and that to not have it in the budget is inefficient and uneconomical.

Senator BENTSEN. What you are calling for is greater Federal responsibility as opposed to the program proposed under the EFA. Mr. PETERSEN. We want an explicit statement about Federal responsibility. We find EFA something of a vacuous concept. How great will be the use of EFA? We have estimates, it is true. But, what we are really arguing for is a better way to get this kind of financial assistance-to the extent that it is truly needed-to communities that are hard pressed.

We think a better way to do that is through the budget, funded by current revenues or funded by direct Treasury borrowings.

Senator BENTSEN. But you would agree that you are calling for greater Federal participation in direct expenditures of the Federal taxpayers' money and therefore an additional budgetary problem?

Mr. FOGARTY. Senator, we are still calling for municipalities issuing the same amount of bonds. We are saying the Government should not have to bear more expense than is necessary.

Senator BENTSEN. I am reading from your statement where you refer to the gaps in the Federal programs and insufficient Federal appropriations.

Mr. FOGARTY. Right. My contention in this area is that the municipalities have no trouble borrowing. It is the operating expenditures that are their problem. That is where I think the grants are needed. Debt service is outside the debt limit. Most cities can levy whatever tax is necessary for debt service but not for operations. Most of them have statutory limitations on tax rates.

Senator BENTSEN. Senator Randolph?

Senator RANDOLPH. Thank you, Mr. Chairman.

Mr. FOGARTY. You were present when I asked a question of the Under Secretary in reference to the Proxmire amendment, and the background which I gave of the earlier consideration in the Senate and Senate-House Conference on that proposal?

Mr. FOGARTY. Yes, sir.

Senator RANDOLPH. At that time, I indicated that it would be appropriate to have the thinking of the Investment Bankers Association in reference to the permission being granted to commercial banks to underwrite the water and sewer revenue bonds.

I want to direct the question now as I directed it then, recalling also to your mind the position that you might have also taken at