Mr. FOGARTY. I think it would be a bigger percentage than that. Most political subdivisions have no credit rating. It is not necessary. Many bond issues we handle have never applied to Moody's or Standard & Poor's for the rating because they are sold within the State and people there know them. Communities have to owe at least a million dollars to get a rating or Moody's does not want to look at them. Senator COOPER. There is something quite apparent all over this country, and that is that communities and voters are refusing to vote for bonds for the most necessary things, such as school buildings. Generally, this is because of the cost, and I must say that I am not convinced at all by your arguments. You are going to get, I believe, at least 80 percent of the market and I just can't understand why you are not willing for a facility to be constructed to assist communities that don't enjoy the kind of credit rating which you then take and underwrite for them. That is my view. I remember I was here when the TVA bill was passed to enable the TVA to finance itself. Everybody opposed it. Treasury didn't want it. They wanted to come to Congress to get their money. Supporters of the TVA didn't want it at the time. The creditors didn't want it. They wanted it on their own terms. They finally agreed upon it and now they agree, because of this marketability, plus the fact that the Treasury can give us approval in time of marketing which has permitted them to market their obligation in a pretty orderly way and without disturbing the markets, as you might suggest EFA might disturb the markets. Don't you think that EFA might also keep the markets a little more orderly? Mr. FOGARTY. No; I don't think so, Senator. Senator COOPER. You are experts. You may be right on your fiscal ideas but I think you are wrong on your social ideas. Senator BENTSEN (presiding). Any further questions, Senator Cooper? Senator CoOPER. That is all. Senator BENTSEN. Senator Tunney? Senator TUNNEY. I have one question. In your statement, you say: Therefore, it is important to bring to your attention that this type of Federal financing would constitute a major change in our governmental structure. This could severely limit political and fiscal flexibility by local governments to make them subservient to municipal requirements of the Federal Govern ment. That is a very strong statement. It is a very broad statement, and I did not see anything in your statement that would back up such a strong and such a broad statement as that. Could you just elaborate briefly as to why you feel that this would make local governments subservient to the budgetary administrative requirements of the Federal Government and is a major change in our governmental fiscal structure? Mr. FOGARTY. This technique could easily be extended to other major areas. We have seen over the past several years a growing trend in Federal programs for buying local communities' bonds and then selling agencies' securities. To the extent that this continues and grows and it reduces the private bond market, we will reach the point, I am afraid, where communities will have to come to the Federal Government to borrow. Senator TUNNEY. Why is this a major change? Isn't this a continuation? Mr. FOGARTY. No; communities sell on their own now. The bulk of their financing is timed by them, brought to the market by them, and financed by them. Senator TUNNEY. I understand that. But how does EFA represent a major change from what has gone on before? Mr. FOGARTY. This is a major program that could cover everything besides water and sewer facilities. We are talking about environmental financing. We also have seen suggested legislation dealing with community development banking. All of this is a part of the pattern whereby eventually we can destroy the private market; where municipalities must come to the Federal Government to borrow. In that case, the local citizen is at the mercy of Federal budgetary problems instead of just his own city's problems. Senator TUNNEY. It represents then a major change, in your view, only as to the scope of the financing of environmental pollution control systems, not a major change in the way Government agencies purchase local bond issues and then resell them. Mr. FOGARTY. This is true. This program is a whole new venture of its own and it could be channeled into every area. Mr. PETERSEN. If I might comment on that, Senator, this program is unique in one respect: It is a wholly owned Federal agency which will not appear in the budget. I think there was some effort to minimize this important aspect by saying it is simply a financial conduit: it will be selling loans that have been guaranteed by another Federal agency, but the fact remains the program has been designed explicitly to stimulate borrowing in a particular area. We are fearful that this technique could be used in lieu of sufficient grants in the future. Under this mechanism, it has been established the program is not clearly reflected in the budget. Under Secretary Walker pointed out that this is a continuing problem. Last year we experienced three pieces of legislation which set up similar devices in other agencies. These are rapidly expanding. Thir impact on the total capital market is growing, and it appears as though federally guaranteed and subsidized loans and borrowings by agencies or by the Federal Government itself soon will represent 40 percent of net funds raised. This is something of great proportion and, I think, deserves a great amount of public understanding and study. The programs themselves certainly may have many merits. We are not denying that. We would like to see a better established need. But these programs have to be viewed in the aggregate at some point. It appears, and there are many in agreement, that these programs stimulate credit demands, raise interest rates, and are applied particularly in times of credit stringency, which is counterproductive insofar as getting a balanced fiscal and monetary policy. We think that this perhaps is the leading edge of a further attempt to use this kind of mechanism in the State and local areas and that it should be viewed that way. Senator TUNNEY. Would you favor the Federal Government participating to a greater percentage in the grant program? Mr. PETERSEN. That is our general stance, yes, to the degree that there can be a substantiated need. Either grants or advances should be used; but, at some point along the line, we have to stop levering funds in the capital markets through credit assistance. But if we are going to do this in the form of subsidization and guarantee, then it should be done in the budget. It should be done with current revenues. It is particularly in periods of capital shortage, when EFA would be used the most, that we think its use would be counterproductive in terms of the total economy. Senator TUNNEY. Thank you, Mr. Chairman. (Mr. Fogarty's prepared statement and a subsequent supplemental statement follow:) STATEMENT OF JOHN FOGARTY OF THE INVESTMENT BANKERS ASSOCIATION OF AMERICA My name is John Fogarty, Vice President of Stern Brothers & Co., Kansas City, and Chairman of the Municipal Securities Committee of the Investment Bankers Association of America. In order to answer any questions which you may have, I am accompanied by Mr. Thomas Masterson, Underwood, Neuhaus & Co., Inc., Houston, Chairman of the Municipal Federal Legislation Committee; Mr. Robert Harkness, President, Adams, Harkness & Hill, Inc., Boston; and Mr. 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 both security dealers and banks-who underwrite and make secondary markets for bonds of the 50 States and their political subdivisons. They have extensive experience and expertise in financing State and local government capital needs. Our members also underwrite and make markets in the securities of corporations and the Federal Government, including its agencies. We expect to continue to serve as bankers and dealers in all debt instruments and we believe we are objective in our appraisal of the effects of proposals to finance Federal programs through the use of credit. What we have to say deals with the way in which the water pollution control effort is to be financed. In particular, what should be the roles of debtfinancing and Federal aid in this effort? That is an important question because we believe that how this program to restore and to preserve our natural environment is financed has very great consequences for another environment which we all inhabit, our financial system. This system too has an "ecology," a complex relationship with balances and limitations. The original savings which our economy generates to preserve itself and to grow is a limited resource, capable of being exploited, overworked, and neglectfully taken for granted. In order that our selection of priorities be effective rather than empty, a continuing problem for public policy is the generation of ample savings and their employment in the most efficient manner. Alternative ways of financing Federal assistance must be examined in terms of meeting that problem. In our testimony this morning, we would like to examine several aspects of the Environmental Financing Authority. First, we will concentrate on the technical difficulties with S. 1015 which cast doubt on the usefulness of EFA as an efficient and dependable means of financing the waste treatment construction program. Second, we will review the supposed need for this new agency. Third, we will broaden the scope of our testimony to consider some fundamental policy questions raised by the creation of new Federal credit programs, and especially their extension to State and local government assistance. These considerations quite apart from the usefulness of the activity to be financed-are of crucial importance to our political and economic structure. Last, we will discuss what we consider to be preferable alternative methods of finance, both in terms of accomplishing control of water pollution in the most efficient manner and in terms of financing that is consistent with the health of the capital markets and the national economy. TECHNICAL AND ADMINISTRATIVE PROBLEMS WITH THE ENVIRONMENTAL FINANCING AUTHORITY Diffusion of Responsibility and Unnecessary Complexity As presently written in S. 1015, the Environmental Financing Authority contributes to a diffusion of responsibility in the Federal Pollution Control program and adds unnecessary administrative complexity to the entire program. Another level of decision-making and another set of criteria are established which would make the program costly and time-consuming in its operation. First, the operations and general policy of the Authority are determined by the Board of Directors and its chief executive, the Secretary of the Treasury. The Authority is authorized (but not directed) to lend to communities determined as unable to secure sufficient credit at a reasonable cost by conventional means. The Secretary of the Treasury is given sole power to determine the Authority's lending rate or rates. On the other hand, the decision is left to the Administrator of the Environmental Protection Agency to determine which borrowers are needy. Securing a loan from EFA is a three-handed decision. First, the Administrator of EPA must certify those borrowers that are unable to obtain sufficient credit at reasonable rates; second, the Authority's Board must decide whether they wish to lend to particular projects and the total amount of lending to be done, given a volume of loan applications; and third, the Secretary of the Treasury alone is empowered to establish the rate or rates at which relending will be done. This diffusion of responsibility injects uncertainty and delay into the timely financing of pollution control programs. The power to propose loans is vested in one department, but the power to lend is left to another. Moreover, the Secretary of the Treasury, by virtue of his controlling influence over the volume of lending and the rate at which loans are made, is given more than a margin of control over the pollution program. Taking a broader perspective, we question the further dispersion of the pollution control effort which would be compounded by establishing EFA. The Federal Water Quality Administration within EPA continues to represent the focal point of the water pollution control effort. However, there exists an extensive network of programs scattered throughout the Federal Government structure devoted at least in part to providing Federal assistance to water and waste treatment and handling facilities. Program requirements and objec tives vary among these. Assistance ranges from generous matching grants and direct loans to guaranteed and subsidized loans that are resold to the public. The Environmental Protection Agency now has the Water Pollution Control Program. Housing and Urban Development still has the Basic Water and Sewer Facilities Program. The Department of Agriculture still sponsors the Rural Water and Waste Disposal Facilities Program. In addition, there are financing programs for water and sewer facilities administered by the Economic Development Administration and the Appalachian Development Program. While there continues to be a shortage of total resources committed to these programs, there is certainly no shortage in the number of programs themselves. It is debatble if adding another operating entity to this galaxy of programs would be a positive contribution to the overall Federal effort. Before setting up an additional program, there are at least two types of cost that should be considered. First, there is the obvious problem of additional program overlap and duplication of staff and facilities, which runs counter to efforts to nationize and simplify the Federal governments administrative structure. Second, there is the cost of confusion and delay engendered by varying program requirements, possible inter-agency competition and the de facto obligation imposed on communities that they shop around for the "best deal" under the various programs. A more fruitful area for legislation might be the streamlining and integration of existing programs to make them reflect new priority areas. No Definition of "Reasonable Rates" A major point of concern is the absence of definitive language to explain what is meant by the term "reasonable rates" in judging eligibility for loans. Provisions of Section 5(b) of the Environmental Financing Authority Act stipulate that: No commitment shall be entered into, and no purchase shall be made, unless the Administrator of the Environmental Protection Agency (1) has certified that the seller is unable to obtain at reasonable rates sufficient credit to finance his actual needs and unless the Secretary has agreed to guarantee timely payment of principal and interest on the obligation. The bill gives no definition, not even a notion, of what constitutes a "reasonable rate". This section delegates to the Administrator of the EPA a highly subjective decision-making function. The term "at reasonable rates" means different things at different times to different people. "At reasonable rates" could mean : (1) A rate of interest commensurate with the borrowing cost or interest rate charged borrowers with similar borrowing conditions at a given time; or (2) A rate of interest sufficiently low to make a project economically feasible in its ability to pay the debt service requirements on the borrowed funds; or (3) A rate of interest which would permit the financing of a project to fulfill a social need or objective regardless of the cost of money or the economic feasibility of the project. The term at "reasonable rates" is ambiguous and the legislation should require clarification as to (1) the policy objective of such rates and (2) how they are to be operationally determined. The intent of the instructions given to the Administrator of the EPA to authorize loans only to those unable to borrow "at reasonable rates" could be that loans be made at a rate of interest commensurate with the borrowing cost or interest rates charged borrowers with similar economic strength characteristics under similar borrowing conditions. Alternatively, it could be that EFA is meant to provide some arbitrary cut-off or ceiling to the costs of credit. Similar provisions are found in existing governmental credit programs and difficulties have arisen over the interpretation of what is "reasonable". Take for example the reasonable rate provision of the Consolidated Farmers Home Administration Act of 1961. In August of 1966, the Administrator of the FHA stated to the IBA his definition of "reasonable rate" as set forth in that Act was "the rate currently prevailing in the community for credit for similar purposes and for the periods of time which the specific borrower will need to be successful".1 Almost immediately thereafter the Department proceeded to make loans at rates below those in the market and below the government's cost of money. Six weeks after the Administrator's statement, the Assistant Secretary of Agriculture wrote that the FHA "is not attempting to determine whether such rates are considered reasonable in the current money market"." These conflicting definitions illustrate the confusion that can surround such an openended term as "reasonable rates". The bill does not state the dollar-dimension of the Authority's lending program nor how it relates to the overall pollution control effort. Concrete information on where, to whom, and how much EFA plans to lend should be supplied by its proponents. The need for a new Agency has merely been presumed. If there is a need, it should be fully documented. And then EFA should be demonstrated to be the soundest, most efficient way to meet that need. No Guide in the Determination of EFA's Relending Rates and Terms A key determinant of the Authority's possible scope and the degree of subsidy it dispenses to needy communities is the rate of which it makes loans. Section 5(d) states: "Any purchase by the Authority shall be upon such terms and conditions as to yield a return at a rate determined by the Secretary of the Treasury taking into consideration (i) the current average yield on outstanding marketable obligations of the United States of comparable maturity or in its stead whenever the Authority has sufficient of its own long-term obligations outstanding, the current average yield on outstanding obligations of the Authority of comparable maturity; and (ii) the market yields on municipal bonds." There is a lack of any real guidance in such a rate setting instruction. Let us examine these conceptions and the possible uses to which they may be put. First, by considering the current yield of U.S. Government obligations 1 Letter from Howard Bertsch, Administrator of the Farmers Home Administration dated August 8, 1966. Letter from John A. Baker, Assistant Secretary of Agriculture, September 20, 1966. |