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March 11, •United States Annuity Bonds91 Mr. Piser Mr* Thurston * proposal from Winthrop W* Aldrich. I would like to have your opinion of the attached suggestion. Offhand, the first objection to it that I see is that it oonteaplates amortisation that might fall in a period when It would be undesirable. In other words, it Is a cossaHasazit to retire debt, though it might be untimely or unwise to do so* Attachment ET:b Form F.R. 131 BOARD OF GOVERNORS DF THE FEDERAL RESERVE SYSTEM Office Correspondence TO Mr- Thnrg-fanyi Date—mr* 15, Subject: Mr«, Kennedy In Mr* Piser's absence I am sending along a few comments on United States annuity bonds, a new security issue proposed by Winthrop W, Aldrich. While the proposed new securities have a number of features that cure favorable, it does not seem that they are needed, particularly if the Treasury will adopt the financing program recommended by the Federal Reserve System* The present savings bonds, together with the short and long non-negotiable issues proposed by the Chairman* pretty well cover the field and there appears to be no need for the proposed annuity bonds* I do not believe that they would take the place of Series E, F, and G savings bonds, as Mr. Aldrich indicates* They would probably not be attractive to the small investor, since the amortization payments, interest and principal, would be very small* The Treasury1s administrative costs in bookkeeping, the mailing of checks, etc*, on small denomination bonds would be prohibitive. The large denomination bonds might be attractive to wealthy individuals or large corporations but funds from this source should find their way into the present savings bonds and proposed new short and long non-negotiable issues* There appears to be no serious objection to the amortization of the interest and principal over a period of time* The bonds would be dated at monthly intervals and consequently the payments would be spread month by month over the years* This is essentially what will take place with respect to defense savings bonds when they begin to mature. The only difference in this connection is that payments on the proposed securities start earlier than the maturity of defense savings bonds* The three-year accrual period might not be long enough to cover the war in which case, as you suggest, the amortization feature might cause hardship on the Treasury* Mr# Aldrich1s memorandum speaks of the demand liability of the Treasury on the large volume of outstanding defense savings bonds* The proposed securities, however, also in a sense would be a demand liability after three years from issuance, and there is no limitation proposed on the amount any one subscriber is permitted to purchase, whereas there is such a limit on defense savings bonds# The fact that the proposed securities in case of redemption would require a larger discount than do savings bonds may not be effective in preventing cancellation if the funds are needed by the investor* CTATES AKNUITY BOMBS A Proposal from Winthrop W, Aldrich, Chairman Board of Directors of the Chase National Bank of the City of .New York Introduction Any proposal, worthy of serious consideration at this time, must recognize the magnitude and com- plexity of the Treasury's task in providing funds for the war effort* The proposal must go further and look to the nature of the Treasury's responsibilities in the transition from war to a peace economy. The bond issue herein described is designed to appeal to the public and at the same time regularize the Treasury's financing without increasing its immediate cash outlay. It is adapted to the basic economics of the present and future situation of the nation, in so for as that situation can be appraised. It is believed that the bond would utilize the present needs of the Treasury for new money to furnish a bridge into the post-war reconstruction of the nation by providing purchasing power ^ to the nation when it will be needed. Briefly, the form of the proposed bond is patterned on the characteristics of term loans as developed in recent years by commercial banks. After a three and one half year grace period, during which interest accumulates, principal and interest would be returned to the purchaser in equal instalments so as to retire the bond at its maturity. Purchases would not be limited to any fixed amount. It is believed that the bond would appeal to large purchasers, as well as to those with medium or small resources. It should attract those whose income during the war will ex- ceed their prospective post-war income, and those who, by reason of age, would be interested in annuities. - 2 The introduction of such a tond would give added strength and security to the fiscal position of the Treasury. For, to the extent that the Annuity Bond fittds favor with investors, the shortterm indebtedness of the Treasury would "be thereby reduced. The fact that the principal repayments are spread over a period of time would, in itself, ease the "burden of debt retirement in the post-war period. Although tax revenues will increase, the projected war expenditures of the federal government will be financed, for the most part, by the sale of its obligations. Estimates contained in the President^ budget message of January 7 indicate the sale of over $19,000,000,000 of obligations in the fiscal year 19lfl-^2, and $3*4.,000,000,000 to $35,000,000,000 of obligations in 19^2-^3* These are sales that must be made in addition to those government issues placed with trust funds under the Social Security and other legisla-* tion. The Status of Defense Bonds With such requirements confronting it, the Treasury must exercise the utmost skill in handling its finances. The security issues most importantly used in the financing of the Treasury are of two types, the general money market bonds issued under the Second Liberty Loan Act (together with Treasury notes and bills) and the "defense bonds11 issued in Series "E", MFlf and V * l/ It has been estimated that of total borrowings, exclusive of trust fund borrowings, approximately $9,000,000,000 to $10,000,000,000 annually will be realized from the sale of defense bonds * These issues are not negotiable but are redeemable* The Series ft E" and !1F1t bonds are pur- chased at a discount of par and are redeemable at successively higher l/ Series "E" bonds are designed for smaller purchasers and the Series fl M F and "GfT for those with larger resources. -3 percentages of par value* The Series "G" bonds are purchased at par and redemption value varies between 9^«7 per cent of par and par during the life of the bond. For the most part, defense bonds are sold to individuals, institutions, and other non-banking purchasers• It is highly desirable that a still larger part of the Treasury's borrowing be done in this manner. The sale of these defense bonds began last May. In the final eight months of lS&l, a total of $2,538,000,000 was sold. Of this total, ^5 per cent went to smaller purchasers in the form of Series Tf E" bonds, and 55 per cent to larger purchasers in the form of Series !fFlf and "G" bonds* Interestingly enough, December sales reversed these percentages, 65 per cent consisting of Series "F" and nGff bonds. Series ir E" bonds and but 35 per cent Series If F" and "Gft bonds contributed about 1*5 per cent of total defense bond sales in the Second Federal Reserve District from January 1 to January 23 > inclusive. The present series of defense bonds appear to be of limited suitability for purchases in substantial amounts by those with large resources. For this and other reasons, it is proposed to supplement and, perhaps, replace the Series "F" and 1fG!l bonds by an issue of United States Annuity Bonds. In addition, the Series !fFlf and "G" bonds have another objectionable characteristic from the standpoint of the Treasury* After six months, they become redeemable on the first day of any calendar month, on one month's notice in writing. The Series "E" and l! t! F bonds are re- deemable at not less than the cost price. The Series "G" bonds are redeemable at moderate discounts of the cost price but at not less than cost price when interest payments are included. Heavy demands on the Treasury in the future might occur under unfavorable circumstances should the sale of defense bonds reach large levels* The one month's grace per*iod would not provide the same relief for the Treasury that it provide© in the case of a bank. In so far as redemption might be demanded by the -k public in successive months, the defense bonds constitute a liability on the Treasury's books of uncertain nature, but one more akin to a demand than to a time obligation with a fixed maturity. Requirements of a Desirable Issue Three important requirements occur in considering the most desirable type of obligation for the Treasury to issue * The bond should appeal more strongly than the Series ff F" and IT n G bonds to potential purchasers who possess large idle balances* The demand liability position of the Treasury should be prevented from increasing in so far as possible* There should be no "unnecessary addition made to the cash demands on the Treasury in the immediate future* If a bond can be devised to accomplish these objectives, a highly desirable revision will result in the Treasury's financing program* The United States Annuity Bond It is hoped that the United States Annuity Bond herein described may accomplish these purposes, The form, of the bond, in substance, constitutes a term annuity. The issue would be dated as of the first of the month in which purchase is made, and would be extinguished 25 years after the issue date* It would be purchased at a discount and interest would accrue at 2 l/2 per cent compounded semi-annually for three years from the issue date. The 2 l/2 per cent rate is used for illustration; it is not put forward as a recommendation. By setting a purchase price of $928.17 a/ per $1,000, the 2 l/2 per cent rate enhances the purchase price to $1,000 principal amount after the three-year period has elapsed. a/ If desired, this figure could be rounded out by accruing interest for three years at a slight variation of the 2 l/2 per cent rate* -5 Semi-annual payments of principal and interest "begin 3 if2 years from the issue date. These semi-annual amortization and interest payments are made in eq.ual aggregate amounts, $30 each six months on a $1,000 bond. The interest paid progressively decreases, while the principal reduction payments progressively increase until maturity when the total principal will have been returBJ9& to the purchaser. The net yield, if held to maturity, is 2 l/2 per cent* The return to the holder after three years is 6 per cent per annum, including both interest and return of capital. The Treasury would mail checks on a single bond each six months. Since bonds would be sold in each month, different bonds would be dated differently and the Treasury would mail checks to various holders on the first day of each month in the calendar year. Each check would carry a notation of the amount to be credited to interest and the amount to be credited to return of principal. The interest accrued during the first three years would be paid out with other payments of interest and principal, beginning 3 l/2 years from the issue date. The schedule which follows shows the semi-annual return of principal with semi-annual interest payments computed at 2 l/2 per cent per annum on the respective unpaid balances of principal at successive intervals of time. These combined payments amount to $30 per $1,000 bond every six months over a period of 22 years, after the lapse of the three and one half year grace period during which interest accumulates on the original purchase price at the rate of 2 l/2 per cent compounded semi-annually. - 6U. S. ANNUITY BOND Payment and Redemption Value Schedule of a $1,000 - 2-J0 Interest bearing Bond producing $60.00 per annum, or $30.00 each six months. This i s a 25 Year Bond with annuity payments commencing 3i?" years from the issue d t These $30. annuity payments become due over 44 semi-annual periods or 22 years. (Not redeemable until end of j j - y e a r period) Approx.In- Approx.Yield on Redemption vestment Semi-Annual Semi-Annual Doliars Net Dollars Yield from value from Semi-Annual Semi-Annual L Interest at Principal Principal Payable of Income Issue Date Redemption if Annuity 2|# per Reduction Balances Periods Date to over Cost to RedempPayments annum Payment s Years Hence of Bond Redeemed if Redeemed t i o n Date Maturity • (Subscription price) ~ % ^28.17 (Average Life Method Used 1 Subscription price m nd of -|-Yr. 939*78 if i «» of $928.17 en95U52 11 hances to $lj ,000. 1-|-Yrs, 963*42 f! u 2 principal, a*; end 975.46 ti ^1- " of the 3rd Year. 987.65 tl O ft • # 1,000.00 30.00 $ 12.50 $ 17*50 912.50 $ 907.00 $ 8.83 •25# 3.300 ft "J» $ 30. ti 12.28 17.72 964.78 .40^ 3.420 884. 15.83 tt 4 I . tt 30. 12.06 17.94 J46.84 •6o# 3*500 964. 25.83 30. 5 n 11.84 18.16 926.68 .80$ 847. 38.83 3.530 30. 11.61 18.39 910,29 1.00$ 3.580 831. 52.83 ft "ti tt g 30. 11.38 18.62 8J1.67 1.20^ 817. 68.83 11.15 30. 18.85 872.85 1.30# 3*.640 80.83 799. tt ^ if 10.91 30. 19.09 853.73 3.730 781. 92.83 30. 7 i •• 10.67 19.33 834.40 1.50JJ 3.750 764. 105.83 30. e " 10.43 19.57 814.83 1.60^ 748. 119.83 3*77$ 732. 30. 10.19 19.81 795.02 1.70JJ 133.83 3.790 30. 717. 9.94 20.06 774.96 1.80$ 3*800 148,83 9, " 699% 30. 9.69 20.31 754*65 1*85$ 160.83 * " 3.830 30. n 10 " 734.08 1.90^ 3.91^ 680. 171.83 9.43 20.57 30. " K>£ » 9.18 20.82 713.26 1.955^ 3.960 662. 183.93 11 \ \ n 30. 8.92 21.08 69^.18 2.00$ 3*990 644. 195.83 30. 8.65 2.05^ 4.09* 625. 206.83 670.83 21.35 «tt H i • • 12 n 30, 8.39 51*61 649.22 2.05$ 4.3<$ 602. 213.83 11 30. 12^- " 8.12 21.88 627.34 2.10$& 4.345s 584. 225.83 it 1^ fi 30. 7.84 22.16 605.18 2.10$ 4.57# 561. 232.83 30. 7.56 22 t 44 582.74 2.155« 4.60# 543. 244.S3 134- " •1 II 30. 7.28 22.72 560.02 2.15$ 4.95# 519. 250.83 11 30. 7.00 23.00 537*02 2.20$ 4.9595 501. 262.83 14^- " 30. 23.29 513.73 2.20$ 5.32^ 477. 268.83 » 6,71 15 30. 6.42 23.58 490.15 2.2596 5-33^ 459. 280.83 I5i " 30. 16 « 6.13 23.87 466.28 2.25T& 5.75# 435. 286.83 30. 1* " 5.83 24.17 442.11 2.30^ 5.70^ 416, 297*83 If 1*7 tt 30. 5.53 24.47 417.64 2,30^ 6.37^ 391. 302.83 30. 367. 171- •• 5.22 24.78 392.86 6.75# 308.83 2.319ft 11 is it 30. 4.91 25.09 367.77 2#32$ Yields from 343. 314.83 fl 1&|- " 30. 4*60 25.40 2.33$ this period 320.83 342.37 319. 19 " 30. 4.28 25.72 316.65 2.34/. on, increase 294. 325.83 30. 3t96 26.04 290.61 269, 2.35Jft quite rapidly 330*83 1 * " 20 " 30. 26.37 264.24 2.37$ 246w 337.83 3.63 11 2O|- " 30. 3.30 26.70 237.54 222. 2-39$ 343.83 21 " 30. 2*97 27.03 210.51 2.410 197. 348.83 30. 2*63 27.37 183.14 173. 2.430 354.83 " 2ljt " tt 22 " 148. 30. 2*29 27.71 155.43 2.450 359.83 fl " 22^ 121. 30. 1.94 28.06 127.37 2.460 362.83 II 23 " 30. 94. 1.59 28.41 98.96 2.470 365.83 1.24 30. 234- " 28.76 70,20 2*480 67. 368.83 ft 24 " 41.08 .88 30. 4U 29.12 2,490 372.83 tt 24^" tf 30 29.49 2.500 373*42 .51 U.59 11.59 tt 25 " -0.14 11.73 1U59 373.56 mm mm — - - 4 1 4 Totals $1,301.73 $301.73 $1,000.00 • Increment of $7l» 8 3 represents an accumulation of 2^0 interest compounded semi-annually on the $928.17 subscription price. # Dollar units were maintained when arriving at Redemption Values. -7 - Registration The bonds would be issued in registered form in denominations of $1,000, $5,000, $10,000, $50,000, $100,000 and $500,000 and made non-negotiable. The rules that now apply to the registration of the defense bonds might be used in connection with the United States Annuity Bond. * Redeemability The issue would not be callable by the Treasury Department, but on one month's notice in writing may be redeemed prior to maturity after 3 l/2 years from the issue date at the ownerfs option at fixed redemption values, as provided in the accompanying schedule. These redemption values represent a greater discount of the face value of the bonds than is now the case with defense bonds. Provision should be made for redemption in full upon the death of the registered owner at the then prevailing principal balance. This is equivalent to making the bonds acceptable for payment of estate and inheritance taxes. Or, if it is preferred by the holder, the annuity payments might be continued after death by registering the bonds in two names, or by naming a beneficiary in the bond's registration. Annuity Bonds For Smaller Incomes The foregoing description and table outline the features of a bond that should appeal to those in the middle and higher income groups, It is entirely possible that the annuity feature could be applied also to a bond designed to draw off - 8the abnormal wartime incomes of many in the lower income ranges. Industrial workers particularly should look with favor upon an instrument in which they could place enhanced incomes today, and have their incomes returned with interest over a period of years in the future. A bond designed for this purpose should have a shorter maturity; should pay out in, perhaps, ten years. Since the annuity feature would be its chief attraction, it might carry a moderate rate of interest. Cash outlays of the Treasury to service a bond paying out this rapidly would be heavier, and the amount issued in any year to any one person might be limited to $2,500» Denominations should be limited, perhaps, to $100 minimum in order to minimize clerical expenses in servicing the issue. The following table describes a $100 bond, at 2 l/2 per cent, to be retired in 10 years. After the three and one-half year period of grace, semi-annual payments of $7*80 would begin# A somewhat larger payment would be made on the maturity date, so as to return principal with interest in full. - 9- U. S. ANNUITY BOND Payment and Redemption Value Schedule of a $100. - Jfr|0 Interest bearing Bond producing $15.60 per annum, or $7.80 each s i x month*, t h i s i s a 10 Year Bond with annuity payments commencing 3^-y«ars from the issue date. These $7*80 annuity payments become due over 14 semi-annual periods or 7 y e a r s . (Not Redeemable u n t i l end of > ^ y e a r period) Semi-Annual Semi-Annual Principal Semi-Annual Semi-Annual Interest at Periods Annuity fc|0 per Reduction Years Hence Payments annum Payments (Subscription price) •• End of -J-Yr# ) Subscription price ti 1 " * of $92.82 enhances t o $100. 1-l-Yrs. fl I! 2 at end of 3rd ytar. % " 8 10 7. so 8.28 .29 .20 .10 6.55 6.63 6.71 6*80 6.88 6.97 7.06 7.14 7.23 7.32 7.42 7.51 7.60 8.18 $ 109,68 $ 9.68 $ 100.00 7 4 4+ " 1 » Totals 7.80 7.80 7.80 7.80 7.80 7-80 7.80 7.80 7*80 7.B0 25 17 09 ,00 .92 .83 • 74 .66 .57 ,48 .38 * Increment of $7.18 represents an accumulation of scription price. Dollars Principal Payable Balances if of Bond Redeemed $ 92.fe2 93 #9*95.15 ?6.34 97.55 98.77 # 100.00 85.90 93.45 78.80 86.82 72.00 ^0.11 65.40 73*31 58.90 66.43 52.50 59.46 45.60 5?.4O 38.70 45.26 31.90 38.03 24.90 30.71 18.10 23.29 11.10 15.78 2.80 8.18 "-0- $ 00.88 1.58 2,58 3.78 5.08 6.48 7.38 8.28 9.28 10.08 11.08 11.88 12.38 16.86 .16$ >4l?o .60$, • 810 1. 01 fo i.210 1005S 1,400 1.500 1.600 1.700 1.800 1.850 5.15)* 6.000 7.000 Yields from this period onf increase quite rapidly interest compounded semi-annually on the $92.#2 sub- # Dollar units were maintained #ien arriving at Redemption Values. Approx.In- Approx.Yield vestment on Redemption Net Dollars Yield from value from of Income Issue Date Redemption over Cost to RedempBate to if Redeemed tion Date Maturity *-~~ (Average Life Method Used) - 10 Economic Effects The economic effects of using amuity bonds as a supplement to Series "U* defense bonds and, perhaps, as a substitute, for Series "F11 and ftG" bonds may be considered from the standpoint: of the Treasury, the holder of the bonds, and the general economy of the country* Effect on the Treasury The present defense bonds create a contingent claim upon the Treasury in any month that holders may wish to redeem* The amount of this contingent claim increases in proportion to the success realized in selling the defense issues* There are two principal reasons why holders might demand payment. Individuals may need funds from time to time which they can conveniently obtain by redeeming their defense bonds* This could result in a large number of demands upon the Treasury in the event of a post-war deflation with rising unemployment# But it is improbable that tjie aggregate dollar demands from this source would be great or would be difficult for the Treasury to handle. Moreover, redemption in these circumstances would supply purchasing power to the community when it would "be desirable* The most important potential demand upon the Treasury in dollar amount is provided by the possibility of a material revision in the economic expectations of the larger holders of defense bonds* A state of high business activity with booming prices might induce redemption of the Series nFt! and "G" bonds especially. In these circumstances, unlike those in a situation of large unemployment, redemption on a large scale would provide the community with new purchasing power at a time when it is most undesirable that purchasing power be increased* A highly desirable feature of the United States Annuity Bond is that it is redeemable at sizable discounts of the face value. In this circumstance, a holder confronted with the decision of redeeming -lithe "bonds to acquire funds to use In other investments must accept a known loss for a contingent gain. It seems less likely that a large "run" on redeemable government bonds could occur in this situation. Even if open-market "bonds should decline in market price to a level making it profitable for the holder of Annuity Bonds to cash his holdings and purchase the opefci^market government obligations, the Treasury would find itself in the enviable position of realizing a net decrease in its debt as a result of the transaction• But this is an improbable contingency in view of the announced intention to maintain comparatively easy interest rates. After the three year accretion period, the service of Annuity Bonds would require greater cash outlays than other types of government issues. The following table uses the 25~year Annuity Bond to show just how much greater this service would be for outstanding amounts from $10,000,000,000 to $1*0,000,000,000, To the extent that it is not financed with new issues, the additional cash outlay represents a reduction of debt and a strengthening of government credit. In addition, it is a determinable amount, whereas the cash outlays to service an equal amount of Defense Bonds might fluctuate within wide ranges, depending upon the rate of their redemption* ANNUAL DEBT SERVICE TO CARRY.DEFENSE PROGRAM (in millions of dollars) Amount $10,000 20,000 25,000 30,000 1*0,000 Six per cent Principal and Interest Service Per Annum $ 6oo 1,200 1,500 1,800 2,1*00 Two and one-half per cent Interest on "Long" Bonds in any event $ 250 500 625 750 1,000 Additional Cash Outlays of Treasury—Applied to Principal Reduction of "Defense" Debt $ 350 700 875 1,050 1,1*00 - 12 - Effect on the Holder The holder of Annuity Bonds has somewhat less to fear from changing economic developments than would be the case if he possessed a marketable government bond of the customary type, which he held to maturity or was forced to sell in the market at an inopportune time* In the third year after issuance, semi-annual return of principal begins in progressively larger amounts until the issue has been fully paid at its redemption date. These successive principal payments provide the holder with the opportunity of reinvesting successive parts of his original funds over a period of time so that the average conditions that pertain over the lifs of the bond are available to him in his reinvestment decisions. This provides him with the opportunity of mitigating the effects of broad economic change upon his personal affairs. Moreover, it provides the holder with a convenient means of saving wartime income that would be returned in instalments with interest over a period of years in the future. This is especially true of the 10-year issue designed to appeal to smaller income receivers. Effect on the Economy The effects of the Annuity Bond issue upon the general economy, and more specially upon the money markets, depend largely upon the extent of their sale. To the extent that the bonds are sold in large amounts to people who use existing dormant deposits, the result is an activating of those deposits. Since the annuity feature of the bonds is designed to appeal to those who have substantial resources, it is reasonable to believe that this would be one of the results. No other type of government issue has been conspicuously successful in tapping these large unused funds. - 13 To the extent that the Treasury might succeed in financing the war effort in this way, there would be a reduction in the amount of new general money market "bonds which it had to sell. Perhaps the most difficult problem today associated with war finance occurs in connection with the now indicated necessity of large bond purchases by the commercial banks of the nation# From the standpoint of the money markets, this problem can be eased somewhat by the Treasury gradually reducing the maturity of its outstanding obligations and concentrating the bulk of its forthcoming financing in the short-tena market. But it still remains true that for many reasons, it is highly desirable for the government to sell as large a part of its issues as possible to nonbanking purchasers. Anything that can divert the forthcoming Treasury financing away from the banks and toward the public will serve the national interest and is worthy of serious consideration. The Annuity Bonds appear to possess the necessary features to attract large balances from private sources and thus to ease this phase of government financef Finally, the method of repayment should have a beneficial effect on the economy. Repayment of the Liberty and Victory bonds of the last war occurred at irregular maturity intervals. This released funds to the money markets that were used to stimulate some of the undesirable financing of the 1920's. In contrast, the provisions of the Annuity Bonds would insure that new funds would arrive in stabilized amounts. To the extent that the bonds might be widely held, funds would be returned to all sections of the nation and not concentrated in the large money markets. January 28, 19^2
@FedFRASER