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Atlanta» Georgia

June 2?» 1940


Yesterday I outlined briefly some general tepeeta of tbc
problem of bank investment in securities with special reference to

Today«* program center* around the problem* of analysi*

of Individual municipal obligation*«

Tbi* 1* * broad subject» but

since it be* been outlined in the memorandum» this paper will be
confined to five significant aspect* of the subject which I have
given additional study since the preparation of the -memorandum:
(1) « A proper maturity schedule;
(2) « The importance of m adequate» dependable and
unified system of revenue;
(3) * The proportion of the total revenues absorbed
by debt service and other fixed charges;
(4) « Tax limitation*;
(5) l The contribution of agriculture to debt-paying


A Proper Maturity Schedule« Thera has been e great

deal of difference of opinion on what is a proper maturity schedule»
although recently» 1 feel this issue has been somewhat clarified*
There is agreement that the common practice of depending upon the
market for refunding 1* unsatisfactory*

Any unit» large or small»

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is in a less miserable position if its budget and maturity schedule
are so planned that interest and principal requirements can be met
without refunding operations*
serious trouble.

Peak maturities may be a source of

It is particularily dangerous for the smaller units

which ordinarily lack the financial connections necessary for refunding
in a bad market to hare a large volume of maturing obligations in any
on© year#

Befunding in itself is not necessarily a matter of concern
to the creditors, but inability to sell bonds when funds are needed
to meet interest or maturing principal results either in a default
or a forced refunding.

If the finances of the government are not

sound, refunding will be difficult.

A municipality in a weak fin*

ancial position will be forced to pay a high rate (in comparison
with the rate paid by sounder governments) in a good market, and
in a bad market will have difficulty selling its bonds under any

Moreover, a continuous use of refunding is expensive and

ultimately results in a high debt*

Serial bonds, if carefully planned, are more satisfactory
than issues which all mature at one date, because they relieve the
officials of the duty of administering sinking funds.

As is

generally recognised, sinking funds are all too often either not
maintained at all or are poorly invested, and in extreme cases
insiders even use them for their own purposes.

A carelessly

arranged maturity schedule of serial bonds, however, may prove

as disastrous as a large maturity of term bonds*

There are times

when it is desirable and necessary to refund maturing serials,
but it is a difficult and dangerous practice to refund them year
after year*

The popular practice of leveling out maturities so that
the annual debt service over a period of years is approximately
equal is a dangerous one.

from time to time a community finds It

desirable or even necessary to issue bonds to pay for improvements
or to meet emergencies*

If there is not to be a more or less steady

increase in the debt, it is necessary that the maturity schedule be
so arranged that there is a gradual reduction in the amount of the
yearly debt service*

Otherwise, new bonds will increase the yearly

debt service and, if this continues until refunding is necessary,
pyramiding of debt will result*

Before a local government incurs an obligations, plan®
should be made for its retirement*

Debts issued to purchase assets

which depreciate should be retired at least as rapidly as the assets
depreciate, with reasonable allowance for obsolescence#

For in­

stance, the annual rate of retirement of bonds issued to purchase
motor vehicles with an estimated life of 5 years should be at
least 20$, or better still, 25$•

It is more difficult to


how rapidly to retire debt issued to make permanent improvements,
but the old rule of thumb that at least 5$ should be retired' each
year seems reasonable*

With the character of cities and neighbor-

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hoods constantly shifting and the wants of the people changing, it
is impossible to forecast with much accuracy the usefulness of a
given project twenty years hence«

Some municipalities grow so

rapidly that it is necessary to install new equipment before the
old is worn out; while others decline in population or fail to grow
and have unused capacity*

Also, most improvements need extensive

repairs if they are to render satisfactory service much beyond
twenty years*

When debt is created to meet an operating deficit,

there is no automatic guide to determine the rate of retirement,
but the frequent recurrence of such emergencies as depressions
and disasters suggests that debts incurred for such purposes be
paid rather quiefcly*

Communities which depend in substantial

part upon wasting assets should retire their obligations even
more rapidly than outlined above*


The Importance of an Adequate* Dependable and Unified

System of Revenue*

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The more I study municipal bonds, the more I

am impressed with the importance of an adequate and dependable
source of funds, and the next revision of the memorandum will be
reorganized with a view toward placing additional emphasis on this
aspect of the problem*

It is important that the revenue system

as a whole be satisfactory.

Hot only should it bring in enough

money to operate the government according to the accepted traditions
of the community and to provide for debt service, but it should be
so planned that it does not disorganize the economy as a whole*

- 5 ~

When evaluating the effect of a given tax upon business, the amount
of other taxes paid by the same taxpayers must also be considered.

A large number of miscellaneous taxes are very annoying and may in
the long run have a more adverse effect upon business than if an
equal m o u n t of revenue were collected by fewer taxes which have
some rationality#

In this connection it should not be forgotten

that high taxes are a brake on business, although if such services
as schools, roads, police and fire protection are excellent, a
high tax rate will not retard the economy of a community as much
as the combination of high taxes and poor services*

If the credit

of a unit is to be maintained at a high level, it must be con­

The debt of the unit should, of course, be maintained

well below the legal limit, but more important it should be main­
tained below the maximum which the community can support*


other words, the debt should not be so high that an increase
necessitated by an emergency will force the burden of taxes re­
sulting from the increased debt service to s point regarded as

la studying sources of revenue, the importance of tax
collections can hardly be overstressed*

Current and past property

tax collections should be studied with a view toward estimating
the probable ability of the unit to levy and collect adequate
taxes in the future.

Grants-in-aid and other miscellaneous

sources of revenue should be scrutinized to see «bother or not
they are likely to continue*


Tfce Proportion of Total Revenues Absorbed by Debt

Service end other Fixed Charges,

More attention should be given

to the proportion of the total revenue absorbed by debt service*
Investors are quite properly cautious when the payment of interest
and principal will consume a large proportion of the total revenue*
It is inconceivable that those charged with the responsibilities
of government will continue debt service for any length of time
if it means drastic curtailment of such items as relief, schools,
and fire protection*

In this connection, consideration should also fee given
t© the proportion of the total budget consumed toy other fixed
overhead expenses, sometimes referred to as mandatory expendi­

Governmental units tend to acquire expenditures which,

for one reaaa a or another, cannot be reduced by local officials*
Some of these have a basis in law, others in controls of the
higher levels of Government, while other expenditures become so
well established and supported by organized pressure groups, that
reductions are not politically feasible.

The salaries of certain

Government officials, such as judges, mayors, member© of the council
etc., are almost always fixed by constitution, law or by charter

Continuing appropriations, and requirements for debt

service tend to increase, while Civil Service regulations and

pension plans make reductions in personnel difficult*

The public

usually thinks of controls of expenditures by the higher levels
of Goveminent as a means of reducing expenses* but in practice the
increased standards of such items as relief sad schools set by
the supervising agencies more often result in higher expenditures.
In any case* it becomes more difficult to make adjustment downward.

Whatever may be the advantages from some points of view
of the assurance that certain items in the budget will not be re­
duced* the fact remains that these mandatory expenditures add an
element of rigidity to the budget which may become serious.

If a

large proportion of the total budget consists of items which earn
be reduced only with extreme difficulty, a decline in tax col­
lections will precipitate a financial crisis»

km Tax Limitations»

Still another factor which tends

to undermine credit is various types of tax limitations*

la re­

cent years there has been a great deal of political pressure for
tax limitations on general property, and several states have already
enacted laws or constitutional amendments limiting in one way or
another the tax which can be levied*

These laws and proposals

differ so widely that the effect of each upon the bondholders
must be considered separately*

Except insofar as the power to

borrow is also restricted, limitations on the power to tax weaken
the position of the creditors*

In recognition of this, proponents

of such laws ordinarily advocate exceptions to the limitation on
tax rate in favor of taxes for debt service.

On superficial

examination these exceptions sometimes appear adequate to protect
the interests of the creditors* but it seems incredible in eases
where the debt is high that the government as a long-run policy
will levy heavy taxes for debt service while drastically curtail­
ing the appropriations for such items as schools* police, fire
protection* sad relief*

If tax limitation laws are not carefully

drawn and strictly enforced* the attempts of the local adminis­
trations to avoid the intent of the law will result in the develop­
ment of a number of unsound financial policies*

If assessments are

not also regulated, hard-pressed local government® are apt to find
the temptation to over-assess irresistible, and if debt service
is exempted from the maximum tax rate, subdivisions are tempted
to run current deficits ae long as the markets will absorb either
the short ter® obligations or the funding bonds later issued*


as the pressure on the treasury becomes greater, there is a ten­
dency to resort to any or all replacement taxes suggested, with
the result that there is less and less rationality to the revenue
system as a whole*

In case® where the units have limited power to

tax, but there is no overall limitation, the intent of thetlaw can
be avoided by the creation of special districts*

The necessity

for such subterfuges makes anything approaching long run financial
planning impossible*


The Contribution of Agriculture to Debt-Paying Ability*

This is an important but difficult topic for me to discuss with you;

- 9 ~

important because a large number of your communities are rural,
ana because it should be made clear to all that our Corporation
does not subscribe to the common doctrine that obligations of
agricultural communities are more risky than those issued byindustrial communities; difficult because yon all know more
about agriculture in this area than I can ever hope to learn.
I hare, therefore, chosen to read to you some paragraphs which
I prepared recently for a more general use:
Agriculture is an important source of income which
should receive serious consideration when evaluating the economic
background of a unit*

In some political subdivisions agriculture

is the primary or only source of income, and in a vastly larger
number, an important contributing source; while all but a few of
the cities depend in part at least upon the surrounding agricul­
tural area as a source of customers.

A combination of a prosperous

industry and a stable agriculture provides an excellent economic
background and even an entirely agricultural background under cer­
tain circumstances can be satisfactory.

An agricultural community with fertile soil and a favor­
able climate is, of course, in a better position to service a high
debt than on© with a large percentage of untiil&ble and barren soil
or other handicaps.

Mstaace fro® markets and lack of suitable

transportafc ion facilities are also limiting factors in some areas.
If assessments are properly made, these adverse factors will be
reflected in the assessed value of the land, so that the same per­
centage of debt will be approximately an equal burden in all lo

- lo ­


Discrepancies ia assessments, however, are so common

that it is always safer to investigate these factors.

Agriculture is subject to a great variety of hazards,
filer© is tbe risk of crop failure, due among other things to lack
of sufficient rainfall, insects, floods, and frost, while soil
erosion and depletion have adversely affected some areas and
threaten the prosperity of others*

Hew crops and new varieties

which are constantly being brought to the market materially in*
1luence the prospects of some regions*

Hew varieties sometimes

make possible the production of a crop ia an area where it was
previously unprofitable#

Such shifts are apt to result in re-*

ducsd incomes in other communities since the new varieties usually
produce higher yields and hence lower prices, at least for the old

Changes in the foreign market have adversely affected

many sections in the last two decades*

On the whole a diversified

agricultural system, makes for a more satisfactory economic back­
ground than an economy centered around one crop*

Rural areas,

like cities, sometimes suffer from booms and during such a period
the temptation to go more deeply into debt for new improvements
is great*

Another situation which should be watched is one where

the income of the community has declined to such an extent that
farmers can no longer support the standard of living they pre­
viously enjoyed*

A trip through an agricultural region in the growing
season is an excellent method of obtaining supplementary information


about its debt paying ability.



It is ordinarily possible on snob

a trip to get a rather accurate impression of the productivity of
the land fey the appearance of the crops.

The methods of tillage

indicate much as to the progressiveness of the area, and since
people in agricultural sections typically know on© another’s busi­
ness, a relatively few questions placed judiciously will bring
out information as to the principal source of cash income and
whether or not large outlays are necessary for fertilizers or
other expenses, and, most important of all, if this season is

A knowledge of local tradition is very helpful in

judging the prosperity of the area.

In the middle west, for instance,

where farmers often spend a considerable part of their income on
improvements, the general appearance of the countryside tells an
imx>ortaat story about income.

If the buildings are large, it in­

dicates that at one time at least income was good, snd if the
buildings and fences are still in good repair, it indicates that
the present income is satisfactory.

Such general impressions

should, of course, be checked against statistics of production
and income.

Although the farmer and villager have typically been
independent personalities and self-reliant, a rural community
tends to more of a homogenous unit than an urban center with its
many diversions and numerous cross currents of conflicting in­

Citizens in the country take a greater personal interest

in good government, at least economical government, than do
city residents*

This seems to be due in part at least to tie

fact that a larger percentage of tie people in rural sections
participate directly in tie government by folding office*


most everyone knows most of tie officials and is well acquainted
with, at least some of them*

For the most part the community

leaders in rural sections regard the credit of their county or
town, and especially their school district, as a matter of honor*
Recently, however, important shifts in the view point of rural
people have taken place*

Relief has become respectable.


benefits are now an accepted source of income, and subsidies
given farm debt are becoming more obvious.

These and other

developments will doubtless alter the viewpoint towards govern­
ment debt, although it is too early to tell whether or not this
will materially affect the will to pay local debts*


Before turning the meeting over to Mr*

Wayne, X wish to emphasise the importance of considering: the
problem as a whole*

It was necessary in the preparation of the

memo rand ua to outline the factors which we regard as important
and discuss some of them in considerable detail.

The danger in

this approach is that we will see the trees but not the woods.
As we look back on actual cases of default, we find that they
usually have been preceded by a combination of unfortunate cir­

I doubt the wisdom of making sn opinion long by the

- 13 -

inclusion of a discussion of factors which appear in the case made*
under consideration to be of minor importance.

On the other hand,

factors which would ordinarily be dismissed as being relatively
insignificant, should be treated in detail if they s o « to have
important bearing on the ability of the unit to pay its debts.
However, mention should always be made of such items as size of
debt, sources and dependability of revenue, and the economy of
the unit