chased war savings bonds. It would not be for the investor looking for the highest rate.

Senator PROXMIRE. You see, the difficulty is with 3 percent bonds at the present time, municipal bonds are selling at about 5, so you wouldn't sell them.

Senator MAGNUSON. People will have to make the choice. We are calling upon them. I think that these bonds will be part of many portfolios just for the sake of doing a little, like the war savings. It may not work. Maybe we wouldn't sell any. I don't know.

Senator PROXMIRE. The only other point you might want to comment on, they say this would be another earmark area and we have gone too far in earmarking already with the highway trust fund and getting into another one is bad policy.

Senator MAGNUSON. I know this is creating another trust fund, that is true. But in some way we have got to get at this thing and give these people a chance to do it. They can't do it the way they are. As a matter of fact, they are having difficulty selling 5 and 52 percent bonds on the market.

Senator PROXMIRE. Right.

Senator MAGNUSON. I thank you very much.

Senator PROXMIRE. Thank you very much, Senator Magnuson. (The following letter was subsequently received from Senator Magnuson :)

Hon. WILLIAM PROXMIRE,

U.S. SENATE, COMMITTEE ON COMMERCE, Washington, D.C., May 31, 1972.

Committee on Banking, Housing and Urban Affairs,
U.S. Senate

DEAR SENATOR PROXMIRE: I would like to address myself to the views of the Department of Treasury on the National Environmental Financing Act (S. 1699) which will be marked-up on June 1, 1972.

First, the Department states that there is no requirement that the borrower demonstrate credit is not otherwise available on reasonable terms.

S. 1699 could be changed to provide that the prospective borrower must show that he attempted and was not able to obtain a loan at a similar or reasonable rate. Certification by the Environmental Protection Agency should be sufficient to satisfy this requirement.

Second, the Department has recommended that Federal lending agencies be permitted to vary the interest rate charged new borrowers from time to time at least as much as market rates and current borrowing costs vary.

The fixed 3% rate on National Environmental Bank loans is not a market proposition. It is intended as a subsidy-as an economic incentive to encourage expenditures in a particular direction of national need. The securities market changes on almost a daily basis with funds flowing between the public and private sectors as interest rates existing in each sector change in response to many forces. We should not let what has been recognized by Congress as a national need depend on the vagaries of the securities market.

The interest rate fixed at a low level, plus the guarantee of the purchase of obligations, allows industry to plan ahead with increasing certainty (in this instance, we are referring to industry that will be constructing the environmental facilities and providing the environmental services.) With variable interest rates and without the guarantee program, this industry would be more conservative in planning ahead to meet anticipated demand.

Third, the Department is opposed to Federal guarantees of tax exempt obligations because of certain problems raised by such guarantees.

The Treasury Department has for some time been arguing that tax-exempts are an inefficient subsidy and conflict with Federal debt management policy.

However, even acknowledging the validity of this arguement, it would mean the total collapse of local government, given the constraints under which these public bodies currently operate. Since tax-exempts have been justified as necessary to allow local governments to provide needed public services, this incentive must be broadened as new needs become known. As the bill states, "The inability of the States and localities to finance needed environmental programs jeopardizes the environment and thereby constitutes a clear and present danger to the public health and welfare".

While it is true that the tax exempts do tend to disproportionately benefit investors in high income tax brackets (thus causing the Government to lose revenue), the effects of pollution control, in increasing land values and worker productivity, will add revenue to the Government.

Furthermore, the limited amount of funds which the Department refers to is not a fixed supply. Rising incomes can be expected to bring about an increasing flow of funds into the securities market. Thus, the guaranteeing of long-term loans would only, to a limited extent, be heightening competition. For the most part, it would be slicing into a greater pool of funds.

Fourth, the Department states that the Environmental Trust Fund would not cancel the costs of the Bank. For this reason, contributions from the general fund of the Treasury would be required.

There is no way of knowing at this point whether the Savings Bond program would generate sufficient capital for the trust fund. It must be remembered, however, that the purpose of S. 1699 is not to provide a financial return to the Government, but rather a social return to the citizenry in the form of urgently needed environmental facilities. As the bill states: "It is necessary and in the national interest for the Federal Government to assist State and local governments in financing needed environmental programs." Thus, if an initial appropriation were required, I think it would be a very worthwhile investment.

Fifth, the Department states that Environmental Savings Bonds may divert the flow of individual savings away from savings and loan associations and other thrift institutions.

The environmental movement has the support of most Americans, cutting across economic and party lines. Under these circumstances, it is likely that it will attract new savings from the private sector-rather than direct savings presently going in other directions. Experience with the savings bond program during World War II substantiates this hypothesis.

Finally, the Department states that, as a general principle of effective budgetary management, Government receipts from taxes or from borrowing should not be earmarked for particular purposes, but should be available in the general fund of the Treasury.

From the viewpoint of budgetary management, this statement is correct, but from the viewpoint of maximizing Government revenue to spend in an area of national concern, it is not. Environmental Savings Bonds, for the most part, will attract funds from individuals who would otherwise have spent their funds on consumption or investment in the private sector. Given the proper motivation, the public will invest in earmarked bonds when they would not invest in general purpose bonds. Thus, there are disadvantages and advantages to earmarked bonds. I believe the latter will predominate.

Also, savings bonds are a less expensive means of providing capital than through the sale of Government securities. Another advantage is that savings bonds can raise revenue that otherwise might have to be provided through the politically tortuous route of increased taxation.

In view of the foregoing, I am hopeful that the Committee will give favorable consideration to S. 1699.

Sincerely,

WARREN G. MAGNUSON, U.S.S. Senator PROXMIRE. Our next witness is Mr. Frank Smeal, executive vice president and treasurer of the Morgan Guaranty Trust Co. of New York.

I am delighted to see you, because I am a fellow alumnus of Morgan Guaranty. I had a worm's eye view, not the kind of eagle's eye view you have. I came in as an executive clerk. They paid me the princely

sum of 25 bucks a week, and I wasn't worth it. We are delighted to have you this morning.

STATEMENT OF FRANK P. SMEAL, EXECUTIVE VICE PRESIDENT AND TREASURER, MORGAN GUARANTY TRUST CO. OF NEW YORK, ACCOMPANIED BY WILLIAM SOLARI

Mr. SMEAL. I am Frank Smeal, executive vice president and treasurer of Morgan Guaranty Trust Co. of New York, in charge of the bank's money market, portfolio, and bond trading division.

I am accompanied by William Solari, who will assist me in responding to any questions the committee may have.

Morgan Guaranty's investments in State and local government securities exceeds $700 million. Its municipal bond department is one of the leading bank dealers in public securities in the country. I make those statements in order to qualify myself and the bank in making comments on the legislation.

I will be testifying from a point of view strongly supporting the provisions of S. 3215 giving State and local governments a choice between, (1) issuing bonds on a conventional tax-exempt basis, or (2) issuing taxable bonds in return for a fixed Federal interest subsidy of 331% percent.

We do not view the proposal as a substitute for the existing market for State and local government bonds, or as a circuitous method of achieving tax reform.

We do view it as an alternative greatly to be preferred to programby-program solutions utilizing Federal credit through a variety of bond banks.

The subsidized taxable muncipal bond is designed to assist governmental units in achieving the lowest possible borrowing cost by broadening the market for municipal bonds.

State and local governmental officials have tended to react negatively to the multitude of recent public financing proposals. They have, however, endorsed the idea of a subsidized taxable municipal bond as an alternative to be preferred to expanded Federal agency credit activity.

They support the concept principally because autonomy at the underlying governmental level has been preserved. In particular, (a) the decision to sell bonds in the tax-exempt or taxable market is left to the discretion of the local community, and (b) the Treasury is required by law to automatically make the one-third interest subsidy payment directly to the issuer or a bond-paying agent.

Complex procedures which invite uncertainties as to continuing appropriation and Federal administrative review are absent.

In addition to protecting the traditional independence of local governments debt financing, S. 3215 will provide a logical means of achieving the lowest possible borrowing cost.

State and local government borrowers will be given access to an additional group of institutional investors-pension funds, savings banks, life insurance companies-in the taxable market, which is in simultaneous competition with the conventional tax-exempt market. For example, the criteria employed by a State or local official in

judging the advantages of either financing method would be based on the market which offers the lowest net interest cost. If the market for the tax-exempts relative to taxables is strong, the need for the onethird subsidy is eliminated.

On the other hand, a stronger taxable market will make the subsidy attractive.

If the latter condition prevailed for an extended period, the reduced supply of tax-exempt bonds would increase the attractiveness of that market, and invite municipal issuers to borrow without the subsidy. A competitive cycle would evolve between the two markets to the advantage of the governmental entity provided the one-third subsidy rate remained constant and the issuers continued to enjoy the option of choosing either market.

Since individual market conditions will likely dictate the direction taken by municipal issuers, it is difficult to predict the extent to which new municipal bond volume would shift to the taxable market.

On balance, it is possible that the lower quality issuer which sells bonds in large amounts would gravitate to the taxable market.

It has been asserted in S. 3215, that the cost of the interest subsidy to each municipality which elects to sell taxable bonds will be more than offset by the increased tax revenues from investors who purchase taxable rather than tax-exempt securities.

The assertion relies on an assumption that the present buyers of taxexempt bonds will invest in the alternative taxable issues and that the income tax will be collected on the interest income from these taxable issues at the weighted average tax rate currently being collected from these investors which the Treasury estimates at 42 percent.

The primary purchasers of tax-exempt securities are commercial banks, fire and casualty insurance companies, and individuals.

Since the alternative financing methods will be voluntary, there would presumably continue to be a large volume of new issue taxexempt securities available for purchase by these investors, not to mention the existing stock of $143 billion outstanding tax-exempt bonds, portions of which are continuously in the secondary market.

Commercial banks, for example, will purchase new issue taxable bonds when the yield on such securities after tax will exceed the taxexempt return on bonds of comparable quality.

But the new taxable municipal securities will also be bought by nontaxable investors, such as pension funds and State and local retirement funds. It is not realistic to assume that the weighted average tax rate of present buyers of tax-exempt bonds will represent a measure of the amount of income that will accrue to Treasury on taxable issues.

As a result, the probable additional revenue to the Treasury as an offset to the one-third interest subsidy expense, will likely be lower than the 42-percent estimate.

Despite the uncertainty regarding the cost or benefit to the Federal Government of the interest subsidy, there is no doubt that the subsidized taxable bond is a relatively inexpensive credit assistance mechanism.

I am deeply concerned about the host of Federal credit assistance programs that are growing at a rapid rate and dramatically changing the composition of credit flows in the economy.

The combined total of federally assisted and direct borrowing this fiscal year will be between $45 billion and $55 billion; aggregate outstanding debt of this type approximates one-half of the GNP. This rapid expansion of Federal credit demands should be of paramount. public concern, especially because most are not subject to budgetary review and control.

Against this background, there are an umber of new proposals being considered by Congress to establish Federal banks as a new source of capital financing for State and local governments.

It is in light of these "Urbank-type" programs that prominent governmental groups have rallied around the option of issuing taxable bonds with a Federal subsidy as an independence preserving alternative.

Since I represent a bank which deals with institutional investors in public securities in national markets, we would probably be able to increase our share of the market by underwriting and trading in the issues of these Federal agencies. We would, in effect, be underwriting an issue usually handled by a local dealer.

Long continued, this process could weaken the regional structure of investment banking which provides the wide distribution for securities, so essential to the maintenance of our wide, viable capital markets. The committee, therefore, should take judicial notice of the fear of these Urbank programs which is expressed by those who are to reap its supposed benefits, the State and local governments. The fear is founded on a number of serious shortcomings inherent in Federal assistance programs.

1. The creation of Federal banks could diminish local autonomy by establishing another Federal bureaucracy which may cause further delays in financing necessary municipal capital improvements.

2. While it is conceivable that a large amount of capital improvements may be funded at lower interest rates through the Federal bank, the existing municipal bond market could be jeopardized over the long term. State and local government may become totally dependent upon the Federal bank, and to the extent that their demand for funds exceeded the banks' ability or willingness to lend, the Federal bank would decide what amounts to lend to whom and for what purpose.

Sponsors of the movement toward Federal agency financing have cited the inadequacies of the present municipal bond market. Critics have asserted that there is some intrinsic marketing problem relating to the size of the community or the size of the issue that keeps certain governmental units from borrowing needed amounts.

There continues to be no documented proof to support this contention. Even at the height of the tight money period of 1969–70, communities of all sizes were able to borrow money if they were not prohibited from doing so by legal restrictions. The fact that they paid varying interest rates throughout the period reflects only that they were in varying market situations, represented different degrees of investment risk and borrowed at different times during the period. Last year with some relaxation in credit conditions and a stabilization of investor confidence there was a strong resurgence in municipal bond sales. An unprecedented $24.4 billion in long-term municipals were sold along with $26.3 billion in short-term notes.