that the expertise of the Committee on Banking Housing and Urban Affairs in these financial matters makes it appropriate for that committee to consider the advisability of defining more restrictively in the bill the "reasonable terms" test found in section 5 (b) (1) of S. 1015.

To avoid interfering with the market, the bill provides an important safeguard: the interest rate at which EFA would lend would be set by the Secretary of the Treasury only after considering the current market yields on comparable Treasury or EFA securities outstanding in the private market as well as the market yields on municipal bonds. EFA would also be authorized to charge fees to cover its administrative costs and provide for reasonable contingency reserves.

The committee is concerned that the proposed legislation may not adequately limit the role of the EFA to financing these obligations which a community cannot sell. The committee believes an amendment to the legislation should be considered to require a market test as a part of the "reasonable terms" requirement of section 5(b) (1) of S. 1015. Such a market test should not be unduly restrictive and could be satisfied by a showing by a responsible broker that the community cannot obtain credit at the posted rate.

The EFA could contribute to the success of the overall municipal waste treatment construction program. If EFA is available, no essential project need be canceled or delayed because the state or local government is unable to market its bond issue on reasonable terms.

S. Rept. 92-424

Senator SPARKMAN. Our first witness today-we have quite a number-in fact our first testimony will be from a panel that has already been assembled at the desk from the Securities Industry Association, headed by Mr. William E. Simon. I shall be very glad now to hear from you gentlemen.

STATEMENT OF WILLIAM E. SIMON, PARTNER OF SALOMON BROTHERS, AND CHAIRMAN OF THE PUBLIC FINANCE DIVISION OF THE SECURITIES INDUSTRY ASSOCIATION; ACCOMPANIED BY JOHN F. FOGARTY OF STERN BROTHERS, KANSAS CITY; THOMAS W. MASTERSON OF UNDERWOOD, NEUHAUS, HOUSTON, TEX.; WALLACE 0. SELLERS OF MERRILL LYNCH, PIERCE, FENNER & SMITH INC.; HAROLD W. CLARK OF CHEROKEE SECURITIES, NASHVILLE, TENN.; GEORGE L. PARTLOW OF HILLIARD, W. L.. LYONS & CO., LOUISVILLE, KY.; EDWARD D. MC GREW OF THE NORTHERN TRUST CO., CHICAGO; AND JOHN E. PETERSEN, DIRECTOR OF PUBLIC FINANCE FOR THE SECURITIES INDUSTRY ASSOCIATION

Mr. SIMON. Mr. Chairman, it is a pleasure to be with you this morning.

The CHAIRMAN. This, I presume, is a copy of your statement?
Mr. SIMON. Yes, sir.

The CHAIRMAN. It will be printed in full in the record. You may present it as you see fit (see p. 100).

Mr. SIMON. Thank you, sir.

My name is Bill Simon, partner of Salomon Brothers in New York City, and I am chairman of the Public Finance Division of the Securities Industry Association. With me are Mr. Fogarty of Stern Brothers, Kansas City; Mr. Thomas Masterson on my left of Underwood, Neuhaus in Houston, Tex.; Mr. Wallace Sellers of Merrill Lynch, Pierce, Fenner & Smith, Inc., New York City; Mr. Harold W. Clark of Cherokee Securities, Nashville, Tenn.; Mr. George L. Partlow of Hilliard, W. L. Lyons & Co.; Louisville, Ky.; Mr. Edward D. McGrew of the Northern Trust Co., Chicago, Ill.; and Mr. John E. Petersen, Director of the Public Finance for the SIA in Washington.

We are delighted to represent geographically the entire United States, including the small dealer, the medium-sized dealer, as well as the major dealers in New York City and commercial banks.

I would like to begin by begging your indulgence, Mr. Chairman. This is the first time in many appearances before congressional committees that we have been called upon to testify on four topics. While there is some interrelation, to do these justice, it is extremely difficult to summarize. I will attempt to be as brief as possible.

By our testimony we hope to lend to these hearings our experience and expertise as underwriters and dealers in all types of securities, those of State and local governments, corporations, and the Federal Government and its agencies. We now serve and will continue to serve as bankers and dealers in all debt instruments. Our basic aim this morn

ing is to appraise the various costs and market effects of the proposed Federal credit programs.

At the outset we want to say that we support, with some qualifications, the Federal Financing Bank and municipal capital market expansion proposals and that we oppose the Environmental Financing Authority and National Environmental Bank proposals.

The Federal Financing Bank is an important measure made necessary by the continued proliferation of special-purpose, awkward, and obscure Federal agency lending programs. We have some reservations as to the scope of its operations and possible conduct. Nonetheless, the FFB is a necessary step to better control and market the awesome array of obligations and guarantees.

The taxable bond option contained in Senator Proxmire's bill, in our opinion, is both conceptually and mechanically superior to a further mushrooming of agency lending programs to aid State and local governments. Its simplicity, impartiality, and use of existing market mechanism makes it a true alternative and lifts it above the Federal agency lending technique.

We continue to oppose vigorously the institution of single-shot, limited-purpose Federal lending agencies such as the Environmental Financing Authority and the National Environmental Bank. They heighten rather than reduce the problems of efficient credit_allocation and contribute to administrative overlap and complexity. It is the proliferation of such devices that the proposed FFB seeks to mitigate. Special efforts must be made to make credit assistance consistent with maintaining the health and flexibility of the capital markets and preserving a true alternative method of conventional, free-market financing. Without such an alternative source, the autonomy of State and local governments is less secure and their optnions severely circum

scribed.

Before considering the above proposals in detail, I would like to discuss the overall performance of the municipal securities market.

The existing market for State and local securities is getting the job done. There is no need for market allocations to be replaced by elaborate new institutions that would allocate credit by administrative fiat.

Following the tight money period of 1969 and early 1970, the municipal bond market has seen a strong resurgence in bond sales. In 1970 over $36 billion in bonds and notes were sold. In 1971, municipal bond and note sales totaled $51 billion. There has been an increase of over 300 percent in the last 5 years in municipal bond and note sales and a growth of 475 percent since 1960.

As tables 1 through 4 document, the rapid growth in municipal bond sales over the past few years has been broadbased. Examination of the expansion in bond sales as classified by use of proceeds, regions of the country, grades of issue, and types of issuers shows that all categories of borrowing and borrowers have shared in the increasing and robust volume of sales.

Despite the great increase in the supply of municipal bonds---and the general pressures of inflationary finance-yields on municipal bonds have ranged between 65 and 70 percent of those on corporate bonds of similar quality during the 1960's.

As table 5 displays, yields on 20-year municipal bonds are now ap

proximately 69 percent of those of comparable corporate bonds. This is an improvement over 1969 and 1970, despite the fact that municipal bond financing has nearly been doubled since the difficulties of 1969. It should be recalled that the tax-exempt bond market labored under severe attacks in 1969. The congressional hearings during the Tax Reform Act cast doubt on the underlying value of the securities to bondholders. Congress rejected the application of taxes to the interest income on State and local government. Moreover, at that time, the enormous demands of the Federal agencies generally heightened the difficulties for all borrowers.

Another important fact in judging the municipal markets' accomplishments is that yields on the lower grades of municipal bondsthose supposedly with the weakest market position-have shown through the 1960's a sustained improvement relative to similar corporate bonds and to higher rated municipal bonds.

Further directions cannot be measured simply by reviewing past performances: there must be projections into the future and comparison of the supply of and demand for State and local securities. But on the basis of most projections, it is evident that the market has by and large kept pace with demands and should be able to do so in the future. Most projections have set the size of the municipal bond market at approximately $25 billion to $30 billion by 1975.

We would like to point out that bonds are currently selling near these annual rates approximately 4 years ahead of schedule. There will invariably be deviations around the trend, but sales volume has maintained and recently has exceeded-its scheduled growth.

While proud of this record, we as an industry must be aware of and to lower borrowing costs that are consistent with the health and ways to broaden the market for State and local government securities preservation of that market. We are keenly aware of the concerns of some critics who believe that the commercial banks, which have been the predominant purchasers of tax-exempt securities, may not always sustain their demand. We are aware that the market has exhibited volatility on occasion and that in times of tight money, tax-exempt securities must compete especially hard for individual investment.

But a major concern is that no matter how well the municipal bond market performs, any reversal in its fortunes-no matter what the cause will be used to undermine further its operation and to replace it with a variety of new Federal credit institutions. Such moves further handicap and constrict the financial markets as the fundamental mechanism in the allocation of credit. It is against this backdrop that we must appraise alternative forms of credit assistance. To date, these alternatives have often demonstrated a desire to reject the principle of free and national market allocations in favor of a growing number of limited-purpose lending institutions.

We are deeply concerned about the large army of Federal credit assistance programs that are growing at an exponential rate and dramatically changing the composition of credit flows in the economy. Elsewhere we have examined the consequences of these developments in great detail. Therefore, at this point, let us quickly review the major difficulties we see in these trends.

In fiscal year 1973, if the budget deficit requires some $30 billion

in public borrowing, as many observers think, and if federally assisted credit programs grow by approximately $30 billion, as is scheduled, then the combined total of federally assisted and direct borrowing will be about $60 billion. This would represent approximately 50 percent of all net credit demands placed on the capital markets in the next fiscal year. By end of year, the combined amounts in publicly held outstanding Federal direct and assisted obligations will equal about one-half of the GNP.

Such a rapid explosion of Federal credit demands should be of paramount public concern, especially because most of them are beyond the pale of budgetary review and control, while others involve awkward, expensive, and discriminatory financing arrangements.

Federal credit programs are preemptive in their demand for credit and generate heightened competition for funds and higher interest rates. In effect, Federal agency lending operations take would-be debtors that have been price-rationed out of the capital markets and reinject them as an agency borrowing with Federal Government backing. Since these programs do not increase the total supply of savings in the economy, their operation merely pushes the pressures along. Market rates of interest go up to create a new margin of hardship cases in some area that is not insulated.

Federal credit programs can be perverse in their impact on monetary and fiscal policy as well. Under conditions of restrictive credit, when monetary policy is forced to work overtime to curb demands by squeezing out would-be borrowers, the injection of new, strongly positioned demands by Federal agencies intensifies this restraint.

Furthermore, the ultimate influence of Federal credit programs on credit flows and resources is unclear and may very well be counterproductive, since any rearranging of credit flows as a means of levering resources from one use to another always involves a loser who has been bid out of the market.

The Public Finance Division of the SIA has long called for simplification and improved coordination of Federal credit programs. From the vantage point of expense, interest costs of Federal agency financings exceed those of Treasury borrowings. Agency borrowing costs are increased by the proliferation of competing issues, the cumbersome nature of their securities, and the frequency with which they come to market about 3 out of every 5 business days.

While there is a thread of control, the potential for adverse impacts on financial markets is serious, especially in periods of credit stringency. Furthermore, the lack of control and the snowballing of liabilities and subsidies has a long-term impact on the budget and lessens its usefulness as a tool of fiscal control.

The proposed Federal Financing Bank will attempt to improve the situation by: (1) A centralization of the marketing of Federal and federally assisted borrowing; (2) Treasury approval of method, conditions, and source of agency financing; (3) requirement of advance submission of budget plans for loan and guarantee programs; and (4) limitation by the President if overall fiscal requirements and credit demands so warrant.

Quite apart from the problems we have with the conduct of the underlying programs, it has long been clear that a central marketing