Aberdeen would not be ready with a runway that is adequate to take care of the jet planes when they come in the spring. We did just complete a sewer improvement where we had the 30 percent grant for antistream pollution-is where it came from, except for the Federal participation. And this, too, would never have been accomplished. It took three attempts at the selling of bonds to do this. So if we are to improve our cities, we are going to have to look for sources of income-in the first place, controlled bond ratings-and sources other than the real and personal property tax. Now, this fairly well completes the prepared portion of my statement. If there are any questions, I will certainly try to answer them. Chairman PATMAN. We will have questions, sir. But our policy is to hear the witnesses first. We will hear Mr. Goodman after you conclude. And after he finishes, Representative Brock and I will ask questions, and if other members come in, they will want to ask questions, too. Senator Proxmire will probably be in here directly. Chairman PATMAN. Thank you, sir. (The prepared statement of Mr. Hurlbert follows:) PREPARED STATEMENT OF MAYOR HURLBERT I wish to thank you for giving me an opportunity to appear before you today, representing Aberdeen and all other smaller communities. I am here because I am vitally interested in the problems surrounding municipal finance. For twelve years, while serving as Mayor of Aberdeen, I have lived with this problem; therefore I speak from experience not theory. The first question we ask ourselves is, how are we going to finance the necessary municipal facilities? The second question is, just how far can we stretch the real and personal property tax dollar, a dollar we feel has already been stretched to the limit? Today we are to discuss the bond rating and what it means to the smaller community. Aberdeen has an "A" rating which on the face of it is good. However, it is our feeling that with sufficient study our rating should be double or possibly triple "A," thus saving the city from $5,000.00 to $10,000.00 annually in interest. The following is a schedule of this bonded indebtedness of the city of Aberdeen as of June 30, 1967: Issue 1948 water and sewer ($651,000).. 1957 storm sewer ($250,000)... 1958 water bond C ($400,000). 2 to 24 percent.. Interest Bonds: 1 to 55, 1.97 percent; 56 to 95, 2 percent. 4 percent, $125,000; 3.75 percent, $30,000; Bonds: 1 to 265, 3.70 percent; 266 to 495, 3.50 1965 sanitary sewer ($360,000) 3.20 to 3.25 percent.. Total.. Included in that schedule is the interest rate, repayment period, date of sale, amount and purpose of bond issue. It has been our experience to receive from three to four bids at each letting. We did not hire a financial consultant, however we did use consulting engineering services in arriving at the costs and the bonds were approved by our local city attorney and bond counsel. We did not receive any assistance from either the Federal or State governments in the preparation and issuance of the bonds or the obtaining of the bond rating. The bond rating was obtained solely by the submission of information to the rating companies. Two years ago the city of Aberdeen did employ the Leo A. Daly Co., Planning Consultants, to prepare a comprehensive plan. This plan was necessary to provide for the orderly development of our City and to aid in the application for Federal grants. It was the planning consultant's estimate that we would require $8,614,500 for capital improvements for the next 5 years. This in addition to our present indebtedness would total over $11,000,000-thus we would be faced with the necessity of levying over $1,000,000 per year for debt and interest retirement, or, approximately 50 percent of our tax dollar would go for this cause. This becomes really serious to us because, and for example, a $20,000 home in Aberdeen pays approximately $600 in taxes. This would increase to approximately $900, an amount far beyond what we feel to be the average individual's ability to pay. In closing, we may ask ourselves what is the answer to our financial problem— should we give up, or attempt to keep pace in the competitive society in which we live? The answer, of course, must be to continue our effort to improve. I will offer the following suggestions that I believe will help: (1) Bond ratings as such, since they play such an important part in bond sales, must be developed into a near exact science. ((2) Long-term Federal loan programs must be made more available to municipalities (example: Housing and Home Finance Agency.) (3) Federal grants must be simplified and increased in amounts. This concludes my prepared statement. Again I wish to express my appreciation for being allowed to appear before this committee. I will be happy to answer any questions you may have. Chairman PATMAN. Our next witness is Commissioner Roy M. Goodman, director of finance, New York City. You have a mighty big job, and I understand you are doing it well. We will be glad to hear from you, sir. STATEMENT OF ROY M. GOODMAN, DIRECTOR OF FINANCE, NEW YORK, N.Y. Mr. GOODMAN. Chairman Patman, Representative Brock, distinguished members of this subcommittee and its staff, I am very deeply appreciative of the opportunity which you afford me this morning to appear before this committee to discuss with you certain thoughts which I have been developing in the 2 years since Mayor John Lindsay, of New York, appointed me to the position which I now hold. May I say that the mayor has asked me particularly to convey to you his warm wishes and high regard, and his regrets that the press of his business in New York rendered it impossible for him to be here. The statement which I make to you, although as seen through the spectacles of the commissioner of finance of the city of New York, I think in a sense applies as much to Mayor Hurlbert's problems and to those of thousands of small municipalities across the country, as it does to the megalopolis-like giants, such as New York, Boston, Detroit, and other major cities. I have prepared for your reference testimony which you have before you in bound form which covers a number of facets of two very critical problems. I have become convinced that a double-barreled financial threat confronts the municipalities of our great Nation. It is for the purpose of describing that threat that I have accepted your gracious invitation to testify in Washington this morning. First, I shall discuss the astonishing and little-understood impact of bond ratings upon the borrowing costs of municipalities. Second, I shall cover the serious impairment of the functioning of the municipal bond market in 1967 by industrial revenue financing-the sale of tax-exempt municipal obligations for the benefiit of private profit corporations-the so-called industrial revenue financing. Now, broadly my thesis this morning will be to you that the combination of these two factors, the extremely difficult problems arising from ratings, and the introduction of more than a billion-dollar flood of industrial revenue bonds into the municipal bond market of the United States has created a very great additional upward pressure upon interest rates which all municipalities must pay when they seek credit. I would like to start by quantifying what I think this means to New York, and it will give you some feel for the kinds of things we are worried about. I would estimate, based upon detailed conversations with a number of municipal bonds experts, that the pressure of lowered rating and of added volume in our market is costing New York somewhere between three-quarters of 1 percent and 1 percent more to borrow its money each year. Now, may I respectfully invite you to stop for a moment to consider what the implication of that fact is. New York borrows half a billion dollars a year, each and every year. This is its approximate capital requirement. In some years it is even greater for housing bonds. One percent of that sum of money, multiplied by the 8-year average life of our bonds, adds up to somewhere between $30 million and $40 million a year of extra expense which the people of the city of New York, already heavily burdened with a debt load which amounts to about 13 cents on every dollar, are confronted with. And what this means tangibly in terms of services which might be bought, even taking the lower and more conservative figure, is something that would involve, for example, 3,000 policemen on the beat, or 700-facilities for 750 patients, or the building of 10 schools, in each and every year. That is what $30 million translates into in New York's terms. Now, Mr. Chairman, what I would like to do, if you permit me in the time allotted to me, is to divide my comments dealing, part one, with the inadequacies of the bond rating system. Chairman PATMAN. And any part of your statement you do not cover, will be inserted in the record. Mr. GOODMAN. Thank you, Mr. Chairman. I think that the statement is so lengthy it would not be feasible for me to read it in its entirety, but I would like to invite you on a little helicopter trip over the statement, to look at the broad topography of this terrain, and try to bring out a few major points. The inadequacies of our bond rating system can best be understood if we give you a little, quick historical sketch of how the system arose in the first place. In 1909, the firm of Moody's first started to rate railroads. It was not long before it added to its roster corporations and public utilities, industrials in 1914; by 1922 Poors had entered the field. Prior to that, in 1919, Moody's began rating municipals. And in 1941 Standard and Poors both merged. The early history of municipal ratings is at best a dubious one. Prior to the depression the rating services were indeed generous in handing out ratings of AAA and AA. And it is interesting to note that 48 percent of the number of defaulted issues in the 1930's, almost half were rated AAA. And if we add to that the AA ratings, that constitutes 78 percent of all the issues rated. So self-evidently, there was something egregiously wrong with the rating system which had to be remedied, and certain modifications in the use of tools have been undertaken by these services through the years. Now, in order to be sure that I bring out to you what I believe to be the most important shortcomings of the rating services, will you permit me to invite your attention to my report, in which there is a summary covering seven points of what we believe to be inadequacies of the existing system. I would like to cover those first, and then I would like to touch upon some specifics in connection with them. First of all, ratings of municipal credits cover only about 70 percent of the outstanding bonds, and about 10 percent of the municipalities capable of selling bonds. So at the very outset, we see that there is a large band of unrated cities who suffer certain very severe disadvantages because of their lack of a rating. I will go into those disadvantages in greater detail with you in a moment. Second, the ratings themselves resemble in a sense the ratings which you see in some of the better gastronomic guidebooks. Instead of stars they assign letters. Moody's assigns a triple A for the best credit, a double A for the second best, a single A for the third best, and so on down the scale, which is basically divided into eight gradations, and the Standard & Poor's system resembles this. These are such broad bands that even with a fairly long record. it is difficult to tell whether a credit is improving or deteriorating. For example, there is such a wide swing between the top of the Arated group and the bottom of the B-double-A category, that the only time the investor would know whether his bond is getting better or worse would be at that unhappy moment when it crosses the river Styx between the A and the BAA band, and that very event triggers a form of municipal catastrophe which I am going to tell you about in the case of New York in a moment-a very dire circumstance when you drop from AA to a BAA. Third, no one, including some of the analysts involved, with whom we have spoken, with whom others that we know have spoken at very great length indeed, are quite sure what a rating is based upon. The criteria are foggy. The rating services maintain a sort of an aloofness and are not too willing to discuss with the representatives in municipal offices of cities what it is about the city that occasions the upward or downward move in a rating. This is a very frustrating and vexatious problem. Fourth, there is no way to relate quality rating to the market. Any bond is attractive at a price. A bond, for example, which is going to mature in 6 month, which bears a BA rating, is probably a vastly better and safer and more reliable investment than a bond which bears a triple A rating, but which will not mature for 30 or 40 years. Obviously the element of time enters very importantly into the chances for repayment. Gentlemen, may I ask you to keep in mind one fundamental theorem with respect to a bond. It is not a common stock, it is not supposed to grow. It is supposed to do one thing, and only one thing. It is a moneymaking machine. It is supposed to pay interest at regular intervals, and it is supposed to pay off at maturity, and in the process it is not supposed to dip severely in market value, preferably it should maintain its market value during the period that it is on the market, and hold its liquidity. It seems to me that a municipal bond rating has as its sole purpose not the use of any common stock growth psychology, but the determination of one simple question-will the bond pay its interest on time, will it pay off at maturity, and in the interim period will it maintain its liquidity. The rating should not concern itself with broad questions of sociology unrelated to this specific. It should only concern itself with the physical trends and other trends which may or may not affect the production of the money machine of its prime mission, which is interest and principal repayment. I fear that we are in an era where bond ratings have forgotten that fundamental principle, and have wandered far from that target. The ratings make no allowance for the fact that a short maturity of a triple B bond-I am sorry-I have made that point. I should go on to my sixth point. The rating services are basically unprofitable. Now, I should make clear to you that I mean no-to defame in no way the rating services or their integrity. On the whole they are a well-intentioned group of men-and by the way a very small handful of men-there are only a dozen analysts in the leading national bond rating service. They are well intentioned. They have been founded for a solely private purpose that of providing a service to their clients for which they are paid a fee or a subscription rate. And the shocking thing is that over the years the two principal private bond rating services have taken on almost Biblical authority in the extent to which they are relied upon around the Nation, by the Nation's banks, its institutional investors, individuals who must make decisions, trustees who must make decisions-in short, the question of whether you have triple A bond or a BAA bond is relied upon as a form of intellectual and appraisitive shorthand which is the underlying mainstay of the whole broad public appraisal of debt securities. Now, no one is saying that it is the fault of the bond rating services that this state of facts has come to exist. But I think the time has come, long past the time, for us to point out these are private services, solely to deliver services to their clients, and the public has placed upon them a degree of reliance which neither their facilities nor their economic posture permits us to continue. Now, specifically the services cannot derive from their fees or from their subscription prices sufficient revenues to do the kind of thorough |