TABLE II

AVERAGE ANNUAL DEVIATION OF NET INTEREST COSTS FROM
BOND BUYER'S INDEX FOR "A," "B," AND UNRATED BONDS
FOR SMALL AND MEDIUM SIZED MUNICIPALITIES

Source: Calculations based upon data provided by the Investment Bankers Association of

America and from the Bond Buyer's Index of 20 Municipal Bonds.

Factors Causing Discriminatory Treatment

Several interrelated factors tend to cause such discriminatory treatment. First, small municipalities market bond issues at infrequent intervals, and these issues usually involve only a limited number of bonds of relatively small total dollar amounts. However, overhead costs incurred in marketing an issue of small dollar amount is not proportionally less than the cost incurred in marketing a sizable issue. As a consequence, market costs per bond are higher for small issues, because the "spread"* is greater for a small issue than it is for a large issue. Major bond buyers, such as insurance companies and commercial banks, usually prefer to purchase bond issues that are large in total dollar amounts because larger issues are generally easier to trade. Thus, bond issues of small municipalities are relatively more costly to market, and less attractive to investors, than are the issues of large municipalities. Second, large municipalities generally can provide quickly and accurately the detailed financial information needed by bond dealers and buyers for an analysis of investment possibilities. Third, small municipalities usually cannot afford to employ the experienced legal and financial advisors necessary to guide the bond issue through the intricacies of the bond market smoothly and effectively. Finally, the influential bond rating services, that evaluate municipal fiscal responsibility, usually will not rate bonds of political subdivisions unless such units have at least a specified minimum amount of debt outstanding. For example, Moody's has followed a policy of not rating debt of governmental subdivisions unless debt outstanding totals $600,000 or more. Standard and Poor's does not rate governmental subdivisions having less than $1,000,000 in debt outstanding. Such policies probably reflect the general lack of interest in the bond issues of small municipalities, and the difficulty in securing detailed financial data from such units. The absence of a rating tends to decrease still further bond buying interest.

The lack of interest by the large, nationwide investors forces small municipalities to seek a market for their bonds in the immediate area, competing for the limited amount of local investment capital with other investments that yield greater returns than do tax-exempt municipals. A large number of small issues are sold to local bankers who feel that their local government should "get at least one decent bid."2 At other times:

A local investor with little expert investment knowledge and considerable
mistrust of the central capital markets may be quite willing to invest in
local municipal obligations even though his use of tax exemption is slight.
3
Local pride and sentiment may support such action.

...

Usually only a few people in the community are in a high enough income bracket to take advantage of the tax-exempt feature. Thus, issues marketed locally frequently must offer a yield approximating the yield offered by taxable securities.4

*The "spread" is the difference between the amount offered for the issue by the underwriters and the price of the issue to the issuer, and serves as compensation to the underwriters for the costs and risks of floating the issue.

The Need for Assistance

Certain factors affecting the sale of municipal issues, such as the availability of investment capital, the relative attractiveness of municipal bonds vis-a-vis common stocks, etc., are beyond the direct control of local officials. At the same time, several steps to improve the marketability of their bond issues can be taken by smaller municipalities. For example, accurate compilations of municipal credit and related financial data over extended periods of time should be maintained and made available to the bond market. A capital improvements program, backed by a sound financial plan, should be developed and utilized to schedule and to coordinate expensive and long-lasting public works projects. In addition, small municipalities should attempt to time the sale of bond issues to favorable market conditions and to advertise any special characteristics that may indicate that the community is stable and a "sound" credit risk.

Smaller units of local government seldom have staffs versed in the specialized techniques involved in preparing and selling bond issues. Being a governmental official in a small municipality is often a part-time job. Many small localities do take advantage of consulting engineers and architects, bond counsels, and financial advisors. Others, however, do not enjoy ready access to these qualified advisors, or fail to recognize their importance.

There are many ways in which state and federal governments could assist small municipalities market their securities. A survey conducted in 1961 by the National League of Cities (then the American Municipal Association) pointed up that most municipalities felt that such assistance would be of value in: (1) preparing economic and financial data to support bond sales; (2) explaining terms and conditions governing loan repayment, establishment of reserves, and issuance of additional bonds; (3) comparing advantages of revenue and general obligation bonds, term and serial bonds, and factors affecting annual debt service costs; (4) explaining techniques and procedures involved in marketing bonds; and (5) scheduling and programming capital improvements.5

State and federal government responsibility for providing assistance and for strengthening the position of small local governments in the municipal bond market has often been expressed. The Advisory Commission on Intergovernmental Relations, for instance, has concluded:

States have an inescapable interest in and concern with the
quality of the debt management practices of their local govern-
ments. Each community's practice is a matter of statewide
concern because a blemish on its credit standing, perhaps on
only a single bond issue, could affect the money markets' judge-
ment of local bond issues in that state. The dramatic increase in
local borrowing since the end of World War II also underscores
the need for state concern with local debt practices.6

The National League of Cities has long supported federal legislation to assist small communities in their efforts to provide adequate public facilities through the issuance of bonds at reasonable rates of interest. Federal assistance has been chiefly given through the Public Facilities Loan Program which, as amended in 1961, authorizes the establishment of technical advisory services to assist municipalities and other political subdivisions and instrumentalities in budgeting, financing, planning, and constructing community facilities.7

The remainder of this report will focus on what state and federal governments have done, and could do, to aid small municipalities prepare and market their bond issues.

THE ROLE OF THE STATES

State Concern With Municipal Credit

State concern with municipal credit historically has been of a negative nature as evinced by the general imposition of constitutional and statutory restrictions. These restrictions generally involved establishment of municipal debt limits at fixed percentages of the assessed valuation, and requirements for voter approval of bonded debt, often by an extraordinary majority. Problems created by restrictive debt limits have been 8 adequately treated by the Advisory Commission on Intergovernmental Relations, and, therefore, are not included in this discussion. It is sufficient to say that debt restrictions frequently have impeded efforts by municipalities to provide needed community facilities. As a consequence, such restrictions, have tended to encourage proliferation of independent, overlapping single-purpose districts, and the utilization of costly and circuitous financing methods.

State Administrative Supervision

Several states have attempted to provide guidance and assistance to municipalities by assigning responsibility for exercising administrative supervision over municipal debt, borrowing, and related fiscal operations to specific state agencies or officials. In such cases, the designated agencies, or officials, are responsible for examining, on a routine basis, the legality of proposed issues, and for assisting municipalities eliminate inadequate or defective local borrowing procedures.* This approach can be constructive and flexible; in some states it has provided positive assistance to small municipalities attempting to market bond issues. The total kind and degree of supervision and assistance provided municipalities by such agencies varies from state to state. The following examples describe the assistance provided by six such state agencies with respect to municipal borrowing.

*The attorney general's office in Arizona, Kansas, New Mexico, Oklahoma, Texas, West Virginia, and Wisconsin perform this function. In Louisiana and Michigan, the state attorney generals are called upon to examine the legality of local

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Michigan:

The Michigan Municipal Finance Commission was created in 1943 to "19 "protect the credit of the State and its Municipalities. The Commission has been given the power to:

2.

Aid, advise, and consult with municipalities relative to proposed or
outstanding indebtedness;

3.

4.

Examine municipal books and records to determine if they comply
with debt provisions established by the Commission, by statute, by
charter, or by ordinance;

Adopt rules and regulations and enforce compliance with such orders and with provisions of state law, charters, ordinances, and resolutions with respect to indebtedness, including the levy and collection of taxes for debt purposes, and the segregation, safekeeping, investment, and application of money for the payment of debt. 10

Local units are advised with respect to the comparative advantage of revenue and general obligation bonds, factors affecting debt service costs, and techniques and procedures in marketing of bonds.

The Commission collects data relative to interest rates, maturities, number of bids, and bond ratings on each bond issue. This information is not currently available for distribution. lī

New Jersey:

The Division of Local Government in the Department of the Treasury has general regulatory control over the fiscal affairs, including borrowing, of local governments in New Jersey. The duties of the Division include:

1.

Receiving and filing copies of annual audits of all municipalities
and counties;

2. Receiving, filing, and certifying all local budgets;

issues in special cases, and in Missouri and Nebraska the state auditor has this responsibility. The same responsibility is assigned to the Tax Commissioner in Connecticut; the Local Finance Office, Department of Finance, in Kentucky; Director of Accounts, Department of Corporations and Taxation, Bureau of Accounts, in Massachusetts; the State Bond Attorney in Mississippi; the Local Government Commission in North Carolina; the Bureau of Municipal Affairs, Department of Internal Affairs, in Pennsylvania; and the Division of Local and Metropolitan Government, Department of Administration, in Rhode Island.