Municipal Bonds U.S. Government Bonds, Etc.
( Originally Published 1918 )
William R. Compton & Co. issue the following treatise on Municipal Bonds:
Money borrowed in large amounts, whether by a municipality, corporation or individual, is most conveniently obtained through the medium of bonds. Bonds, in the commercial sense of the word, are simply integral parts of a debt in convenient denominations, generally ranging from $1,000 down to $100. The total represents the amount of money borrowed and is properly secured by a pledge for the equal benefit of all the bonds. Ordinarily coupons are attached to each bond. They represent the yearly or semi-yearly interest and are to be cut off at each interest period and presented at the place of payment, where the cash may be obtained. Your local banker will collect the funds for you.
Corporation and individual bonds are usually secured by a mortgage on tangible property. The sufficiency of the security thereof is a matter of judgment on the part of the investor, or of the banker with whom he deals. Bonds of this nature are of such variety that a separate treatise on each class is necessary.
We only attempt in this article to inform you about Government and Municipal bonds. Bonds of this class are debts of a nation, state, city, county or a district. These governmental units whether they be a city or county or a unit created for special purposes such as School Districts, Districts for Roads, Bridge, Drainage, Levee or similar public enterprises are all within the broad meaning of the word municipalities. They have powers, limited by law, to borrow money, issue bonds, pay interest on such debts and impose taxes upon property. Sometimes the tax is imposed upon real estate, personal and corporation property, in fact all tangible property; at other times it is simply on real estate. These taxes are collected annually or semi-annually; and the funds, which are separated from other funds, are used to pay the interest on bonds and are of sufficient aggregate amount to pay the bonds themselves the money loaned when it is due.
Practically all communities borrow money, and when you pay your taxes, a certain amount is for the definite purpose of providing the interest and principal on that part of your city, county or district debts (bonds), which in equity is your pro-portion. No one who has property escapes; and, in fact, even those who have no tangible property indirectly contribute toward the taxes. Look around in your community and realize that every building, every vacant lot, every farm, every store, factory, railroad, corporation ,and all personal property is taxed to extinguish these debts. Every year this process is repeated. If the owner of any property does not pay his taxes, his property is sold for those taxes which are due; and each succeeding owner must stand his share of the burden which is subsequently imposed upon that property. If you own a mortgage on a building or farm or, in fact, on any real estate, you are not safe unless the owner pays the taxes, or you pay them for him. Taxes are a first lien upon any property; a mortgage can only be a lien second thereto.
Municipal bonds are usually authorized by the voters of the community in which they are issued, either through the exercise of the ballot, by right of protest in court, or through due notice by a court of the intention to tax you, thus giving you the right to file legal objections if you consider your tax unfair. The legislature of each state passes laws granting to these municipalities the power to borrow money, telling them the purposes for which they can incur indebtedness and setting out all the conditions precedent to their issuance and also granting authority to levy the necessary taxes to pay off the indebtedness.
These legislative enactments, in most cases, have been reviewed by the courts of each state and thus have become well settled, recognized laws which serve as a guide in the necessarily legal proceedings prior to any community's bonds being marketed.
All property is supposed to be assessed that is, a value is put on it, by public officials appointed for this purpose, which may be its true worth or only a percentage of its actual value. The latter is usually the case; property is undervalued for taxation rather than overvalued. The aggregate of all these assessments of property is the "assessed valuation" of a community. You will see such figure in the financial statement of any city, school district or county. The debt then represents a percentage of the assessed valuation. Thus the city of St. Louis has an assessed valuation of $624,577,260, and a debt of $24,388,000, which is 4 per cent of the total assessed wealth. Again, the school district of Cleveland has an assessed valuation of $885,000,000 and a debt of $6,947,500. This sum is money borrowed to build new public schools. This debt is considerably less than 1 per cent of the assessed value.
Large cities, being better known, naturally can obtain money at less interest rates than small communities. But the bonds of any thriving community, having a reasonable debt which represents a small proportion of the assessed valuation, afford investors equal safety. The same methods are pursued in providing the means of payment taxes must be paid in small communities as well as in large ones; the laws regulating and limiting the issuance of bonds are just as strict and much better interest rates can be obtained.
You will frequently notice municipal bonds designated as legal investments for savings banks. Each state has its own particular laws governing such investments. Thus, in New York State, among other requirements, a bond must be issued by a city having 45,000 population or more and no school district outside of New York State is recognized. Certainly a bond issued by the school district of Cleveland, Ohio (the district includes the entire city) is just as safe as a bond of the city itself, and, again, a city having a population of 5,000 or 10,000 is just as able to pay its relatively small indebtedness as is one of 45,000 population.
Again, many municipal bonds are accepted by the Postoffice Department at Washington as proper security for deposits of Postal savings funds. In every community the government selects one or more local banks as a depository for such funds. The postmaster, as the deposits accumulate, turns the funds over to this bank and the bank itself sends to Washington a sufficient amount of government or municipal bonds of an acceptable class. If they are government or state bonds having a market value equal or above their face value, they will be taken as security for a like amount of government money; or they will be taken at their market value if that be less than their face value. In no case, however, will they be taken at over their face value. Bonds of cities of a population of 30,000 or more are taken at 90 per cent of their face value, and those of smaller communities at 75 per cent of their face value. These are some of the restrictions and requirements of the government which render bonds acceptable ; and all bonds on our list, which are acceptable, are designated as such and can be bought with such assurance on your part.
District Bonds. School bonds are usually district bonds. The manner of providing for their payment is the same as if issued by a city-the same property is taxed, both real and personal, and frequently suburban property, the population of which enjoys the school privileges of the city, is also included in the district. Some few municipalities administer their school affairs as well as the city affairs and, in such cases, bonds issued for school purposes are city bonds; but this condition is infrequent. The majority of communities separate these governmental functions and elect school directors or trustees who administer school affairs and issue bonds when directed to do so by a vote of the people.
Drainage Bonds. Good roads are necessary. Drainage for valley lands and protection from overflow by the building of levees are equally necessary for proper productivity and sanitary purposes. Districts created for such purposes do not include whole counties but only such parts thereof as are benefited. The property benefited should and does pay the cost, the land benefited being taxed, and thus each piece bears its separate burden. The taxes are collected by the county officials, the same officials who usually collect the other taxes school, county and state. Each property owner has his opportunity to object to the tax imposed upon him and the right of appeal to the higher courts.
Bonds of This Class are serial in form. That is to say, so many $100, $500 or $1,000 bonds become due and are paid yearly; sometimes payment begins a year after issuance and always within reasonable time. Thus as taxes are collected, they are rightfully applied to the extinguishment of the debt. Good interest can be obtained on these securities yields varying at present from 5 per cent to occasionally 5 1/2 per cent.
Free From Income Tax. Bonds mentioned herein that is, government, state, county, city and district are in most states all exempt from the Income Tax, and are so declared by law. You are not annoyed by signing a declaration of ownership, as you must do if you buy any other kind of bonds. The advantage is so apparent that the market for all municipal obligations is constantly broadening.
Selecting Your Banker: When you have cash, you place it in a bank which you know is sound and whose officials you believe are careful business men. You usually prefer a bank that has been in existence many years and which has proved itself conservative. Your banker loans the money you leave with him, and he must select good security for his loans or you will not receive back your funds when wanted. He often buys these bonds.
The Salient Feature to be remembered in regard to tax bonds is that they are based upon the approval of those who will have to pay them, and consequently the tax for their payment is not a source of friction to the taxpayer. In other words, a municipal debt is self-imposed. The advisability of undertaking any municipal project, for the payment of which a debt must be incurred, is put before those who will have to pay it the taxpayers and if approved by them, or their representatives, bonds are issued to finance the improvement.
Another factor of prime importance is the, absolute necessity of governments, both for the economic and social welfare of the people of any community, whereas no commercial undertaking is of such vital importance. Mr. Dwight W. Morrow, of the firm of Messrs. J. P. Morgan & Company, in a recent speech explained this difference as follows :
"The history of the last hundred years compels us to judge a Government obligation by a standard different from that applied to an obligation that depends merely upon the skill and ability and foresight of men, however wise they may be. A new invention may do away with prosperous sailing vessels. A change in a form of machinery may do away with this mill or that mill. In a single decade high grade first mortgages upon real estate in a great city may lose a portion of their value by the removal of lines of trade to a new section of the city. Railroad investments and electrical investments have their time of popularity and unpopularity. But back of all ordinary investments stand governments; and government obligations have been and will continue to be if there is to be any order in the world the premier security into Which investment money can go."
While Mr. Morrow confined his remarks to government obligations, the same general principle holds true in regard to all tax obligations. Cities, schools and various other governmental functions are all necessary "if there is to be any order (or progress) in the world."
The effect of this was shown at the outbreak of the European war. Factories were closed, railroad earnings fell off, receiverships of every kind were the order of the day.
The government, however, continued to exercise its functions as did the governments of the various cities, towns and districts throughout the country. Taxes were assessed and collected as usual, with the result that tax bonds, both principal and interest, were paid as usual. What was the result?
While all classes of commercial obligations were greatly depressed in price, and in fact were practically unsalable for a time, municipal obligations suffered relatively little in price and could be marketed with much greater facility than commercial obligations.