the chances for default in the case of the general obligation bond are very remote. The taxing power and the full faith and credit of the entire community are behind the general obligation bond and are the security for its payment.

The special assessment bond is payable from assessments levied against the property according to the adjudicated benefits, and where the taxpayer has paid his assessment in full, he cannot be called upon for any additional assessment to take care of delinquencies of others. It is customary, however, in special assessment districts, to spread a levy in excess of the actual amount necessary to meet the obligation, thereby providing a reserve to take care of such delinquencies. Usually a margin of 10% is considered safe. There have been cases, however, where delinquencies have been far in excess of 10% and defaults have resulted. In choosing a general obligation bond, the purchaser has only to consider the ability of the community as a whole to pay. It is quite different, however, in the case of the special assessment bond. It is then necessary to check very carefully on each parcel assessed and the character of the taxpayer. Too much caution cannot be exercised in purchasing a special assessment bond.

To illustrate the reasons for extreme care in considering special assessment bonds, let us take, for example, a very small, hypothetical special assessment district against which bonds have been issued to pay for certain improvements in the district. We will say that 60% of the property is owned by four persons and the remaining 40% of the property is owned by one person. The four who own 60% of the property pay their proportion of the special assessment levy, but the fifth person, who owns 40% of the property, refuses to pay. Sixty per cent of the bond issue is paid, and to pay the remaining 40% the property of the dissenting person is seized and sold under order of court. As might easily be possible, the 40% area seized might not bring enough to pay for the 40% of the bonds in default and thus the bondholders would lose.

WORK OF THE INVESTMENT BANKERS ASSOCIATION

OF AMERICA

As mentioned before, public finance in this country has gone through a wonderful stage of improvement. We can now profit in sound and equitable public financing by a great deal that has gone before since the United States became a nation. One of the greater forces in furthering sound public finance has been the recognized, reputable dealers in municipal bonds, and within this force the Investment Bankers Association of America has performed an invaluable service in furthering uniform laws and practices in the issuing and selling of municipal bonds. Just as our Federal Government consists of a system of balances and checks, so bond dealers and the Investment Bankers Association of America represent a balance and a check for the sounder conduct of public financing.

THE TAX-EXEMPTION FEATURE

Municipal bonds are exempt from all federal taxes, except inheritance taxes. That characteristic has made them popular since 1917 with persons of large incomes on whom the high income taxes weigh heavily and who are compelled to invest in tax-exempt securities. This situation has resulted in a great deal of criticism of tax-exempt bonds. Much of this criticism is just and much of it is unjust. The buyer of a tax-exempt bond pays a higher price for it than for a sound bond of private enterprise. In so doing he automatically pays a part of his taxes, and, further, he pays them in advance. He enables the state or other taxing subdivision to borrow money more cheaply and to some extent he pays for whatever of tax-exemption he receives.

During the war the issuing of municipal bonds was greatly restricted. Financing was subordinated to the government's war needs. The National Commission on Capital Issues restricted municipal bonds very largely to educational

and health purposes. When the war ended, municipalities and other taxing subdivisions were very much behind in their building, just as there was a shortage in dwellings. Communities had to issue bonds in larger amounts to make up for the years when little improvement or necessary extensions of public necessities and conveniences could be made. In other words, communities had to catch up in constructing public improvements just as they have had to catch up in building homes. For that reason much criticism that has been directed at public officers because of the unusually large amount of municipal bond issues since the war is partly unjust. I must admit that I think a number of bond issues have not been well advised, but at the same time we must take into consideration the fact that large bond issues were needed. It is significant that in 1920 the Investment Bankers Association of America issued a warning against too great expansion of public credit and that the association and the recognized, reputable bond-houses have worked continually to prevent such expansion.1

SELF-TEST QUESTIONS

GENERAL

1. Define municipal bonds.

2. Define a taxing subdivision. What is the relation of this political unit to the security of municipal bonds?

3. What are the "two vital essentials" in all municipal bonds? Why are they called "vital essentials"? Which of the two is the more important and why?

HISTORY OF STATE BONDS

1. How does the Fourteenth Amendment to the United States Constitution affect security of state bonds? Why was it passed?

2. What effect did the coming in of the industrial era have upon the amount of bond issues sold by the states? Upon the security of state bonds?

3. Why and how did "certain southern states" default, compromise or repudiate their bonds? Was repudiation economical for them, in the long run? Why or why not?

"This lecture was delivered April 4, 1924.

4. For what purposes may states issue bonds today? For what purposes are they usually prohibited from issuing bonds?

RESTRICTIONS ON CREATING STATE DEBT

1. Distinguish between "debt limit" and "tax rate limit." Which is the more important to the investor and why?

2. Do you favor the stipulation of both a tax rate and a debt limit? Why or why not?

3. What is the maximum desirable ratio of net debt to assessed valuation?

4. How would you calculate "net debt"?

5. What factors should determine the maturity of a bond? Why?

6. What other factors should be weighed in analyzing a state bond?

BONDS OF POLITICAL SUBDIVISIONS

1. How do bonds issued by taxing subdivisions differ from state bonds?

2. Where does the political subdivision of a state get its taxing power?

3. What limits are usually placed upon creation of debt by the political subdivision?

4. What factors should be considered in analyzing bonds of political subdivisions and why?

5. In what way is the serial bond better for investment purposes than the sinking-fund bond? Inferior?

SPECIAL ASSESSMENT BONDS

1. Distinguish between general obligations of political subdivisions and special assessment bonds.

2. How is the risk of assessment delinquencies met?

3. What factors should be considered in analyzing special assessment bonds and why?

XI

RAILROAD BONDS

By JOHN E. Blunt, Jr.

Vice-President, Illinois Merchants Trust Company, Chicago

Early history and growth of railroads. Classification of bonds. Review of railroad financing. Sinking funds. Equipment bonds. Analyzing bond issues. Railroad reorganizations. Chicago and Eastern Illinois reorganization. Market for railroad bonds. Course of bond prices. Conclusion.

RAILROAD bonds are merely one form of corporation bonds, and in reviewing some of the previous chapters, it will be found that a considerable portion of the subjectmatter which might be covered here has already been presented to you. In Chapter III several pages have been devoted to railroad securities and many of their essential features have been presented in a clear and comprehensive

manner.

What may be termed the "railroad situation" has a direct bearing on the security of railroad issues. This situation is both complicated and constantly changing, and to cover it accurately would require a great deal more time and research than the author has been able to give.

The railroads of the United States may be likened to the veins and arteries of the human body, and as the life of the body is dependent on the circulation of the blood, so is the welfare of the country dependent on the circulation through these arteries of transportation. The great famines of India were primarily due to lack of transportation. Since the advent of motor transportation, it is hardly probable that a complete shutdown of railroad operation would result in actual starvation, though there would undoubtedly be great privation in many sections of the country.