Cyclopædia of Political Science, Political Economy, and the Political History of the United States

Edited by: Lalor, John J.
(?-1899)
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Editor/Trans.
First Pub. Date
1881
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New York: Maynard, Merrill, and Co.
Pub. Date
1899
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Includes articles by Frédéric Bastiat, Gustave de Molinari, Henry George, J. B. Say, Francis A. Walker, and more.
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MUNICIPAL BONDS

II.338.1

MUNICIPAL BONDS, instruments issued for the payment of money by municipal corporations, such as counties, cities and towns, negotiable inform and clothed with the attributes of commercial paper. These bonds usually run from ten to thirty years, and ordinarily have interest coupons attached to them, which are separately negotiable, and may be enforced by the holder without producing or even proving an interest in the original bond. There is no country in the world where these securities have been issued in such quantities as in the United States, whose total municipal indebtedness was estimated, in 1876, to amount to over a thousand million of dollars.

II.338.2

—The authority to issue such securities is not incidental to the ordinary powers of municipal corporations, but must be conferred by express legislative grant. Whether or not the state legislature has the power to confer authority, in the absence of express constitutional provision, to issue these bonds for purposes not strictly public, as, for example, in behalf of railroads, is a question which has long been combated in the highest courts of various states, as well as in the United States courts, and both sides of the question are supported by strong arguments of reason and common sense. As the question involves the power of taxation, and as the state constitutions invariably contain inhibitions upon taxation other than for public purposes, it is of vital importance, in considering the validity of such securities, first to determine whether the purpose for which they have been issued is a public purpose within the constitutional phrase.

II.338.3

—The various questions relating to this peculiar class of commercial paper did not assume great importance before the civil war. Before then the issues of such bonds had been for purposes, for the most part, undoubtedly "public," such as the erection of town halls, the construction and maintenance under corporate supervision of water works, roadways, etc. But when, at the close of the war, a large non-producing population were scattered throughout the rich agricultural regions of the west and northwest, and became producers in their turn, there soon arose, in those fertile but sparsely settled districts, the urgent necessity of better means of communication with the great distributing points and centres of trade. Railroads were demanded by the farmers of the grain-bearing areas at the west and northwest, in order to put their products upon eastern markets. But the construction funds had to come, in the main, from eastern capitalists; and the farmers, in order to meet the then paramount want, were ready to pledge the corporate credit of their towns and counties to any extent.

II.338.4

—It is a curious social fact that a body of men, acting as an aggregation, will often commit themselves to a line of conduct which as individuals they would strongly condemn. It is not, therefore, to be wondered at that the honest farmers of the great northwest, while despising the owner of a small holding who would mortgage his crop before sowing the seed, should have been so ready to plunge their communities into corporate debts of extraordinary amount, especially when the pay day was put at twenty or thirty years in the future. Judge Dillon, who formerly sat as United States circuit judge in the eighth circuit, where numerous cases involving the validity of such securities arose, declares "that he has known of a newly organized county government, whose population did not exceed 10,000, vote in behalf of a single railway company bonds to the amount of $300,000," bearing interest at the rate of 10 per cent.! "And," he adds, "instances are not infrequent where bonds have been issued to greater amounts than the assessed value of all the taxable property at the time within the municipal or territorial subdivision"! ("Dillon on Municipal Bonds," 5.) For a time this sort of financiering was an apparent success. The demand for railway facilities was undoubtedly based on an imperative want, and it did not take long for this demand to work its way into local politics, as soon as the popularity of schemes for "developing the resources" of this region or that began to be seen. Occasionally a conservative voice could be heard protesting against what has been described by the supreme court of the United States as "the epidemic insanity of the people," "the mania for running in debt for local improvements," (Mercer County vs. Hackett, Wallace, 96), but such opposition to the universal clamor was futile, and only exposed the objector to local and political unpopularity. Thus bonds to the amount of hundreds of thousands of dollars were issued by communities which had scarcely begun to assume municipal duties, and interest-bearing securities were negotiated, involving heavy taxation, by towns which existed little more than on paper. The interest in most cases was at first met with reasonable promptness. The bonds were generally disposed of to non-resident buyers, selling at absurdly low rates, in cases where no ordinance forbade their disposal at less than par—and few municipalities were wise enough to set a minimum selling price. Towns and counties were often so eager to lend the aid of their municipal credit to proposed railroad schemes, that, in many cases, an out-and-out donation of bonds was voted in behalf of the railroad company, instead of the usual stock subscription payable in bonds. The railway officials would then sell the bonds, generally in large amounts to banks, brokers or "syndicates," and often at a great discount, to secure the necessary construction funds, and the long-needed railway would then be built. It is thus a matter of record that more than one railroad has been laid in sparsely settled districts only to be abandoned when the funds to support it had failed, and the expected traffic fell far below the hopes of the sanguine promoters. In the six states of Illinois, Wisconsin, Iowa, Minnesota, Nebraska and Kansas there was an increase in the mileage of railroads of from 6,992 miles in 1876 to 17,645 miles in 1873—an increment of no less than 254 per cent.! While in the western states and territories alone, during the five most active years of railway construction, nor less than five hundred millions of dollars were expended in building railroads. (See article by Mr. Charles Francis Adams, Jr., in "North American Review," vol. 120)

II.338.5

—It was about 1870 that these prodigal communities began to feel the weight of their obligations. The proceeds of their indebtedness had been spent in "improving" their lands, but there lay a sting in the galling fact that the debts themselves were, for the most part, in the hands of foreign holders, who now began to press for their dues. Pay day was drawing near, when the principal would become due, and, in the meantime, the interest coupons had to be taken up with harassing regularity. Towns and counties, which had been only too ready to pledge their corporate faith for hundreds of thousands, began to cast about for ways of meeting the payment of the hundreds due as interest; and when this was found to involve a regularly laid "interest tax," which meant just so many dollars from every tax payer's pocket, the idea of a further demand by way of provision for a sinking fund, with which to meet the principal became unbearable, and, before a quarter of the coupons had been taken up, men who would have scorned to employ dishonest means to avoid their personal debts, were anxiously seeking to escape from debts, which, acting together in a corporate capacity, they had just as honestly incurred.

II.338.6

—The word "repudiation," in its now common significance, is said to have been used for the first time by the governor of Mississippi, in a message to the legislature of that state, in January, 1841. He alluded to a plan which had been suggested, of repudiating certain bonds of the state issued in support of a banking institution, and which had been sold, contrary to the law regulating their issue, at less than their face value. The state legislature set a noteworthy example to succeeding generations of law-makers less sensitive for the honor of their commonwealth than they. They resolved as follows: "That the state of Mississippi will pay her bonds and preserve her faith inviolate. That the insinuation that the state of Mississippi would repudiate her bonds and violate her plighted faith, is a calumny upon the justice, honor and dignity of the state."

II.338.7

—Unfortunately the worthy example set by the Mississippi legislators of 1841 has not been followed in their and some other states. The political huckster was only too quick to learn that a policy of repudiation, so far from exciting the indignation of his constituents, if boldly supported by glip and specious argument, was one of the surest claims to local popularity. Indeed, these interest-burdened communities were so hot to rid themselves of the weight of debt which they had undertaken, that any scheme for resisting the non-resident, and therefore "grasping," "avaricious" and "bloated" bondholder, was certain of a strong popular indorsement, even though based upon palpable fraud. This state of public sentiment, and the action to which it led, were simply parts of a natural sequence. It may be safely laid down as a general proposition, which the student of municipal affairs can readily verify, that whenever a community assumes obligations of a public character which unexpectedly become so heavy as to oppress the private individual, repudiation follows as an inevitable consequence. It was thus with the communities above referred to Public meetings were held and resolutions passed, urging town and country officers to refuse to take up the interest coupons as they came due, and plainly intimating that a compliance with the law and a non-compliance with the demands of the voters would involve a loss of place at the ensuing election. The effect of such proceedings may be readily guessed. Payments were not met, often through actual lack of funds, but often, too, in accordance with the orders of the voters in town hall assembled. The bond question became a political question, and, in certain districts of Iowa and Minnesota, resolutions were passed by nominating conventions which virtually pledged the nominees to the policy of repudiation. The bondholders were driven to their legal remedies, and various methods were tried to enforce their rights. Suits were brought against municipal officers to compel the payment of over-due interest, and when the treasury of the town or county showed a lack of the necessary funds, an application would be made for a mandamus compelling the assessment of a special interest tax. The defenses raised to such actions were founded upon all sorts of pretexts, but they may be generally resolved under two heads: 1. those which pleaded want of power on the part of the municipality to issue the bonds in question; 2, those which alleged various irregularities or defects in the exercise of the power. The decisions of the lower state courts were almost invariably in favor of invalidating such bonds, so strong was the feeling against them; and it is notorious that in certain districts, judges, on the one hand, lost their seats because their decisions maintaining the public credit were so obnoxious to the popular demand, and, on the other, owed their elevation to the bench, to the explicit understanding that they were pledged to decide against the validity of these securities, in such cases as might come before them.

II.338.8

—The "Grangers," or "Patrons of Husbandry," a secret order, modeled after the manner of the "Odd Fellows," directed their energies to the accomplishment of two great results: lowering the rates of railway transportation, and "wiping out" railroad of municipal bonds. One of their officers, who represented the Northwestern Farmers' convention, before the Windom committee on transportation rates (U. S. senate, 1873), when it was suggested to him that the United States supreme court might declare unconstitutional any act changing rates from five cents per mile to three cents per mile, where the charter allowed five cents per mile, was for "wiping out the supreme court, and getting one that would decide it." Thus is precisely what the people of the "granger" states did, i.e., reversed the decision of their judges upon the question of the validity of town and county bonds, by electing others pledged to a construction of the law favoring their views. A striking instance of the way in which an elective judiciary may be influenced by an erroneous and mischievous popular sentiment, is to be found in such a decision, referred to by the United States supreme court, in the case of Gelpeke vs. Dubuque, 1 Wallace U. S. Rep., 206, as "standing out in unenviable solitude and notoriety." The opinion of the federal court concluded with these words: "We shall never immolate truth, justice and the law because a state tribunal has erected the altar and decreed the sacrifice." (See Mr. Adams' article, above referred to.) On another occasion, in 1875, the same court, referring to the great commonwealth of Minnesota, said: "The faith of the state, solemnly pledged, has not been kept; and were she amenable to the tribunals of the country as private individuals are, no court of justice would withhold its judgment against her."

II.338.9

—Unfortunately, popular opposition to the payment of municipal debts has not been confined to the granger states. In the option of the federal bench, if not elsewhere, even the New York court of appeals has lent its sanction to schemes of repudiation, by declaring certain bonds void upon grounds which the United States supreme court has pronounced unsound, (see Starin vs. Bank of Genoa, and Gould vs. Sterling, 23 N. Y. Rep., 439, 453); while the most flagrant case of refusal to meet a municipal debt justly incurred is to be found in the recent (March, 1882) action of the people of Greenwood, Steuben county, New York, who by threats and force actually prevented the sheriff from collecting an interest tax in favor of bonds whose validity had been sustained by the highest court of the state. To enforce the tax the governor was compelled to issue a proclamation declaring the town to be in a state of insurrection! When cases involving the defenses mentioned above came to be submitted finally to the scrutiny of the federal judiciary, the rights of innocent holders of these bonds were firmly upheld. The sound and honest reasoning upon which the supreme court of the United States based its decisions in these cases may be summarized, briefly, as follows: 1. The power of municipal corporations to issue such securities is derived only from express legislative grant, and is not to be implied; and the legislature may grant this power if not prohibited, either expressly or by necessary implication, by the constitution of the state or by that of the United States. 2. Where authority to issue such bonds exists, no mere defect or irregularity in the exercise of that power will suffice to invalidate the security in the hands of an innocent purchaser. This second point is one upon which the supreme court and the highest appellate courts of several states, notably the New York court of appeals, are still at odds, the latter insisting, with strong show of reason, it must be admitted, that if the purchasers of such securities are not required to verify their bonds, except by the recitals upon their face, and the act authorizing their issue, the door is at once thrown open to the fraudulent schemes of official rascality. Judge Dillion himself, who, in his decisions, has invariably "set a face of flint against repudiation in all its forms," admits that "the frauds which unscrupulous officers will be enabled successfully to practice, if an implied and unguarded power to issue negotiable securities is recognized, and which the corporation or the city will be helpless to prevent is a strong argument against the judicial establishment of any such power"; and he suggests this query, "Do not the decisions of the supreme court of the United States lead to this conclusion, 'that where the power to issue bonds is given upon the condition of a previous vote in favor of the proposition, the public or municipal officers can, where no vote whatever has been taken or the proposition been voted down, bind the county or municipality by the false recitals in such unauthorized bonds, provided they are issued by the officers entrusted by the statute with the power?" A query which has been emphasized by the conduct of the mayor of Adrian, Mich., who sold to various New York bankers forged bonds, the power to issue which existed as recited on their face, although no authority had been given by popular vote. It is a serious question whether the bonds are not binding upon the town under the decisions of the United States supreme court, which has declared against the repudiation of such bonds even by municipalities which have been deceived and defrauded in their issue. (See New York papers, Feb. 13, 1882, passim)

II.338.10

—There is no doubt, that, but for the position assumed by the highest tribunal in this country upon the question of municipal bonds, dealers in this class of commercial securities would be subject to far greater risks than they are at present. It is well for them, however, to bear this much in mind, that want of power to issue is a good defense even against a purchaser in good faith. In other words, such purchaser is bound to know whether or not the legislature has expressly authorized the particular issue by the municipal officers executing the same; although he is under no obligation to examine the records of the town or country in whose securities he proposes to deal, in order to see whether or not the declarations upon the face of such bonds are true as to the performance of the details in the exercise of that power, when those declarations have been duty verified by the municipal officers named in the legislative act.

II.338.11

—The lesson of 1868-73 has been a bitter one for the people of many promising towns and counties, and it will be years before some of the more prodigal communities recover from the load of taxation recklessly but voluntarily assumed. Grass grows upon the track, and ties not along the line of more than one railroad in districts whose inhabitants will, for years to come, pay interest on money spent in its construction.

GEORGE WALTON GREEN.

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