Funding Act of 1790
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The United States Funding Act of 1790, the full title of which is "An Act making provision for the [payment of the] Debt of the United States", was passed on August 4, 1790 by the United States Congress as part of the Compromise of 1790, to address the issue of funding (i.e., debt service, repayment and retirement) of the domestic debt incurred by the Colonies; the States in rebellion; in independence; in Confederation, and subsequently the States' comprising and within, a single, sovereign, Federal Union. By the Act the newly-inaugurated federal government under the US Constitution assumed (and thereby retired), the debts of each of the individual Colonies' in rebellion and the bonded debts of the States in Confederation — debts that each state had individually and independently issued, on its own "full faith and credit", when each of them were in effect, an independent nation.
The United States government then (through its also newly created Department of the Treasury), issued U.S. Treasury Securities (backed by the "full faith and credit" of the United States of America) offering these securities to the bondholders of the former States' and Confederation's bonded debts, at par. That is, at 100% of their face value (full assumption); and at rates of interest (and all other terms) that were as specified on the bonds when they were issued by the states and Confederation. When this was done, it resulted in the "full assumption" of state debts by the federal government through the issue of federal securities. And for the states of the new union, the full and complete retirement of their bonded obligations incurred in the Revolution, and the Confederation.
With the formation of the new government in 1789 and under the recently adopted US Constitution, the settlement of the Revolutionary War debt was a matter of prime importance. As a result, the first House of Representatives directed the first secretary of the treasury, Alexander Hamilton, during the presidential administration of George Washington, to draw up a plan for the support of public credit. Consequently, the First Report on the Public Credit was issued on January 9, 1790, which became the foundation for subsequent action taken by Congress for funding and paying the public debt. The Funding Act of 1790 that followed was concerned primarily with funding the domestic debt held by the states.
The Funding Act authorized the federal government to receive certificates of state war-incurred debts and to issue federal securities in exchange. It essentially proposed “a loan to the full amount of the said domestic debt.” The terms of the loan were that two-thirds of the principal of the debt subscribed should draw an interest of 6% per annum, from January 1, 1791, and the remaining one-third of the principal to receive interest at the same rate (6%) from 1801, with interest “payable quarter yearly”. The debt consisting of arrears of interest should bear an interest of 3% from January 1, 1791.
- New Hampshire - $300,000
- Massachusetts - $4,000,000
- Rhode Island and Providence Plantations - $200,000
- Connecticut - $1,600,000
- New York - $1,200,000
- New Jersey - $800,000
- Pennsylvania - $2,200,000
- Delaware - $200,000
- Maryland - $800,000
- Virginia - $3,500,000
- North Carolina - $2,400,000
- South Carolina - $4,000,000
- Georgia - $300,000
Not all the state quotas were filled, so the total assumed was only $18.3 million. Furthermore, although the Act was limited to one year, it was later extended till the entire debt was subscribed and funded according to the law.
This sum was also to be loaned to the United States with the terms such that each subscriber was to be entitled to a certificate equivalent of 4/9ths of the sum subscribed, bearing interest at 6% per annum, another certificate equal to 3/9ths of the sum subscribed bearing interest at 3% with both commencing January 1, 1792, and a third certificate of the remaining 2/9ths of the sum bearing 6% interest starting from the year 1800.
The Act also provided for the funding of securities issued by the Confederation into new federal issues. State governments had acquired nearly $9 million of the $27.5 million of Confederation debt outstanding in 1789. The law provided that for every $90 worth of principal turned in, there should be issued $60 worth of 6% stock and $30 of deferred that would bear interest after 1801. Arrears of interest were funded into 3% stock.
Finally, the funding program resulted in the settlement of accounts between the states and the national government completed in 1793. This was intended to equalize the per capita burden of war expenditures among the states. Each state was credited with the amount it spent during the War and debited for sums received from the national government.
The shedding of the state debt burden allowed the states to reduce taxes, resulting in the lowering of taxes in many states including Maryland, Pennsylvania, New York, Virginia and Massachusetts. However, this was associated with a subsequent imposition of federal taxes, therefore effectively leaving the status quo unchanged. The Funding Act left the states with substantial revenue earned through the federal securities, with income from this source making up nearly one-fifth of total state revenue. This income enabled states to directly invest in industry and promote economic enterprises.
Three major financial and policy criticisms of the Act (for both then and into the present day) were: (1) the passage of Act, to raise federal revenue and to refund the debt (of the States and their Confederation), wrongly, artificially, and unnecessarily raised the value of the debt being assumed by the Federal Government (in most cases far beyond the market value of those debts (in disregard of the unnecessary increase in the costs of this action to the Treasury, and ultimately, US Taxpayers); (2) full assumption (done in the way that it was) was a "windfall" to the stock jobber merchant class of financial (soon to be known as Wall Street speculators), who reaped (personally as a class) enormous unearned and windfall profits, for no work and no risk of their capital invested; (3) small share investors who had purchased the States' bonded debts originally realized none of the windfall of the US Government's policy choice for "Full Assumption". The windfall value was on average; for debt principal: five and one-half times; and, for interest in arrears, by three times.
Fiscally, it was unnecessary. In current terms the Colonies' in rebellion's debts were at or below junk bond status. The Colonies in the Revolution had issued small denominated debt instruments to entice small share savers and merchants to support the war effort. These individuals bought the debt, surrendering their hard currency (foreign exchange notes, gold or silver coinage), for their Colonies' worthless pledges of future interest payments. Over the seven plus years of revolutionary war and post-war Confederation, the nearly worthless Continental denominated debt had been sold by its original "patriotic" buyers, who needed cash as the war wore on; and sold their bonds at deep discount just to receive the "not worth a Continental" currency. Speculators, had then taken up the bonds at deep discount (5% - 20% of face value), maintaining them in debt markets, abet for purely speculative purposes.
The newly formed US Government could have; as a policy alternative, retired this debt directly by prospectively invalidating its legality; then, offering the speculator-holders; retirement of the issues, based upon the highest average price over the 12 months previous to the proposed date of invalidation. Unless, the holder could establish, that he/she was the original; or inheriting purchaser (i.e., a person having received the bond(s) as an inheritance from the estate of an original purchaser). This policy would have achieved the objective of retirement of all such bonds as issued by the former Colonies and Confederation. Holders would either have turned them in; and received for them the value which they had actually paid; or held onto them, and received nothing.
The policy alternative of giving a "windfall" of 500% in principal; and 300% in interest, to "stock-jobbers" would not have been pursued. And this kind of speculation would have been discouraged in American financed. The cost to the US Treasury and the taxpayers would have more realistically related to actual cost of retirement of the debt.
Hamilton convinced President Washington (who, with his Treasury Secretary, led his Cabinet on this issue) to first an foremost disregard all of the then present domestic effects (as enumerated above) of Full Assumption. Hamilton's (and after Washington was won over, the Administration's) position was, that Full Assumption was first and foremost a declaratory signal, message, and statement by the US Government; to the financial class in the then emerging global financial centers of Europe (London, Amsterdam, Paris, Bonn, and Vienna); and North America, that the United States of America understood their primacy, their principles; and, their rules; and, would always govern themselves (i.e., the US Treasury) accordingly. This was Washington's/Hamilton's and the Administration's principal reasoning behind full assumption.
Moreover, at the time, the Act was criticized for widening the influence of the federal government at the expense of the states. However, it is now believed that as a result of the assumption of state debts, the states were in a better position to focus on economic growth and development, whereas the federal government was left with trying to finance the large debt it had acquired. The most controversial aspect of the Act was the large benefits allegedly reaped by speculators – especially by the assumption of state debts. Many states’ securities sold in the open market for 10% of their face value or less at the time the Act was being debated. This furnished considerable scope for speculative gains. However, taking into account the low security prices before 1790 owing to the general economic depression, monetary stringency of the times and the use of paper money by the states for debt service, the rise in security values was inevitable after 1790, once the causes of depreciation were ameliorated.
Some academics have argued that the long-term effects of Hamilton’s program on the states may have proved to be detrimental. This idea is premised on the economic concept of “moral hazard”, with the argument being that states were relieved of the responsibility of debt, began to excessively rely on federal assistance and funding through assets rather than taxation and became extravagant in incurring debt in the years to come. Hence, this “bailout” for the states set a bad precedent and may have proved disadvantageous to the economic progress of the states.
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- Funding Act of 1790 Date of Publication: 1790 Early American Imprints, Series 1, no. 46047 (filmed) Title: [Bill. 1790] An act making provision for the debt of the United States. Also available at http://en.wikisource.org/wiki/United_States_Statutes_at_Large/Volume_1/1st_Congress/2nd_Session/Chapter_34