Proposed Bonds Offer Way to Support the War Effort

Looking for ways to finance the yet-to-be-determined costs of the nation’s war on terrorism, Congress is on the verge of authorizing the first war bonds in at least a generation.

Both houses of Congress have approved war bond measures and are working on a combined bill that legislators expect to deliver to President Bush within weeks.

But the move has spawned controversy. Top Treasury Department officials have said they don’t need or want authorization to borrow more money, with the government still operating with a budget surplus.

Even so, lending Uncle Sam money via war bonds may appeal to many Americans--perhaps depending on the interest to be paid on the bonds.

“The American people are hugely united in looking for methods to tangibly express their support of the war effort,” Rep. John E. Sweeney (R-N.Y.) said last week. “This is going to be the most obvious way to do that.”

Here is a look at the history of war bonds and answers to some questions investors may have about any new war bond campaign:

Question: When was the last time war bonds were issued?

Answer: That depends on how you define them. The government issued Liberty Bonds starting in 1917 to help finance World War I.

During the 1940s, about $185 billion in war bonds were sold to help finance World War II, beginning with the first issue of Series E savings bonds in 1941. The interest paid on long-term bonds during World War II amounted to about 2.5% a year.

In 1967, during the height of the Vietnam War, the Treasury began to market savings notes dubbed Freedom Shares that paid 4.7% a year.

The basic idea behind any government bond is the same: An investor lends the government money in return for a specified annual return and a guarantee that the principal will be returned in full by a set future date.

Question: How would new war bonds be structured, and what would they pay?

Answer: Those details aren’t available yet. The authorizing legislation says the secretary of the Treasury could issue war bonds in “whatever form the secretary deems appropriate.”

Question: Would the proceeds go directly to the war-on-terrorism effort?

Answer: Not necessarily. The legislation says money raised would go into the government’s general fund, which means it could be tapped for both war and non-war-related efforts.

This gives the government flexibility to use proceeds to rebuild the communities damaged in the Sept. 11 attacks as well as for military purposes, said Sweeney, one of the House bill’s primary sponsors.

Question: Has the Treasury asked for war bond authorization?

Answer: No. In fact, top Treasury officials have strongly suggested there is no need to undertake such a borrowing program, given that the government continues to run a budget surplus.

“The intent behind the war bonds is quite understandable. However, in terms of finding a solution ... I would say that we would first recommend Americans continue to contribute to charities, as they have been doing,” Brian Roseboro, Treasury assistant secretary for financial markets, said at a bond market conference in New York last week.

He also suggested that consumers could help the war effort by spending money to boost the economy.

But some experts say the war bond authorization could come in handy later. If the government begins to operate at a deficit once again, or if market interest rates rise on conventional Treasury securities, Uncle Sam may need a lower-cost channel for raising money, said Gary Schlossberg, chief economist for Wells Capital Management, an investment arm of Wells Fargo Bank.

Question: If the Treasury decides to issue war bonds, when might they be available?

Answer: Treasury officials say it typically takes about 18 months to create a product and design the systems and software needed to support it.

Because of that long lead time, some experts speculate that Treasury might simply rename one of the existing types of savings bonds a “war bond” rather than create an entirely new product.

Question: How do existing savings bonds work?

Answer: The Treasury currently sells two types of savings bonds: Series EE bonds, which pay an interest rate that’s adjusted every six months; and Series I bonds, which pay a set minimum rate and then add on a return that compensates for inflation over time.

Series EE bonds are “zero coupon” bonds, which means that they are sold at a discount to their face value. A $50 bond would cost an investor $25 today. At maturity, the bond would be worth $50, but it can continue to earn interest and thus rise in value after its official maturity date.

Series I bonds are sold at face value.

Both types of bonds are issued in denominations ranging from $50 to $10,000. Investors can purchase as much as $30,000 in savings bonds each year.

Question: How much interest do savings bonds pay now, and are they a good deal relative to other savings options?

Answer: The current annualized yield on Series EE bonds is 4.5%. It’s adjusted every six months, on Nov. 1 and May 1. The yield is set at 90% of the rate paid on five-year Treasury notes for the preceding six months.

The current five-year T-note yield is about 3.75%, so the EE bond yield is sure to decline at this week’s semiannual adjustment. Still, the EE rate may compare favorably with yields on bank certificates of deposit now, experts say.

The effective yield on Series I bonds also changes every six months.

Series I bond yields have two components: a fixed rate set for 30 years (currently 3% on newly issued bonds) and an inflation adjustment based on changes in the consumer price index.

The effective annualized yield on Series I bonds issued over the last six months has been 5.92%, the Treasury says. That reflects an inflation rate of about 2.9% added to the bonds’ 3% set rate.

Question: Is savings bond interest taxable?

Answer: The interest is exempt from state and local taxes. That’s an advantage over bank CD interest, which is fully taxable.

Savings bond interest is subject to federal income tax, but investors can elect to defer the federal tax until the bonds are redeemed.

That can make the bonds a good alternative over even slightly higher-yielding savings accounts for those in high tax brackets who don’t mind locking their money up for a while.

Question: How long must an investor hold a savings bond?

Answer: The bonds must be held for at least six months. Investors can cash them in after that, but will pay a three-month interest penalty if they redeem the bonds within five years of purchase.

Question: Where does an investor buy savings bonds?

Answer: Both types of bonds are available for purchase through banks and employers offering payroll deduction plans and through direct purchase from the Treasury. For more information, go to https://www.savingsbonds.gov.