State to Sell $1,000 Bonds Geared to Tuition

SACRAMENTO — California will begin selling low-cost savings bonds tailored for families who want to put away money for their children’s college education, under a program launched Tuesday by Treasurer Thomas W. Hayes.

The new program, which Hayes said he could undertake without legislative authorization, calls for issuing tax-free bonds in denominations of $1,000 that can be cashed in 10 or 15 years from the day they are purchased.

Fashioned after programs set up in at least 10 other states, the Hayes plan is designed as a college savings program but the tax-free bonds would be available to anyone who could afford them. There are no strings on how the money could be used.

Several efforts have been made by the Legislature to address the problem of soaring college tuitions, including a bill passed last week by the Legislature that also called for using tax-free bonds as a savings tool.

That bill, drafted by Assemblyman Tom Hayden (D-Santa Monica), was specifically designed to help provide a nest egg to meet college costs and thus would be limited to educational expenses. The Hayden bill awaits action by Gov. George Deukmejian, who vetoed similar legislation last year.

Hayes said that by using revenue bonds, he bypassed the need to have his plan approved by the governor and Legislature. An independently elected constitutional officer, Hayes said he has enough authority under existing statutes to undertake the bond program himself.

Until now, California bonds, free from both state and federal taxes, have been available only in denominations of $5,000 or more, an amount that puts them out of the reach of most middle-class Californians.

Under the Hayes plan, the state would sell zero-coupon bonds, or bonds that are sold at a deep discount with interest paid in a lump sum when the bonds mature in 10 or 15 years. By postponing interest payments until the end, the bonds can be sold at a much lower price, similar to the way United States Savings Bonds are sold. For example, a 15-year, $1,000 bond would cost only $331 at a rate of 7.5%. The outlay for a shorter-term bond would be more. A $1,000 bond redeemable in 10 years and earning 7.25% would cost $490.

“The concept is basically to provide a vehicle for tax-free savings that will be initially at a low cost to parents, grandparents, relatives, or anybody that wants to buy them,” Hayes told reporters at a Capitol news conference.

By making them available to anyone, Hayes said he expects to create a new market for California bonds and encourage savings generally.

The initial offering of the bonds will be made in October as part of a University of California bond issue. The rate of return, or the rate of interest that investors will receive, will depend on market conditions at the time. The state is paying a rate of 7.05% on the most recent offering of California bonds, a $700-million offering sold to banks, brokers and investment banking firms in late August.

Like other state bond issues, the zero-coupon bonds will be sold through banks and retail brokers.

Manuel M. Mateo, chief of the treasurer’s trust services division, said he expects that the state initially will sell $10 million to $20 million worth of the bonds.

Investment officials contacted by phone Tuesday said that, based on the experience in other states, they expect the California program to be popular.

John Roth, a senior vice president in the municipal bond department of Dean Witter Reynolds Inc., said from San Francisco, “A lot of other states have tried it and it has worked well. We expect it would be popular in California.”

Grover McKean, a partner in the investment banking firm of Lazard Freres & Co., said from San Francisco, “It’s an excellent program. You can buy California zeroes now, but only in increments of $5,000. By offering them in $1,000 denominations, you are making them more accessible to small buyers. Similar programs have worked well in Oregon and Hawaii.”

However, Bill Richmond, a senior investment officer with Security Pacific National Bank in Sacramento, cautioned that the profit margin is so small on municipal bonds that banking firms would have difficulty selling them and covering their costs. He also said small investors who want to put money away for 10 or 15 years might be better off in other types of investments, such as buying into a mutual fund that owns stocks.

Hayden, the author of the bill that the Legislature sent to Deukmejian, criticized the proposal as a piecemeal effort, calling it “an investment plan masquerading as an education program,” but said he supported the concept if “it is fleshed out.”