What are muniland’s biggest players?
The retail investor is king in muniland, holding about $1.81 trillion of municipal securities in the second quarter of 2012, according to the Federal Reserve Flow of Funds report. But where are the other big players in the municipal bond market, and what are their investment objectives? Here’s a quick rundown of the different parts of the financial business that held $1.789 trillion in muni bonds in the second quarter of this year.
Securities dealers
Big bank dealers like Citi, JP Morgan Chase, Bank of America Merrill Lynch, Morgan Stanley and Goldman Sachs held a relatively small amount of municipal bonds this year, with $31 billion in the second quarter. But they play an outsized role in muniland. The dealer banks underwrite a vast majority of new municipal bonds, they write derivative contracts to municipal issuers and they control the flow of trading between market participants. Their basic advantage comes from knowing who bought bonds in the underwriting process, and who might be willing to trade old bonds out for new ones. Bank dealers hold their bonds typically as trading inventory. Securities dealers have decreased their holdings, down from $51 billion in 2006.
Government-Sponsored Enterprises (GSEs)
The GSEs held a tiny amount of municipal bonds, $19 billion in the second quarter. This number only seems tiny because the bonds somehow snuck onto the $6.351 trillion portfolios of GSEs. It makes me wonder if some traders there just made a mistake when choosing which bonds to buy.
Money market funds
Money market funds held $271 billion of municipal securities in the second quarter; about 18% of their total credit market instruments. Money market funds often purchase VariableRateDemandObligations (VRDOs) or TenderOptionBonds(TOBs), which are synthetically created by a bond dealer or otherparty with long-term bonds purchased in either the primary or secondary markets. These bonds are put into a trust, part of which is sold to a money market fund as a short-term, tax-exempt instrument whose yield is reset daily or weekly based on an index of short-term municipal rates. Dodd-Frank tightened the rules on TOBs, so they are likely to end in 2014 unless a structure is developed which evades the new rules.
There is tremendous demand for municipal bonds. When you break down the major market participants, it’s easy to understand why muniland yields are at historic lows. The supply of municipal bonds is tight, and many players want their piece. Join DiscussionIn Fed policy, the losers are people with savings
In Atlantic Media’s newly-launched financial vertical, Quartz, they have included a section entitled “low interest rates.” It caught my attention because I’ve never seen a financial publication that baked an assumption about the direction of interest rates into their format. That is like assuming oil or grain prices would always be low. A post, No, Ben Bernanke’s goal isn’t to reduce grandma to abject poverty, suggests that someone has to lose in executing monetary policy, and it is savers who must bear the most pain:
“But what about the savers?” That cry went up yet again when the US Federal Reserve promised, earlier this month, to keep interest rates at zero at least until 2015. The Fed, of course, was trying to perk up the American economy, but in monetary policy there are always winners and losers, and—with the Fed’s interest rate target having already been at or near zero for more than four years—the losers are people with savings. Yields on CDs (fixed-term deposit accounts) have collapsed. The yields on safe bond investments, like US Treasuries, is so low that after a few years of inflation, returns on those investments are almost certain to be worth less than what investors first put in.
Ben Bernanke, the Fed chairman, took the somewhat unusual step of acknowledging some of these concerns. In an attempt to assuage them, he pointed out, “low interest rates also support the value of many other assets that Americans own, such as homes and businesses large and small.”
Clearly the Federal Reserve has chosen sides. But the Fed has landed on the side of those who own assets. Artificially low interest rates punish the elderly and other low income households who live on fixed incomes and rely on the interest earned on their savings to supplement their Social Security checks. The most recent data from the IRS (2009) says that 15.8 million people, who earn between $0 and $30,000 a year, relied on $20.9 billion in interest-income to supplement their incomes. The average interest earned for this group in 2009 was $1,322 per year. You can see the breakout below. $1,322 goes a long way in a household earning less than $30,000 a year. But with interest at or near zero that income would be gone.
The data that Quartz uses from Stone and McCarthy misrepresents the number of households with transaction accounts, certificates of deposit and bonds (interest-bearing financial assets). Quartz (citing Stone and McCarthy) has the number at 22%, while the Federal Reserve data (Appendix Table 2A) says that 92% of households have transaction accounts. This is important because the Dodd-Frank financial reform bill changed Regulation Q, which had previously restricted banks supervised by the Fed from paying interest on demand deposit accounts (savings accounts).
What happens when an individual or family doesn’t earn any interest on their savings? Most have to reduce their spending or start using their savings.
The Federal Reserve has clearly made a poor choice in extending its zero-rate interest policy for the third year. The Fed has punished savers, who are the bedrock of a stable economy, to force money into other financial assets like the stock market, which can have massive volatility. Join DiscussionLocal officials need governance resources
Every one of the 19,492 municipal and 16,519 township governments in America is unique. But, when it comes to the fiscal affairs of these entities, there are a lot of similarities. Almost all local governments provide fire and police protection, libraries and parks, tax collection and public works like street maintenance and garbage collection. Generally the 50,432 school districts in the U.S. act as independent political entities with their own budgets, tax collection and bond issues.
Most of these municipal governments and school districts are governed by everyday citizens who are elected to positions of public authority. They rely on paid administrators to efficiently provide public services and educate children, but they must still make important decisions about taxation, approve personnel contracts and agree to bond issuance and refinancings. For officials who may be working part-time on the job with scant experience, these can be daunting responsibilities.
In the personal finance space there are loads of websites like Mint.com and HelloWallet.com that help individuals monitor, plan and project their expenses. I wondered if there were comparable ones in muniland to help small governments and school districts get a sense of how their spending patterns compare to other comparable municipal entities.
After searching around I found several great sites for municipal officials, bond market participants and interested citizens to get a better understanding of the fiscal picture of municipal entities.
The Pioneer Institute of Massachusetts has an excellent tool called Muni Guide Utilty that allows officials in one Massachusetts town or city to compare their economic and fiscal data with other cities of comparable size. This tool allows the user to drill down to specific budget line items to see how they compare to others. It also offers a more general reference guide to budget issues called “Guide to Sound Fiscal Management for Municipalities”.
California aggregates data from all local government financial statements on the State Comptroller’s website. Data is broken down on issues like the percentage of voter-approved indebtedness versus property tax valuations. According to the Comptroller’s data, California municipalities spend 17.41% of general revenues on police expenditures and 6.86% of aggregate city revenues on fire protection. You quickly get a sense that the city budget of bankrupt San Bernardino was out of balance when you compare their 72% of the general fund on fire and police, when the average for California cities is spending 24%.
The International City/County Management Association offers its Municipal Yearbook 2012. It includes chapters on health care coverage for municipal employees, compensation guidelines for chief administrative officers (think Bell, California paying it’s city manager $800,000 a year), police and fire personnel expenditures and a directory with the 79 professional, special assistance, and educational organizations that serve local and state governments.
Governing a municipality is hard work. As states push more fiscal responsibility down to the local level, they would do well to increase the amount of support and training they provide to local officials. Local public servants are the frontline of good government and efficient use of tax dollars. They need all the help they can get. Join DiscussionWith a growing number of local governments facing significant fiscal stress, State Comptroller Thomas P. DiNapoli announced plans today to implement an early warning monitoring system that would identify municipalities and school districts experiencing signs of budgetary strain so that corrective actions can be taken before a full financial crisis develops.
http://osc.state.ny.us/press/releases/se pt12/092412.htm
Should bankrupt California cities disincorporate?
California State Comptroller John Chiang said in a press conference yesterday in San Francisco that he expected more municipal bankruptcies in the Golden State. Bloomberg has the details:
“We will start to see more bankruptcies, not necessarily because of pension issues,” Chiang said. “We need the state to participate in trying to prevent these bankruptcies.”
California cities that have hit their fiscal bottoms have been turning to the Chapter 9 municipal bankruptcy process. Recently, Stockton, Mammoth Lakes and San Bernardino voted to put themselves under the protection of a bankruptcy judge and shield themselves from new legal claims. Bankruptcy is a complex and expensive process. Fitch Ratings said in a recent report (page 5) that the state of California offers no other intervention process for broke cities.
California has an effective mechanism to support school districts that experience financial distress, but provides no such assistance for cities. Many states have some form of intervention program that can help turn around financial decline by providing a control board, financial manager, or similar structure. In 2011, the state enacted Assembly Bill (AB) 506, which provides for a mediation process among localities and their stakeholders prior to bankruptcy.
Rather than preventing default and bankruptcy, AB 506 may have accelerated their occurrence. While state intervention is not factored into ratings unless the program is invoked and proven effective, Fitch believes credit deterioration can be forestalled for an entity in a state with an effective intervention program.
There is, in fact, another process in California law that Fitch and others might not be aware of. This is the process of disincorporation that has existed in California law for decades. John Knox, a law partner at Orrick, Herrington & Sutcliffe in San Francisco, wrote a white paper on disincorporation. Here is some background from Knox’s paper:
Seventeen cities have disincorporated in California’s history, including the cities of Long Beach, Pismo Beach, and Stanton, each of which later reincorporated. However, since the creation of LAFCOs [local agency formation commissions] in 1963, only two cities have disincorporated – Cabazon in 1972 and Hornitos in 1973. Of these, only Cabazon’s disincorporation went through the process prescribed by the Act; Hornitos was disincorporated by [legislative] statute.
What happened in Cabazon?
Disincorporation is not a simple process, but in some cases it might be preferred over bankruptcy for its relative simplicity and sometimes lower cost. In some cases citizens could benefit from their services being absorbed by the county. California needs every option possible in its toolkit, and discorporation may be a useful new addition. Join DiscussionThere might be one little problem with disincorporation and turning over services and money (if there is any left) to the counties. Just how well are the county governments doing? Will they be able to absorb the needs of the cities who choose this method? County law enforcement in the form of Sheriff’s Departments is undermanned and underfunded in many counties across the country. Are California’s counties in shape to pay the costs for services to these cities?
Muniland’s sour fraudster
In 2010, the small town of Moberly, Missouri issued $39 million in municipal bonds for a private manufacturing facility that the town hoped would add 600 jobs to its community of 14,000. Yesterday the Missouri Attorney General Chris Koster filed felony theft and securities fraud charges stemming from the collapse of that project, the Mamtek sweetener factory. The charges were made against California businessman Bruce Cole who was the CEO of Mamtek. Cole was arrested at his home in Dana Point, California and Attorney General Koster said extradition proceedings would begin immediately.
In short, Cole is alleged to have used proceeds of the municipal bond offering for personal expenses. The Moberly Monitor has the details:
The probable cause affidavit alleges that shortly before the sale of the Mamtek bonds, Cole directed a Mametk consultant to prepare an invoice purporting to come from “Ramwell Industrial, Inc.” This invoice requested payment of $4,062,500 for Ramwell’s services, including $3,562,500 for “Design, acquisition, and installation of five production lines,” $325,000 for engineering and design, and $175,000 for project supervision.
Cole directed that this invoice be submitted for payment even though Ramwell was never incorporated, never had any employees, never owned any property, and never provided any goods or services to Mamtek U.S. The day after the invoice was submitted, it is alleged, Cole instructed a bookkeeper for Mamtek U.S. to wire $700,000 to Cole’s wife, Nanette.
Within 48 hours of receiving the $700,000 wire from Mamtek, Nanette Cole wrote a $281,046.30 check to cash. The Coles immediately made a payment on their mortgage in the amount of $243,018.73. Shortly thereafter, the scheduled foreclosure auction of the Coles’ Beverly Hills home was canceled.
Muniland fraud doesn’t get any simpler than this. Submit a false invoice and then have money wired to your personal account. Cole actually had submitted the false invoice to the Moberly city finance manager who had authority to approve expenses as described in the criminal complaint:
The city finance manager reviewed the invoices and receipts in the request. If he concluded that an expenditure was not permitted under the Financing Agreement, e.g., travel expenses, he rejected that particular item and reduced Mamtek’s request accordingly.
The finance manager with guidance from bond counsel allocated the amounts requested to one of the three series of bonds to ensure that money was drawn from the appropriate taxable or tax-exempt bond series.
The finance manager then prepared a requisition form, attaching the draw request, asking the bond trustee to disburse funds to the appropriate recipients, typically directly to the contractor or supplier. In the case of Ramwell invoices [the invoices fraudulently prepared by defendant Cole], those disbursements were wired to Mamtek directly.
Obviously Cole is a swindler if the facts alleged in the criminal complaint are true. But where was the oversight? The Moberly city finance manager and bond counsel obviously didn’t delve very deeply into the invoices they were presented. But that was late in the game. Oversight needed to happen before the bonds were issued. Moberly city officials did some due diligence on the intellectual property collateral that Mamtek was pledging to the city, but there was no direct inquiry into the representations that Mamtek had made about its Chinese operations, which were the model for the new Missouri factory. The state economic development agency that shopped the Mamtek project around the state appeared to have done no due diligence in its zeal to create jobs for the state.
There is only one bright spot in this whole sad tale. A freshman state legislator representative Jay Barnes attempted to pass legislation that would have created some public oversight of the process of committing a community to an economic development project. Unfortunately Representative Barnes’s legislation was quietly mothballed by the leaders of the Missouri legislature. From the May 18, 2012 Columbia Daily Tribune:
Often bond offerings are rushed through local council or committee meetings with little or no time for public comment. Slowing down the process and requiring more due diligence could vastly improve these bond offerings. Join DiscussionMunicipal issuers: Know your friends
Having spent almost a year on Capitol Hill when the Dodd-Frank financial reform bill was being debated and drafted, my antenna goes up when an industry trade group praises something done by Congress. It’s usually a sign that the trade group was successful at getting their points of view adopted into law. I’m much happier when trade groups are screaming and kicking about provisions of the law, such as the new rules for derivatives trading and reporting.
This week the Bond Buyer ran an op-ed from Michael Decker, managing director of the securities industry and financial markets association (SIFMA),that praises recent legislation by the House Financial Services Committee. The new legislation amends the Dodd-Frank definition of “municipal advisors” by narrowing who the law would cover and specifically removes securities dealers from that designation. Municipal advisors are professionals paid to advise cities and other municipal issuers on the best ways to structure new bond offerings and manage the debt they have outstanding.
Thankfully the legislation leaves in place a “fiduciary” responsibility for municipal advisors, which requires that they act in the best interests of their clients, the municipal bond issuers (ie cities, states, sewer and water authorities). A “fiduciary” obligation is the strictest form of relationship between two parties.
This threshold of care makes sense for a party acting as a “municipal advisor” to public officials who are directing or investing taxpayer funds. The problem with the recent legislation is that it exempts the following parties who might be doing large transactions with the municipal entity:
[B]rokers, dealers, municipal securities dealers, any investment adviser registered under the Investment Advisers Act of 1940, commodity trading advisor, swap dealer…
In the past, some of these market professionals have acted in the role of muni-advisors, and then switched hats when it was time to do a transaction, throwing away their fiduciary responsibility.
The exemption basically covers all securities professionals who are not registered municipal advisors. This means these parties only have the regulatory threshold of “fair dealing” with municipal issuers, which is a much weaker standard of care. The danger of exempting securities dealers, especially those who act as underwriters to municipal issuers, was perfectly illustrated in a comment letter to the MSRB on proposed changes to Rule G-23 from Nathan R. Howard, a municipal advisor at WM Financial Strategies:
New legislation amends the Dodd-Frank definition of "municipal advisors" by narrowing who the law would cover and specifically removes securities dealers from that designation. Municipal advisors are professionals paid to advise cities and other municipal issuers on the best ways to structure new bond offerings and manage the debt they have outstanding. Join DiscussionIt is an inability to prioritize that has paralyzed Washington
President Obama’s proposal for cuts to the federal budget, which Congress directed him to detail as part of the sequestration process, was released last week. The cuts must come from the annual $1.2 trillion in discretionary (non-entitlement) federal spending. Reuters reports:
The White House presented a detailed breakdown Friday of $109 billion in across-the-board spending cuts scheduled for January, setting off a fresh blame game between the Obama administration and Republicans over responsibility for what both say is a preventable budgetary calamity.
The itemization of the so-called “sequestration” plan showed potential pain all around: $11 billion out of the Medicare healthcare program for the elderly, a $15.3 billion cut in defense procurement accounts and hefty cuts to a Department of Agriculture program that supports farm prices.
After the November election, a fight over specific cuts or tax increases or decreases is likely to be enormous. The number of interests that are preparing to protect their turf run the gamut from defense contractors to public employee unions. Here is the battlefield:
Various groups have chosen different political postures. J. David Cox, president of the American Federation of Government Employees, is arguing against cuts to entitlement programs, which is not even currently on the table. From the Washington Post:
The federal government consumes 24% of GDP and sequestration is an effort to slow the expansion of this number. Yet, the federal sequestration process is discussed as if it is a giant ax that will indiscriminately cut programs and federal employment. Affected agencies should be actively reviewing their priorities and spending and give Congress the necessary information to allow for decision-making. Join DiscussionOMB’s sequester report is not a “proposal” for cuts to the federal budget, as the report makes clear. The Budget Control Act provides very little flexibility on the part of the executive branch of what it should cut. For example, the president can (and has decided to) exempt appropriations for military personnel from cuts, and the law exempts several programs from cuts as well. Otherwise, the president must apply the same cuts to every function of the budget. As a result, this report is not a proposal, but rather an explanation of what will happen under existing law. Aside from this fact, the article is well founded.
A new higher education online business model: Open and non-profit
Online higher education 2.0 has arrived. It is open source, open enrollment and often provided by non-profit colleges. It has the potential to greatly expand access to higher education and to rapidly improve the knowledge base of global citizens. It is the antithesis of high-priced, online for-profit schools like University of Phoenix.
The momentum in online education is being captured by schools like University of California Berkeley, which recently joined Harvard and MIT in a not-for-profit online learning collaboration supported by edX, an open source technology platform.
Online collaborative platforms support massive open online courses (MOOC), which are often offered for free (or for small fees) and allow students from around the world to register for coursework from top tier schools. In a recent report, Moody’s described the potential for universities using MOOCs:
Massive Open Online Courses enable colleges to experiment and refine electronic delivery methods, evaluate scalability, identify best suited faculty, gauge the quality of student learning outcomes, and assess demand. MOOCs diverge from traditional online courses which sought to duplicate the classroom experience, including approximate class size. In addition, the availability of open platforms enables a university to post content without incurring the cost of developing and maintaining the platform.
Online learning technologies will play an increasing role in creating new efficiencies and lowering the cost per student. Successful adoption enables educators to expand and diversify their student bodies and increase faculty scheduling flexibility and productivity.
Moody’s sees several possibilities for schools to earn revenue from MOOCs:
Potential new revenue opportunities are clear for the market leaders. Growth potential includes charging tuition for certificates or degrees, selling courses/content to other colleges, attracting paid advertising to the web site, and increased philanthropic/foundation support for these innovative initiatives. The use of proctored exams to verify a student’s identity and to reduce cheating paves the way for fee-based certificates or course credits. As an example, Udacity and edX have partnered with Pearson VUE testing centers to certify the learning outcomes of MOOCs.
It is easy to see the potential for MOOCs, but their lack of barriers to entry like application screening and fees can mean enormous up-front enrollments. This may not be a problem due to the automation of the technology platform, but graduation rates tend to be low.
Online higher education 2.0 has arrived. It is open source, open enrollment and often provided by non-profit colleges. It has the potential to greatly expand access to higher education and to rapidly improve the knowledge base of global citizens. It is the antithesis of high-priced, online for-profit schools like University of Phoenix. Join DiscussionThe stampede into muniland
The stampede into municipal bonds has been strong since the market hit a low point after Meredith Whitney’s famous prediction in 2010 of hundreds of billions of dollars in defaults. Her words caused a run out of muniland, which damaged a lot of retail investors who sold their holdings at market lows.
The rebound in demand since then has pushed down yields to near historic lows, as investors stampeded back into muniland in a search of security and returns. This excellent chart of yields for AAA general obligation bonds from Daniel Berger at Thomson Reuters Municipal Market Data is worth a thousand words.
Further:
Bloomberg writes, “State-Local Government in Best of Times for Finance: Muni Credit”
The rebound in demand since then has pushed down yields to near historic lows, as investors stampeded back into muniland in a search of security and returns. This excellent chart of yields for AAA general obligation bonds from Daniel Berger at Thomson Reuters Municipal Market Data is worth a thousand words. Join DiscussionPennsylvania may miss out on Marcellus riches
The first round of Pennsylvania’s natural gas impact fee has been collected and the media is crowing. Collections of the fee, which applies to drilling in horizontal and vertical wells regardless of their production, came in at $197 million, according to the state Public Utility Commission. This figure is about ten percent higher than a recent legislative report had predicted, and is assessed on wells drilled through December 2011.
Media and fracking proponents are focusing on the fact that revenues bested the legislative estimate, but no one has taken the trouble to measure fee revenues against what the state could have collected if they had followed the practice used by other energy rich states like Oklahoma and Texas. All other energy-producing states collect severance or royalty fees based on well production. I have never understood why Pennsylvania chose the flat fee. However, Governor Tom Corbett and state Senate President Joseph Scarnati, who pushed the legislation, have received substantial contributions from gas companies and drillers.
The Pennsylvania gas fee — dubbed an Impact 13 fee — is a fee assessed on the well itself. The fees rapidly step down from $50,000 per well in the first year of production to $20,000 per well in the fourth year (based on natural gas prices between $3.00 and $4.99 per thousand cubic feet). After the 11th year of production, the fee is $10,000 per well. The fee step-down, which varies with the price of gas, can be seen in the chart above.
The impact fee step-down mirrors the decline in production that gas wells typically encounter. When a new well is drilled, the underground natural gas is often under pressure and it quickly rises to the well-head. As pressure diminishes, the well production declines.
Four legislative plans were proposed for taxing natural gas drilling in Pennsylvania. Three of them would have imposed a five percent severance or royalty on drillers. These proposals eventually were defeated in favor of a flat fee. The way to evaluate the fairness of the current impact fee is to compare the revenue that was just collected against the proposed five-percent fee using production data from last year.
Fewer drill rigs boring new wells in Pennsylvania means less revenue from high early year impact fees. With another year of data it will be very clear to Pennsylvania residents whether they are missing out on the riches of their Marcellus shale gas reserves. Join DiscussionFascinating; the whole article is about increasing taxes but at the every end you state that the rig count has dropped substantially. Please advise on how increasing taxes would slow that decline.
Also,maybe you could add that the states you referenced with a severance tax have little or no state income tax or corporate tax or a rolling stock and capital tax while Pa has among the highest FOR ALL THREE. Lets pass a severance tax and use the revenue to eliminate all three of aforementioned taxes.
And then for good measure, maybe report all of these taxes currently paid by the gas companies along with other state revenue contributions like state sales taxes for materials and equipment, restaurant and hotel taxes, income taxes, fuel taxes and the many more I cannot enumerate here.
-
Resident Muniland expert
-
