The Senate Finance Committee’s top two tax writers asked their 98 colleagues on Thursday to submit detailed proposals justifying which tax breaks should be kept in the code as they move forward on comprehensive tax reform.

Committee chairman Max Baucus, D-Mont., and ranking minority member Orrin Hatch, R-Utah., called for a “blank slate” approach to tax reform, stripping all existing tax deductions, exemptions and credits including the tax exemption for municipal bonds from the code.

“This blank slate is not, of course, the end product, nor the end of the discussion,” Hatch and Baucus wrote in a “dear colleague” letter to senators. “Indeed, we both believe that some existing tax expenditures should be preserved in some form. But the tax code is also littered with preferences for special interests.”

Both Baucus and Hatch are meeting with their respective members this afternoon to discuss the plan, sources said. Senators have until July 26 to submit their proposals.

Baucus and Hatch said “special attention” will be given to bipartisan proposals. They said they plan to operate from the assumption that all special provisions are “out” unless there is clear evidence that they help expand the economy, make the tax code fairer or effectively promote other important policy objectives.

Mike Nicholas, chief executive officer of the Bond Dealers of America, said that the muni bond tax exemption accomplishes at least two of those three issues.

“You think about infrastructure, jobs, or capital improvement growth, Nicholas said. “That’s been done for 100 years by issuing tax exempt debt.” Nicholas added that if the goal is to simplify or make the tax code more fair, “the muni bond tax exemption is not one of the extra layers that has made the code more complicated. It has been in the tax code since there was a tax code.”

Chuck Samuels, a lawyer at Mintz Levin, Michael Decker, managing director of the municipal securities group at SIFMA and other market participants said the muni bond community should have no problem making the case on the merits of the tax exemption so that it will be retained.

To aide senators with their submissions, the nonpartisan Joint Committee on Taxation and the Finance Committee staff analyzed the relationship between tax expenditures and the current tax rates if the current level of progressivity is roughly maintained.

“The blank slate approach would allow significant deficit reduction or rate reduction, while maintaining the current level of progressivity,” Baucus and Hatch wrote. They warned that each tax preference inserted back into the code reduces the amount of deficit reduction or revenue that could go towards lowering individual and corporate tax rates. “As we work to craft a tax reform bill, we will bear these trade-offs in mind,” they wrote. The letter omits how much revenue the plan would raise or how low they aim to get tax rates.

Some market participants were skeptical. “There are so many details that need to be filled in that we are not optimistic that the Senate could act in this Congress,” said Lars Etzkorn, program director for the National League of Cities’ center for federal relations, who expressed support for a simplified tax structure and the plan’s “noble” policy goals. “The clock is ticking and time is limited for the Senate to act.”

Etzkorn said he hoped that the Senators would include state and local groups like the NLC in the conversation beceause there could be serious consequences with a comprehensive overhaul.

“If the muni bond exemption was eliminated it would be detrimental to home towns,” Etzkorn said. “We don’t need a local tax increase as part of federal tax reform.”

The framework is similar to the “Zero Plan” used by the National Commission on Fiscal Responsibility and Reform in 2010, co-chaired by Erskine Bowles and Alan Simpson. The Bowles-Simpson Zero Plan would establish three individual income tax rates of 8%, 14% and 23%. It would repeal all individual and corporate tax expenditures and would tax capital gains and dividends as ordinary income.

by: JENNIFER DEPAUL

Bank of America Merrill Lynch remained the leading senior manager of municipal bonds in the first half of 2013, outpacing its competitors by a considerable margin.

The bank was credited with underwriting 208 issues, totaling $25.1 billion by par amount, according to Thomson Reuters data. That number is slightly down from the 238 issues totaling $25.6 billion that B of A worked on during the first half of 2012.

The decline is part of the broader 11.5% decrease in total amount of municipal market long-term issuance. Despite the decrease, B of A increased its market share from 13.4% last year to 14.8% this year.

The bank also came in first place among senior managers working on both negotiated issues, with $17.2 billion in par value, and competitive issues, with $8 billion. B of A was also the top co-manager on all issues.

The top four underwriters remained unchanged compared to the first half of 2012, with JPMorgan coming in second, followed by Citi and Morgan Stanley. Wells Fargo jumped up to fifth place from sixth, while Goldman Sachs dropped to seventh from fifth.

JPMorgan worked on 172 issues totaling $19.7 billion, for an 11.6% market share. Last year the firm worked on 198 issues totaling $22 billion with an 11.5% market share.

Paul Palmeri, managing director and head of public finance at JPMorgan, said the firm has continued to focus on its banking efforts and capital commitment over the past few years.

“We’ve continued to improve our banking coverage by leveraging our industry specialists with geographic expertise,” Palmeri said.

In addition to slightly increasing its total market share, JPMorgan also increased its market share of negotiated issues to 11.2% from 10.4% last year. The firm worked on 110 negotiated issues, totaling $14.6 billion, keeping its number two spot. In the competitive issue category the firm dropped to third place from second last year, with 62 issues totaling $5.1 billion.

Among co-managers, JPMorgan jumped to second place from sixth last year, with 168 issues totaling $5.6 billion.

Within specific industries, the firm has made significant strides in the transportation, utilities, healthcare, and higher education sectors, Palmeri said. JPMorgan focuses on those four industries, as well as general municipal finance and housing.

Palmeri said there’s still a tremendous amount to get done both on the new money side and on the refunding side.

“Both on the taxable and tax-exempt side a number of deals have been temporarily sidelined, and with a bit more rate stability, we’re confident that those deals will come to market,” Palmeri said.

Third-ranked underwriter Citi was credited with 207 issues totaling $18.7 billion during the first half. Citi also came in third place among negotiated issues, and second place among competitive issues.

RBC Capital Markets jumped two spots from last year to sixth place, credited with 347 issues totaling $10.4 billion.

While the industry total declined during the first half of the year, RBC actually saw an increase in the total value of issues it worked on from the $7.8 billion during the year before. The firm also saw its market share increase to 6.2% from 4.1%.

Among negotiated deals, the firm jumped to fifth place from eighth place last year, with 333 deals totaling $9.9 billion.

Mark Maroney, head of the RBC U.S. rates, municipals and securitized products business lines, said that RBC’s goal is to be among the top five underwriters of negotiated deals.

“We’ve had a nice mixture of our local middle market business with some large issuer transactions throughout the first half of the year,” Maroney said. “You can tell by the number of transactions that we’ve been busy with 333 negotiated deals.”

Some of the larger deals RBC worked on this year included a $540 million transaction for Denver Public Schools, $372 million for Dallas Fort Worth Airport, and a $328 million Phoenix excise tax deal.

“If you look across our activity we had a broad base of business across the United States,” Maroney said. “There were some large issuer deals out west, in Colorado, Texas and California, and also in the middle markets, in particular, in Texas and Pennsylvania. We’ve had a good number of deals sprinkled across the U.S.”

Among financial advisors, Public Financial Management Inc. kept its number one spot on the Thomson Reuters table. The firm worked on 398 issues during the first half of the year, totaling $18.8 billion and a 15% market share.

“It’s nice to have these kinds of results and so consistently, but they’re not the beginning and the end for how we measure ourselves,” said John Bonow, chief executive officer of PFM. “It’s our client satisfaction and the trust our clients have in us that really matters to us.”

Behind the firm’s consistent success is a focus on building, earning, and keeping the trust of its clients, as well as helping them navigate through tough times, especially during the last five or six years, he said.

“I think our clients know that we’ve got solutions to offer them, not just better mechanics or a better mouse-trap,” Bonow said. “Over time it’s our ability to focus on solutions and be comprehensive in our advice that has caused many of our clients to be with us for decades, and many more to come our way as these challenges arise for them.”

Bonow said the first half of the year was typified by the dramatic decline in interest rates, before the last few weeks in June, as well as new regulations in the money market. The low interest rate environment allowed PFM to help its clients lower their borrowing costs to take advantage of the refinancing market.

The firm also experienced recent expansion in the Northwest region with its acquisition of SDM Advisors, a Seattle-based advisory firm. Bonow said PFM is well-structured at present and is looking more toward internally-generated growth, and not necessarily looking for further acquisitions. Though, he added, PFM is always alert for opportunities.

Bonow said he believes the challenges for the industry include new regulations  and the overhang of retiree-related costs, such as pensions and other post-employment benefits.

“We’ve got groups focused on solving those problems systematically for our clients so that they have sustainable finances going forward and I think that’s where the growth is going to come from in our industry—the ability to be a comprehensive advisor to municipalities and non-profits,” Bonow said. “And if debt transactions occur because they’re prudent and they’re a good piece of the financial management puzzle, then I think we’re well-positioned to assist clients there as well.”

The top four financial advisors remained the same as the first half of 2012, with Public Resources Advisory Group coming in second place, FirstSouthwest third, and Lamont Financial Services Corp coming in fourth.

by: TONYA CHIN

Wall Street’s brokerages would spend an average of $8 million each to implement a plan being considered by the U.S. Securities and Exchange Commission to impose higher ethical standards on brokers who give financial advice, according to estimates by the securities industry’s largest trade group.

The Securities Industry and Financial Markets Association will present its figures to the SEC in a letter on Friday, the last day for interested parties to respond to a sweeping public request for information that could help the agency determine whether to impose a new standard, known as the so-called fiduciary rule.

SIFMA’s findings and others could further delay the standard that has been long discussed and deferred by the SEC. At issue is a long-running controversy about the differences in responsibilities toward clients for securities brokers, who register with the self-regulatory Financial Industry Regulatory Authority, or FINRA, and registered investment advisers, or RIAs, another type of financial adviser overseen by the SEC.

Imposing traditional fiduciary standards for investment advisers on brokerages could mean big changes for the industry’s business practices, such as possibly disclosing to investors when the “best” investment choices are available elsewhere.

Typically, brokers are compensated by sales commissions and must only meet a “suitability” standard by suggesting investments that are suitable for their clients. But RIAs, typically paid by clients, must be fiduciaries – they must put their clients’ interests above their own at all times. The SEC is considering whether to streamline those standards through a new rule.

Developing and maintaining new compliance procedures to adhere to a fiduciary rule – everything from training staff to monitoring transactions – would run an average of $5 million per firm during the first year, Kevin Carroll, SIFMA associate general counsel, said in an interview with Reuters.

A potentially new broker disclosure brochure under consideration by the SEC would cost each brokerage, on average, about $3 million to develop and update during the initial year, he said.

SIFMA has faced criticism that it is pushing the SEC to adopt a fiduciary standard in name only, because it wants rules that would accommodate traditional brokerage business practices, such as selling brokerage-branded funds that can be more expensive than alternatives.

Some Washington insiders are skeptical that the SEC will ever develop a fiduciary rule for brokers, given intense lobbying by the industry. On Tuesday, for example, the National Association of Insurance and Financial Advisors (wrote in a letter to the SEC that imposing a fiduciary standard on brokers would make their services pricier for middle class investors. NAIFA represents insurance agents who also sell securities.

The group developed the figures based on estimates it collected from 12 large firms and six regional firms. While the identities of those firms are unclear, SIFMA’s membership includes the largest brokerages, such as Morgan Stanley and Bank of America Corp.’s Merrill Lynch unit.

The $8 million estimate represents a fraction of each firm’s annual budget.

At least one fiduciary advocate is skeptical of SIMFA’s figures. A $3 million price tag for a brochure of disclosures is “questionable on its face,” said Knut Rostad, president of the Institute for the Fiduciary Standard, a group that promotes imposing a traditional fiduciary standard on brokerages.

The Investment Adviser Association, which supports imposing a traditional fiduciary standard on brokers who give investment advice, is concerned about how the agency’s process for reviewing the varying ethical standards may affect SEC-registered advisers. The discussion in the SEC’s data request “appears to favor imposing the broker-dealer regulatory regime on investment advisers,” wrote David Tittsworth, the group’s executive director.

A spokesman for the Financial Planning Coalition, a trade group that also supports imposing a traditional fiduciary standard on brokers who give investment advice, said it will file a letter with the SEC on Friday. He declined to comment on SIFMA’s remarks.

Like Coloradans as a whole, voters in Colorado Springs voted to legalize recreational pot last fall. Nonetheless, their city leaders held a packed public meeting Thursday to seek opinions on whether local businesses should be able to sell it.

Colorado Springs, the state’s second-largest city with roughly 426,000 residents, is one of numerous municipalities in Colorado that are considering opting out of part of the state’s new marijuana law. The legislation allows anyone 21 and older to possess and grow pot in small amounts but also gives local authorities the right to bar pot plantations and stores.

More than two dozen cities and towns, including Calhan and Woodland Park near Colorado Springs, have already prohibited marijuana retail stores, according to the Colorado Municipal League, a lobbying group for the state’s cities. Others, like Aurora outside of Denver, decided to postpone a decision on whether to allow sales. In Denver, leaders want to allow pot sales, but have said they want to push back the starting date for new businesses other than medical-pot outlets.

The opt-out clause included in the Colorado pot law doesn’t exist in Washington, which also legalized recreational pot last November. But local officials there have some control over rules such as licensing and zoning, and some are using that authority to keep pot shops at bay.

Richland, a city of roughly 49,000 people in southeastern Washington, passed an ordinance that requires marijuana stores to comply with federal laws, for example, which is impossible because of pot’s continued federal status as an illegal substance.

Local power to determine how the marijuana trade operates, or whether it exists at all, will likely be included in measures that pot advocates attempt to pass in other states as they seek to broaden pot legalization.

Part of the reason some municipalities in Washington and Colorado have been reluctant to allow pot sales, experts say, is uncertainty over how those states will handle the new marijuana market. Both are still setting up regulatory systems for recreational pot.

In Washington, where rules won’t be finalized until August, applicants for pot licenses have a 30-day window in September to file paperwork that is supposed to include where they plan to set up shop. That means jurisdictions would have only about a month to study the state’s rules and come up with their own in time for locals to apply for licenses.

“It’s going to be a little bit bumpy as we roll out this new legalized system,” said Brian Smith, a spokesman at the Washington State Liquor Control Board, which is now tasked with also regulating marijuana.

In Colorado, a pending issue is taxation of pot, which will be used to fund the state marijuana enforcement agency. Voters in November are set to vote on a 25% tax rate proposed by lawmakers. Until then, local officials won’t know what kind of resources state officials will have to oversee marijuana businesses.

The discussion in Colorado Springs is complicated by local politics. The city at the base of the Rocky Mountains is home to large socially-conservative groups that are against marijuana use, but is also a stronghold for libertarians, who view pot smoking as a personal freedom government shouldn’t interfere with.

In El Paso County, where Colorado Springs is located, voters passed the marijuana amendment by only 10 votes, 141,696 to 141,686. The Colorado Springs City Council is expected to take a vote on pot stores next month.

Keith King, the council’s president, said he favors a moratorium, but added that the council is evenly divided between that option, a ban and allowing sales.

Mayor Steve Bach, who doesn’t have a vote, wants a full ban. He and others in the business community said allowing sales amounts to endorsing marijuana use, which would alienate military facilities and religious nonprofits that make up a large portion of the local economy.

“We have to give a message to our employers that we are not going to promote a drug that is federally illegal,” Mr. Bach said.

But others said prohibiting sales would deny expansion opportunities to the 50 or so medical-pot dispensaries in the city, which would have the first shot at recreational licenses, and go against the town’s traditional hands-off approach to government. “This is more than just about pot,” said Liz Oldach, who chairs the local chapter of the Libertarian Party of Colorado. “It’s about freedom.”

The prospect of a ban in one of the state’s biggest cities isn’t discouraging the activists that pushed for legalization. “Marijuana will be legal for adults…regardless of whether businesses are allowed in their localities,” said Mason Tvert, a spokesman for the Marijuana Policy Project.

Lost amid the Supreme Court’s high-profile decisions on affirmative action, voting rights and same-sex marriage was another ruling that may turn out to have a profound impact on American society. The court handed down a decision on Tuesday that, in the words of Justice Elena Kagan, will “work a revolution in land-use law.”

While that may sound obscure, the decision in Koontz v. St. Johns River Water Management District will result in long-lasting harm to America’s communities. That’s because the ruling creates a perverse incentive for municipal governments to reject applications from developers rather than attempt to negotiate project designs that might advance both public and private goals — and it makes it hard for communities to get property owners to pay to mitigate any environmental damage they may cause.

The court’s 5-to-4 decision, with Justice Samuel A. Alito Jr. writing for the majority, arose from an order issued by a Florida water management district denying an application by Coy A. Koontz Sr. to fill more than three acres of wetlands in order to build a small shopping center. The district made clear that it was willing to grant the permit if Mr. Koontz agreed to reduce the size of the development or spend money on any of a variety of wetlands-restoration projects designed to offset the project’s environmental effects. Because Mr. Koontz declined to pursue any of these options, the district denied the permit.

Mr. Koontz, who is now deceased, went to court and claimed that the permit denial constituted a “taking” under two Supreme Court precedents, Nollan v. California Coastal Commission and Dolan v. City of Tigard. These cases established that when the government approved a development subject to certain conditions, like a requirement that a developer dedicate an easement to the public, the conditions would be deemed an appropriation of private property unless the government could show a logical relationship and a “rough proportionality” between the conditions imposed and the projected effects of the development.

The Florida Supreme Court rejected Mr. Koontz’s takings argument on two grounds. First, it interpreted Nollan and Dolan as being limited to cases in which the government has issued a permit subject to a condition — not in those in which a permit has been denied. Second, it ruled that Nollan and Dolan applied only when the government’s condition took an interest in some tangible property (like demanding an easement, for example), not when a government imposed a generalized requirement on someone to spend money.

In what can fairly be described as a blockbuster decision, the Supreme Court has reversed the Florida court on both points.

Leaving the majority’s legal reasoning aside, the Supreme Court’s ruling is likely to do some serious real-world damage. As Justice Kagan correctly explains in her dissent, the decision will very likely encourage local government officials to avoid any discussion with developers related to permit conditions that, in the end, might have let both sides find common ground on building projects that are good for the community and environmentally sound. Rather than risk a lawsuit through an attempt at compromise, many municipalities will simply reject development applications outright — or, worse, accept development plans they shouldn’t.

“Nothing in the Takings Clause requires that folly,” Justice Kagan said. But arguably it does now.

As for the second part of the majority’s ruling, that Nollan and Dolan apply to permit conditions requiring the general expenditure of money, that will also have unfortunate consequences. Cities and towns across America routinely attach fees and other payment obligations to permits, for example, to support wetlands mitigation banks, to finance roads, to pay for new schools or to build affordable housing.

While, to be sure, such mandates must be reasonable under the Constitution, the revolutionary and destructive step taken by the court in Koontz is to cast the burden on the government to justify the mandates according to the heightened Nollan-Dolan standard. This is contrary to the traditional court approach of according deference to elected officials and technical experts on issues of regulatory policy. Moreover, this heightened standard will result in a huge number of costly legal challenges to local regulations.

Consider the challenges of waste disposal. Many communities impose development-impact fees on developers if a proposed project would require expanding waste-disposal sites or building new ones. Before Koontz, a developer could raise a constitutional challenge if the charges were unreasonable, but judges typically deferred to local governments in such cases.

After Koontz, developers have a potent new legal tool to challenge such charges because now the legal burden of demonstrating their validity is on the communities themselves.

In the wake of this under-the-radar ruling, the cost of protecting a community from a harmful building project now lies not with the developer but with the local residents and taxpayers. It’s hard to fathom that the framers of the Constitution would call this either fairness or justice.

Prospective borrowers ranging from U.S. companies to county governments on Monday shelved a raft of deals to raise new capital or refinance debt as a suddenly uncertain interest rate environment dented demand.

In the municipal bond market, half a dozen deals aimed at raising collectively more than $300 million were postponed, while several companies pulled plans to refinance syndicated bank loans. Corporate bonds, meanwhile, passed a fourth day with no deals brought to market, either in the risky high-yield sector or the safer investment-grade sphere.

Raising capital has been challenging to say the least since last Wednesday when Federal Reserve Chairman Ben Bernanke sent interest rates soaring by outlining a plan to wind down the central bank’s massive stimulus program.

Known as quantitative easing and consisting of $85 billion a month in bond purchases, the program was instrumental in a rally of bonds, equities and commodities, and had driven interest rates to record lows. But since Bernanke’s comments last week, the yield on the benchmark 10-year U.S. Treasury Note has shot up 37 basis points, briefly touching a two-year high of 2.67 percent on Monday.

“We need to have panic selling (in Treasuries) out of the way and a stable level on the 10-year Treasury,” before the new-issue market can return, said Scott Schulte, senior investment-grade corporate bond syndicate manager at Citigroup.

That needs to be followed by borrowers willing to sell bonds at higher yields than they had to under the Fed’s easy-money regime.

Corporate bonds had been flying off the shelves until recently as companies looked to refinance at record low rates and yield-hungry investors were ready to sign checks. Since Bernanke first floated the notion last month of a pull back from bond buying, corporate bonds have fallen hard and are now down for the year by 3.74 percent on a total return basis, according to the Barclays investment-grade index.

“The level to which investment grade corporate bonds are interest rate sensitive will certainly be an eye-opener to many total return investors when they open up their quarterly statements on June 30,” said Edward Marrinan, head of Royal Bank of Scotland’s US research.

Said CrediCorp Capital CEO Christian Laub: “What we know is that we won’t see cheap financing like we did in the early half of the year.”

MUNI BOND SALES STALL; LOAN REFINANCINGS SHELVED

Municipal issues have also slowed to a crawl, with bond sales worth $331 million postponed on Monday. That brought the total value of deals shelved since mid-June to $2.6 billion.

A steep price drop in the $3.7 trillion municipal bond market has lifted yields on bonds due in 10 and 30 years to levels not seen since 2011.

“Public officials do not want be the ones selling a deal at yields which result to be top of the market,” said a municipal bond analyst who declined to be named. “They prefer to wait for the market to calm down and become more stable before pushing ahead with their sales.”

Loop Capital, a muni bond underwriter, recently cut its estimate for 2013 muni issuance to $360 billion from $400 billion, but Loop Managing Director Chris Mier said they may cut their forecast more if present conditions persist.

Still, the two big munis deal of the week remain on the calendar for now: $1.3 billion each from the state of Illinois and the city of Los Angeles.

Choosing the bleakest statistic from a report issued by Kevyn Orr, Detroit’s emergency manager, on his city’s financial health is like choosing the wettest raindrop in a monsoon. It could be the $1.3 billion general-fund deficit Detroit is forecast to run, absent restructuring, by the 2017 fiscal year. It could be the $200m revenue decline since 2008, the roughly $3.5 billion in unfunded pension liabilities or its $5.7 billion in non-pension retiree liabilities.

On June 14th Mr Orr announced that Detroit would miss a $40m unsecured-bond payment, and proposed a restructuring that would mean some holders of the city’s unsecured debt receiving pennies on the dollar. If creditors reject Mr Orr’s offer bankruptcy looms. Detroit would be the largest-ever American city to go bust, but hardly the first. In recent years issuers of municipal bonds that have filed for Chapter 9 protection from creditors have included Stockton, Vallejo and San Bernardino in California; Central Falls, Rhode Island; Jefferson County, Alabama; and Harrisburg, Pennsylvania. Others have defaulted without going bust. America’s $3.7 trillion muni-bond market has long had its doomsayers. Is this their moment?

The situation remains grim. According to the National League of Cities, an advocacy group, American cities in 2012 experienced their sixth straight year of constant-dollar declines in general-fund revenues. Year-on-year sales-tax collections rose modestly in 2012 but income-tax collections fell for the third year in a row. So did property-tax collections, despite a recovery in housing markets; assessed values, which determine property-tax rates, usually lag the market by at least 18 months. Cash reserves have fallen by almost 50% since 2007 to 12.7% of expenditures, their lowest level since 1996. (The picture is a bit rosier for states, which tend to have more flexibility in raising revenue than cities do.)

Borrowing costs are going the wrong way. Municipal-bond yields have been rising in anticipation of the Federal Reserve scaling back its bond-buying. American municipal-bond funds saw billion-dollar outflows during the weeks ending June 5th and June 12th. Some may also be worried by Barack Obama’s proposal, released in his budget in April, to limit the tax-exempt status that most municipal bonds enjoy (although getting that passed would require a degree of backbone currently absent from American politics).

None of this means a wave of defaults is around the corner, however. Assured Guaranty, a municipal-bond insurer, has exposure to roughly 11,000 different municipal bonds; it expects to take losses on fewer than 12. The high-profile cases of Detroit and Jefferson County are idiosyncratic. Detroit has been shedding population for years, and the decline of its car industry has destroyed its tax base. The woes of Jefferson County—which this month proposed a plan to emerge from bankruptcy that also involved creditors taking losses—stemmed from a sewer project that stank of corruption and mismanagement.

Bart Mosley, a co-president of Trident Municipal Research, calls these cases “exceptions that prove the rule that state and local-government credits are solid…[and] highlight the extent to which state and local governments have been much more fiscally responsive” than the federal government during the crisis. Mr Mosley points to narrowing yield spreads over the past two years between A-rated and AAA-rated municipal bonds as evidence that fear of default has been priced in.

The concern for the municipal-bond market is less about an imminent deluge of defaults, and more about the lasting precedents set by places like Detroit. Cities and states face huge long-term pressures from health-care costs and pension obligations. Investors are used to seeing governments raise taxes and cut spending to ensure repayment. They are learning that “full faith and credit” has its limits.

Government policy is becoming a more prominent topic of conversation between financial advisors and their clients, according to a recent study as well as anecdotal reports — and remarks by the Federal Reserve chairman last week on the future of the Fed’s stimulus policy have spurred even more discussions about government policy.

“When Bernanke says what he says, it becomes a top-of-mind topic of discussion for us,” says Paul Tramantano, chief executive of Constellation Wealth Advisors in New York. But Constellation isn’t adjusting portfolios in response, he cautions: “Our clients’ portfolios are positioned the way we want them to be.”

Concerns about government policy ranked second among the most popular topics of conversation — behind portfolio rebalancing but ahead of portfolio performance, retirement concerns and estate planning, according to Russell Investments’ latest quarterly Financial Professional Outlook survey.

And among topics initiated by clients, government policy tied for the top spot with concerns about the stock market, advisors reported.

The increasing concern with government policy “is an interesting shift for advisors,” the Russell report states. “We believe the most likely reason … is interest rates. We believe that as long as the Fed maintains its current interest rate policy, advisors should be prepared to continue having similar conversations with clients.”

While advisors at New York-based Altfest personal Wealth Management generally do not bring up government policy with clients, they welcome the conversation when clients initiate it, says Karen Altfest, co-principal of the firm.

“Sometimes they need to be reassured, and sometimes we have to check the accuracy of what they thought they heard,” Altfest says. “But it’s a good opportunity to listen to them and hear their concerns. They bring up something that’s on their mind like health care which we didn’t hear about before.”

The Russell survey also found that nearly 90% of advisors are optimistic about their ability to attract and retain clients this year, primarily through referrals.

Despite rankings that say being a financial advisor is one of the best careers, people are leaving the industry faster than they join. Cerulli Associates says U.S. advisors have decreased 1.3% during the past year, and contraction is expected through 2016. The average age of an advisor is 51, and most expect to retire at 68.

There’s a shortage of younger advisors entering the field, and it’s only going to get worse. Firms need to beef up their training programs and explore new sources of talent.

Wendy started out as a sales associate for a wirehouse in the Southeast. After four years in that role, she was encouraged by the advisor she worked for to get licensed as an advisor. She had already established solid relationships with clients and knew she could learn the rest of the business. After working for three years as a junior, Wendy decided to take the clients that she had built on her own, and now eight years later, Wendy has a successful book of business with nearly $150 million in assets under management.

But this scenario is rare in this industry. Several studies have been published warning of the impending shortfall of advisors entering the field, and the growing percentage of baby boomer advisors nearing retirement.

Over the past year, advisor headcount has declined by 1.3 percent, according to Cerulli Associates, due to terminations, retirements and advisors exiting the industry by choice, and Cerulli expects the decline to continue through 2016. Meanwhile, the average age of an advisor was 51 in 2012, with most looking to retire at 68.

Despite the fact that the financial advisor profession is consistently ranked as one of the top career paths, college graduates are reluctant to enter the field because of the high failure rate of those who have gone before them. And for females, despite their natural fit for the job as relationship-oriented multi-taskers, the largely male dominated culture has kept far too many away. According to the CFP Board, not only are women not entering the profession, more are leaving it, possibly because of a lack of network, mentors and sponsors, negative stereotypes, and competing priorities.

Before the financial crisis of 2008, the big firms all offered strong training programs and actively recruited into them. While the big firms are now starting to reinvest in those programs to increase the percentage of successful graduates (historically only 40-50 percent), programs lack the attention and resources required because management does not completely embrace them as fertile ground for growing top talent. In an attempt to mentor younger advisors, management sometimes partners them with senior producers, but many of these junior advisors end up feeling like indentured servants—essentially building someone else’s brand and book—not a business of their own.

It is my belief that business-minded, second career professionals—especially women—are an appropriate place to mine for talent. These folks, perhaps a decade older and more seasoned than their newly graduated counterparts, can be CPAs, MBAs, attorneys, etc.  They have a natural Rolodex, maturity and life experience. Client sales associates, too, should be nurtured and encouraged to move into advisor positions given their front line support experience, industry knowledge and ability to hit the ground running. But to attract all of these potential candidates, firms need to have better compensation models to incent them, structured mentoring programs and women’s networking groups.

While there is a serious advisor shortfall, there is also a deep bench of talent sitting on the industry sidelines. Take Cindy, who started out as a teacher. After teaching for three years, Cindy determined that she wanted to build a business of her own. She had friends who were financial advisors, and she believed that she could transfer many of her skills to that profession, make a far greater living, and build a clientele of professional women. Today, Cindy is in her second decade as a wirehouse advisor with nearly $750 million in AUM. She has a robust support staff, which enables her to focus on her core competencies and spend time with her three children.

Between young people not choosing financial services as a career and firms not having enough young talent to meet their growing needs, the industry has reached a critical point. Let’s see if firms answer the call.

The bond insurance industry is one segment of the municipal market that stands to benefit as interest rates continue to rise.

Assured Guaranty Ltd., one of the two active bond insurers in the municipal market, has already noticed increasing interest in its product in the relatively short period since rates have gone up, according to Robert Tucker, head of investor relations and communications.

“As interest rates rise and credit spreads widen, we would expect an increase in demand for bond insurance as investors become less focused on yield alone and increasingly incorporate the benefits of insurance in their investment decisions,” he said.

The bond insurance industry was all but wiped out during the financial crisis, which left Assured Guaranty as the only active bond insurer for years to follow. At its peak, the industry was responsible for insuring more than half of muni bond issuance in a year. Last year, only 3.5% of new issues carried insurance. Low interest rates, among other limiting factors, have prevailed for the past four years, reducing both investment income for insurers and the amount of absolute spread available for issuers to fund insurance.

Interest rates have finally reversed direction in recent months, taking off Thursday in response to Federal Reserve chairman Ben Barnanke’s comments that hinted the Fed may start tapering its bond purchasing program by the end of the year. Following Thursday’s close, yields on the Municipal Market Data triple-A scale were up 90 basis points in 10-year maturities, and 104 basis points in 30-year maturities since May 1, with much of the increase taking place since June 3.

“Higher rates probably increase our opportunity to save issuers money as a logical consequence of wider spreads between credits,” said Sean McCarthy, managing director and chief executive officer of the newest bond insurance company, Build America Mutual, which launched in July.

“That said, today in any interest rate environment, BAM’s success is primarily driven by providing greater access for small- to medium-sized issuers, who benefit from the name recognition and liquidity the AA/stable guaranty provides.”

National Public Finance Guarantee Corp., MBIA Inc.’s municipal-only insurer, also said rising interest rates would be a positive for bond insurers.

“As rates rise and spreads widen, insurers will be better positioned to create value for more issuers while charging premiums sufficient to achieve an acceptable return on the capital deployed,” said Adam Bergonzi, a managing director at National.

The currently inactive bond insurer is a subsidiary of MBIA Inc. and was formed in 2009 when MBIA separated its municipal bond insurance business from its other, mostly asset-backed business. National has been preparing to re-enter the market, and the company has said it expects to do so sometime in the near future.

“Over a longer period of rising rates, debt buyers can be expected to become increasingly selective, as they will have more options to satisfy their investment goals,” Bergonzi said. “And as the market becomes more discerning over credit, insurance becomes compelling in a greater number of circumstances.”

Until recently, yields had been declining to historic lows, creating a challenging environment for the declining bond insurance industry. With borrowing costs already very low, municipal bond issuers find the bond insurance product — which provides credit enhancement to help issuers save on borrowing costs — less valuable.

In November of 2012, the Bond Buyer 20-bond index — a selection of mostly double-A general obligation bonds maturing in 20 years — dropped to 3.29%. That was its lowest level since Sept. 2, 1965, when it was also 3.29%.

Interest rates ended 2012 lower than they began at 1.72% in the 10-year, and 2.83% in the 30-year. The 20-bond index was at 3.58% as of Dec. 27, slightly down from the beginning of the year, when it was at 3.83%.

“It’s a positive development,” said Alan Schankel, managing director at Janney Capital Markets. “I don’t think there will be an overnight change, or a rush to embrace insurance because rates are a little higher, but in general, it’s a positive point for insurers and one of the things they need going forward to grow their business and grow their market share.”

In assigning ratings to bond insurers, credit rating agencies have cited the low interest rates as a limiting factor in bond insurers’ ability to generate new business.

Standard & Poor’s, for example, has assigned Assured Guaranty a financial strength rating of AA-, saying the company has a strong competitive position and strong capital, but limited business growth prospects due to the low interest rates.

Moody’s Investors Service rates the company lower at A2, also citing the low interest rates, among other factors.

Analysts at Moody’s say the rise in interest rates is a positive sign for the industry, but it also has to overcome other problems.

“There are two primary reasons why new business volume has been so low,” said James Eck, vice president and senior credit officer at Moody’s. “One is the low absolute interest rate environment, which has led some issuers to feel that since they’re able to issue at such low rates, the additional savings from bond insurance either aren’t there, or do not produce meaningful savings. The other potential reason is general investor skepticism of the value proposition.”

Stanislas Rouyer, associate managing director in the financial institutions group at Moody’s, said that the investor skepticism is based on the fact that the industry almost disappeared during the financial crisis and that, until recently, there has only been one active bond insurer.

“Now, with BAM being active, and National possibly re-entering the market, there is more of an industry,” he said. “More players appears to be a good thing for the industry overall. It gives more of a sense of the durability of the product.”

The other issue that causes investor skepticism is the legacy exposures of guarantors. Situations like Detroit remind people of the risks in the industry, Rouyer said. But at the same time, they can also highlight why the product is useful.

Schankel also believes events in Detroit, as well as Jefferson County and other troubled municipalities, will help illustrate the value of bond insurance. He says that time is also a factor that will help the industry to grow.

“The further away we get from 2008 and those bad memories of insurance, I think the better opportunity insurers will have to penetrate the market, at least on the retail level,” he said, adding that he doesn’t think the industry will ever return to the 57% market share it saw in 2005.

Standard & Poor’s analysts said in a July 12 report that the bond insurance industry could see its market share of insured new issues return to 20% to 30% in a “normalized interest-rate environment.”

However, in the current environment, yields aren’t quite there yet.

Matt Fabian, a managing director at Municipal Market Advisors, noted that while yields have increased, they have only risen 1% in the last few months.

“This isn’t nearly what we’re talking about when we say that higher yields would help the insurers,” he said. “Getting back to more ‘normal’ yields, at least for when the insurers had their heyday, might take another 1% or more.”

In addition to a waning investor acceptance, the industry has a few structural factors working against it as well. These include the movement away from direct retail ownership to funds and separately managed accounts, rating recalibration, and the reduction in the use of variable-rate and other products that depended on insurance, Fabian said.

“Lack of issuance, in particular longer fixed rate bond issuance, and the severe downward pressure on underwriting fees” are other limiting factors, he added. “These don’t leave a lot of room to pay an insurer for their services.”

by: TONYA CHIN

States and cities across the nation are starting to learn what Wall Street already knows: the days of easy money are coming to an end.

Interest rates have been inching up everywhere, sending America’s vast market for municipal bonds, a crucial source of financing for roads, bridges, schools and more, into its steepest decline since the dark days of the financial crisis in 2008.

For one state, Illinois, the higher interest rates will add up to $130 million over the next 25 years — and that is for just one new borrowing. All told, the interest burden of states and localities is likely to grow by many billions, sapping tax dollars that otherwise might have been spent on public services.

The same concerns about rising rates that have buffeted the world’s stock markets recently have also affected the market for municipal bonds. The muni market, despite a modest rally on Wednesday, is headed for one of its worst months in years.

Much as home mortgage rates are making home buying a bit more costly as they rise, so, too, are the rates at which states and cities borrow money. Public officials — and taxpayers — may feel the effects for years. Perversely, the places with the greatest distress are likely to see their borrowing costs rise most.

Over the last few days Georgia, Philadelphia, the Metropolitan Transportation Authority in New York and others have delayed sales of new bonds, citing the precipitous plunge in prices that is driving up interest rates.

Gov. Pat Quinn of Illinois attributed the extra cost to the state’s failure to shore up its finances, particularly its rickety pension system. Illinois has the lowest credit rating of any state, and as interest rates rise they tend to rise fastest for the weakest borrowers.

“Borrowing money when you’re already in debt doesn’t seem like a good idea to me,” said Felicia Hill, a 44-year-old Chicago woman who wondered how the state could bear the rising cost. “I think it could have waited, when we have bigger problems in Illinois.”

The sell-off in the municipal bond market has followed the general rout in the overall bond market, which was set off when Ben S. Bernanke, the chairman of the Federal Reserve, indicated that the strength of the economic recovery might allow the central bank to pull back on its $85 billion-a-month bond-buying program earlier than anticipated.

The Fed was not buying municipal bonds, but the market reacted anyway. Investors expected interest rates to rise, and because prices move in the opposite direction, the values of the municipal bonds they already held dropped.

Investors apparently started selling, not wanting to be the last one out. That caused a flood of bond sales. For the week ended June 19, $3.368 billion flowed out of mutual funds that hold tax-exempt municipal bonds, according to the Investment Company Institute. The outflow for the previous week was $3.236 billion.

Such sell-offs tend to hit the municipal bond market hard because it has many individual investors who buy bonds to hold them, either directly or through mutual funds, rather than financial institutions that trade them quickly.

“The mutual fund’s customer has proven to be fickle in these volatile periods, and you get the sticker-shock effect,” said Chris Mauro, the head of municipal bond strategy at RBC Capital Markets. The trend starts to feed off itself and can last for a long time, he said. “As they liquidate, there’s pressure on the mutual funds to raise cash, which puts more selling pressure onto the market.”

Some analysts thought the sell-off was made worse by the actions of Detroit as it flirted with bankruptcy. The city’s emergency manager, Kevyn Orr, proposed inflicting severe losses on its bondholders earlier this month as he struggled to keep the city from declaring what would be the largest municipal bankruptcy in history. That prompted investors to sell Detroit bonds, and raised questions about whether Detroit’s approach could set an example that other distressed cities would follow.

Some local governments that had planned to issue bonds this week decided to wait and see whether the market improved. But Illinois was among those that could not afford to wait. It had been conserving money by delaying road maintenance and the building of new schools.

Abdon Pallasch, an assistant state budget director, cited in particular the risk of delaying reconstruction of the city’s commuter rail system in hopes of obtaining better rates on the bonds, which have a total value of $1.3 billion. He said service had been halted on the Red Line, Chicago’s oldest, inconveniencing 80,000 commuters a day.

Mr. Pallasch said that state finance officers had calculated the state’s $130 million market penalty by comparing the rate Illinois will pay on these bonds with the rates being paid on similar bonds issued by states with AA ratings. That, he said, was Illinois’s credit rating before the state’s pension problems boiled up.

Illinois has shortchanged its pension system for many years and has now fallen so far behind that it cannot catch up without diverting money away from other programs. Governor Quinn has tried several times without success to push pension overhauls through the legislature. Moody’s Investors Service downgraded the state’s credit to A3 in June, soon after one failed legislative effort, and Fitch went to A-, the equivalent in its ranking system.

Although those ratings are the lowest of any state, they are still several notches above junk grade.

Governor Quinn said that the state was paying an average interest rate on the bonds of 5.042 percent. He called on lawmakers to enact pension changes “by July 9, so we can stop the bleeding, prevent future downgrades and jump-start Illinois’s economy.”

Daniel Berger, senior market strategist for Thomson Reuters Municipal Market Data, said the pension-related downgrades cited by the governor were important factors but not the only ones.

He said that market conditions had driven the interest rate on a typical 10-year municipal bond up by more than one percentage point since the beginning of May. The rate for longer-maturity bonds were more than 1.25 percentage points higher.

“He’s ignoring the adverse market conditions,” Mr. Berger said.

BY MARY WILLIAMS WALSH

A research paper released last week suggests that widespread violations of MSRB fair pricing rules are rampant in the municipal market.  Scratching just below the surface, however, reveals serious flaws in the methodology and assumptions underlying the authors’ conclusions.

First, the paper does not provide any indication as to how the authors determined markups on municipal bond transactions. The authors indicate that they use data collected by the MSRB under their Real-Time Transaction Reporting System. However, RTRS data does not separate out markups, which need to be inferred from trade price information. Without knowing how the authors used trade price data to determine markups, it is nearly impossible to replicate their calculations or determine their validity.

Second, the authors pay virtually no attention to the Financial Industry Regulatory Authority’s robust examination and enforcement system for detecting unfair pricing activity and sanctioning violators. Rooting out fair pricing violations is a key element of virtually all FINRA municipal examinations.

Third, the authors state that “the MSRB instructs members to calculate markups on municipal bond trades as the difference between the prices charged to the customer and the prevailing market price and to calculate markdowns as the difference between the prices paid to investors and the prevailing market price. The broker-dealers’ contemporaneous cost of acquiring…the bonds through inter-dealer trades or offsetting trades with investors establishes a presumption of the prevailing market price.” In fact, MSRB rules do not include any such instruction. The citation provided by the authors refers to draft MSRB interpretive guidance which was never adopted. Rather, MSRB Rule G-30 requires dealers to buy or sell securities “at an aggregate price (including any mark-down or mark-up) that is fair and reasonable.” The MSRB’s fair pricing rule does not directly set guidelines or standards for markups and does not use the concept of contemporaneous cost.

Fourth, in their discussion of markups, the authors take no account of fundamental issues such as costs to dealers of financing and hedging inventories and servicing customer accounts and for market movements that could account for differences in the prices at which dealers purchase and sell securities. One of the examples cited by the authors involves an inventory position which, according to the authors, a dealer acquired then sold off in a series of customer trades over a four-week period. Without analyzing those specific bonds, generally the authors fail to address questions such as how market benchmarks performed over that period and what the dealer’s cost of financing and hedging that inventory over four weeks was.

Moreover, a key issue the authors neglect throughout the paper relates to the cost of servicing customer accounts. The markup earned by a dealer on a single sale must often cover the cost of servicing that customer position, including periodic valuations and statements, possibly for decades.

Fifth, the authors overstate the portion of outstanding municipal securities held by individuals. Citing SIFMA data, the authors state that “one half of the $3.7 trillion in municipal bonds outstanding at the end of 2012 was directly held by individual investors.” Our data on holdings of municipal securities come from the Federal Reserve Board’s “Flow of Funds” publication, which tracks holdings of “households,” not individuals. Moreover, “households” are a residual category, meaning that household holdings really reflects the holdings of any category of investors not otherwise accounted for, including individuals but also including others. In addition, a growing portion of the municipal market held by individuals is owned through separately managed accounts, which are professionally managed and generally buy and sell bonds in block-size transactions.

Sixth, the authors make no distinction between trades involving fee-based accounts and traditional brokerage accounts. This distinction is important because with a fee-based account, because a dealer earns periodic fee revenue based on the size of the account, markups on transactions can be smaller. With traditional brokerage accounts, all the dealer’s revenue is derived from markups on customer sales, so markups must be larger to account for dealer costs of servicing accounts. Including markups on trades involving fee-based accounts makes the average and median markups smaller than they would be on trades involving only traditional brokerage accounts. For an “apples-to-apples” comparison, the authors should have analyzed markups on fee-based and traditional accounts separately.

Seventh, the authors’ proposals for addressing perceived shortcomings in municipal securities pricing rules are deeply flawed. They suggest a municipal securities pricing rule based on “dealers’ contemporaneous cost,” an elusive concept in a market like ours where most bonds trade very infrequently. When a dealer buys a bond that remains in inventory for weeks, the dealer’s “cost” relative to current market pricing is often almost impossible to determine. That is the reason the MSRB has successfully administered a rule based on fair pricing rather than markup regulation for decades.

Finally, Misters Deng and McCann are not independent academics but rather professional witnesses closely affiliated with plaintiffs and claimants in securities litigation and arbitration cases against broker dealers. It should come as no surprise that their conclusions suggest significant numbers of pricing violations against investors, potentially leading to actions in which the authors would have a financial interest.

Enforcing fair pricing standards in a thinly traded market like that for municipal securities is difficult and complex. Determining fair prices is often subject to interpretation, and intelligent and informed market professionals can and often do disagree about the value of a bond at particular time. While it is appropriate for regulators to periodically review pricing rules to ensure customers’ prices are fair, and academic research can help inform that process, there is no systemic mispricing of customer transactions as the authors claim.

by: Michael Decker

Michael Decker is a managing director and co-head

of the municipal securities group at SIFMA.

Detroit’s default and debt-restructuring plan are precedent-setting in the U.S. municipal market, Moody’s Investors Service said on Monday, because the city is looking to bondholders, as well as labor unions and pensioners, to share the pain.

The city on Friday defaulted on a $39.7 million payment on certificates of participation and presented a plan to restructure its finances.

“The restructuring plan is unconventional and precedent-setting in the municipal market. It builds a strong case for insolvency, girding the city for a tough fight with creditors of all types,” Moody’s said in a statement.

The proposal by Emergency Manager Kevyn Orr calls for unsecured creditors to take a pro rata share of $2 billion of new limited recourse participation notes, which would be issued to replace approximately $11 billion of unsecured obligations.

“The substantial reduction offered to unsecured creditors, the extent of the city’s financial stress and the complexity of the city’s debt add to the uncertainty of many classes of debt ultimately recovering their investment,” the rating agency added.

On Thursday, before the city’s announcement, Moody’s downgraded several classes of Detroit debt to Caa2 with a negative outlook.

Moody’s also said the plan is unusual as it proposes similar treatment of various debt security types.

It noted that Orr did not propose a plan for creditors who are considered secured, such as the debt of the city’s water and sewer enterprises or the city’s general obligation debt, which is enhanced by state aid and claims relative to interest rate swaps. However, the latter are subject to negotiations.

“The plan appears to treat the general obligation and pension obligation certificates similarly, which would be a break from tradition,” Moody’s said.

Standard & Poor’s, which on Friday downgraded the city to CC from CCC minus, said it was sure to cut the rating further.

If you bought Detroit debt without making sure it came with support from credit enhancement or a revenue lien, you will now pay the price, Detroit emergency manager Kevyn Orr says.

“If you lent money to an insolvent city that has been going insolvent as openly and notoriously as possible since 2000, and you don’t have a security interest, then you are an unsecured creditor,” Orr told The Bond Buyer in a telephone interview Tuesday. “This has been building for decades and decades. They understood the risk.”

Orr’s comments come days after he unveiled a comprehensive but controversial restructuring plan that relies on slashing the city’s unsecured debt. Orr wants to issue $2 billion of notes to pay off holders of $11.4 billion of unsecured debt on a pro rata basis.

He said he should know within 30 days whether he will file a Chapter 9 bankruptcy.

The plan puts $650 million of the city’s unlimited- and limited-tax general obligation bonds on par with $5.7 billion of retiree health care, $1.5 billion of pension certificates, and a newly assessed $3.5 billion unfunded pension liability. Orr, a corporate bankruptcy attorney who worked on the Chrysler restructuring, said his decision to lump GO bonds in with debt like unfunded retirement liabilities and POCs reflects “traditional categories.”

“For those that were apparently unsecured, they were all treated equally,” he said. “We’ve been saying since the beginning that our thinking, our methodology, is to treat all claimants equally within their class.”

The restructuring plan was not vetted by the state and came solely from his office, said Orr. It does not reflect a formal position by the state on the classifications of a local government’s debt.

“We have not talked to the state about this, and the state has no obligation to us on this proposal. This is our proposal,” he said.

The treatment of $650 million of the city’s GOs — out of a total of $1.1 billion of GOs — as unsecured surprised many in the municipal market, who note that unlimited-tax GOs are typically considered among the safest products in the market.

Orr countered that assessment, saying UTGOs are no more than “the safest unsecured debt” in reality.

“I know the whole moral argument,” he said. “But unsecured claimants always say, ‘It’s not me’.”

The banks that are counterparties on the city’s eight interest-rate swaps hedging $1.4 billion of pension certificates, for example, were savvy enough to demand a lien on casino revenues in 2009 when it became clear Detroit would have a hard time making the payments, he said.

“The factors that have gone into underwriting since 2000 reflect the acute deterioration,” said Orr.

As part of the restructuring plan, Orr announced an immediate moratorium on repayment of all unsecured debt, starting with a $39.7 million payment due Friday on the pension COPs.

Holders of the COPs have the ability to sue the city in state court over the default. If they win, the court would order a judgment levy forcing the city to raise taxes to generate new money to cover the debt payments.

But Orr cautioned that a lawsuit could push the city closer to a Chapter 9 filing.

“We expect to have intense negotiations that would forestall any lawsuit,” he said. “Any lawsuit would cause us to reassess our plan to try to pursue an out-of-court settlement. If I were the parties, I would not run to the courthouse.”

Detroit will continue to default on unsecured debt, including its GOs, that comes due during negotiations, Orr said. It will also continue to make payments on the debt it considers secured, while negotiating with creditors on a restructuring or refinancing aimed at providing the city relief on its annual debt service burden.

Secured debt totals about $7 billion, including $5.9 billion of water and sewer revenue bonds and $480 million of GOs. Nearly all the debt carries bond insurance.

Orr said he expects to meet with bondholders later this week and next, with some meetings in person and some on the telephone. It should become clear within the next 30 days whether the city will file for Chapter 9 bankruptcy.

“That doesn’t necessarily mean we’re going to file in 30 days,” he said. “If we’re making progress, we’ll continue to negotiate.”

The emergency manager said he’s not focused on the impact the default or proposed haircut may have on other Michigan issuers or the broader municipal market.

“Frankly, my focus is on the obligation I have for the city of Detroit,” he said. “I cannot really take into account the potential impact it may have [on the municipal market].”

He added that he doubts the city’s default or a bankruptcy would stain other local governments or the state itself.

“Detroit is such a unique situation,” he said. “Detroit is so clearly insolvent that for anybody to impute anything on another municipality because of Detroit is wrong.”

Orr said he’s not worried about future access to the markets when the city may badly need borrowed money.

“My experience is once you get a debtor in a position with better cash flows and lower debt, that they’re more credit worthy,” he said.

The restructuring plan included a new assessment of the city’s pension liability that boosts the unfunded figure to $3.5 billion from about $640 million. Orr has a meeting set with labor to discuss cuts on Thursday, and would not go into detail ahead of the meeting on the new pension figures, which are based on more conservative investment and amortization assumptions.

“There’s no mysteries here,” he said, “It’s straightforward math.”

He also declined to comment on the notion that the restructuring plan favors unions and employees over bondholders, saying only that labor feels as strongly as bondholders that they are facing unfair sacrifices.

“If you ask unions, this is yet another Wall Street bailout,” Orr said.

“I can’t be governed by perception — only by the reality of where we are,” he added. “I understand different people are going to be upset, but at the end of the day we tried to adhere to the benefits of the bargain they cut.”

Orr said he is negotiating with creditors on a class-by-class basis. The city may enter into separate — confidential — agreements with creditors of the same class, he noted.

“There may be times when different people want to cull themselves from the herd, and we may enter into confidential settlements with those folks,” he said. “We reserve that right.”

As to whether the city can expect help from the state or the federal government, directly or indirectly, Orr said it’s unlikely.

“Let me put it this way: It’s been made clear to me that we are on our own,” he said. “The cavalry is not coming.”

by: CAITLIN DEVITT

“The dual trend of low interest rates and a slowly improving economy is creating a perfect storm for new debt issuance,” said Richard Peterson, Director, Global Markets Intelligence, S&P Capital IQ. “The jury is still out on how long that environment will last, but for now, all signs are pointing to increases in issuance over the next several weeks.”

The full press release is available at:

http://img.en25.com/Web/StandardandPoors/CUSIP%20Issuance%20Trends%20May%202013_PR.pdf

Clarence Anthony of the National League of Cities has commented on proposed regulations (REG-118315-12) on the annual health insurance provider fee under the Affordable Care Act, seeking clarification that governmental employers who self-fund their benefit plans on a pooled basis, and the pools in which they participate, fall under the self-insured employer exclusion and, thus, aren’t covered entities subject to the fee.

June 3, 2013

The Honorable Daniel Werfel

Acting Commissioner

Internal Revenue Service

CC:PA:LPD:PR (REG-118315-12)

P.O. Box 7604

Ben Franklin Station

Washington, DC 20044

RE: Health Insurance Providers Fee Notice of Proposed Rulemaking — Comments and Request to Testify

Dear Acting Commissioner Werfel:

The National League of Cities (“NLC”) on behalf of cities and towns throughout the country appreciates the opportunity to provide comments to Treasury and the Internal Revenue Service (“Treasury”) on the Notice of Proposed Rulemaking (“Proposed Rule”), Health Insurance Providers Fee, as published in the Federal Register on March 4, 2013 (78 Fed. Reg. 14034), and subsequently corrected on March 22, 2013 (78 Fed. Reg. 17612). Many of these cities and towns have joined together to form public entity health care pools to provide health care insurance coverage to their employees. Without the benefit of these pools, many of these entities would not be large enough to self-insure and all would face either larger or more unpredictable costs to provide these essential benefits.

Section 9010 imposes an annual fee on covered entities engaged in the business of providing health insurance for any U.S. health risk. ACA §§ 9010(a)(1) and (c)(1). Generally, section 9010 provides that the term “covered entity” does not include: (1) any employer to the extent the employer self-insures its employees’ health risks; (2) any governmental entity; (3) certain nonprofit entities that do not engage in certain political activities and receive more than 80-percent of revenues from Medicaid, Medicare, and SCHIP; and (4) non-employer established VEBAs.

While the Proposed Rule defines the term “governmental entity” to include political subdivisions of a state, it does not include instrumentalities of a governmental entity. 78 Fed. Reg. at 14042.

The preamble notes that instrumentalities that provide health insurance may qualify for other exclusions under section 9010, such as the exclusion for employers that self-insure their employees’ health risks. 78 Fed. Reg. at 14037. Treasury invites comments on the types of instrumentalities, if any, that would be covered entities under the general definition and the extent to which they would qualify for exclusions consistent with the statute. Our detailed comments are below.

We also request an opportunity to testify at the public hearing on June 21, 2013.

I. Background

NLC is the country’s largest and oldest national organization serving over 19,000 cities and towns throughout the country and 49 state municipal leagues. Founded in 1924, NLC helps city leaders build better communities through federal advocacy, research, and information sharing between and among cities and towns and state municipal leagues.

State municipal leagues are intergovernmental organizations comprised of member cities and towns within a state. They were formed and operate to improve the operations of their municipal government members and promote the welfare of citizens of those municipalities by faciliating and coordinating research and programs that (i) advance the efficient and effective operations of member municipalities, (ii) promote governmental efficiency and effective governance, and (iii) coordinate and effect advocacy and communications with the legislative, administrative and judicial branches of state and federal governments on issues affecting member municipalities.

Many governmental entities are authorized under state law to join together to self-insure health benefits for their employees through risk-sharing pools, trusts or other group arrangements (collectively, “Pools”). These entities are operated exclusively for the benefit of the municipal employers. An NLC affiliate, the NLC Risk Information Sharing Consoritum (“NLC-RISC”) is an association of state municipal league intergovernmental risk-sharing Pools in thirty-four states. NLC-RISC member Pools offer property, liability, workers’ compensation, unemployment, and/or employee benefit programs to their combined 16,000+ member cities, towns, counties and other local government entities.

NLC-RISC member Pools are universally exempt from tax under Code § 115 or as VEBAs under Code § 501(c)(9). Many have private letter rulings recognizing that they perform an essential government function on behalf of their municipal participants with all of a Pool’s income accruing solely for the benefit of their participating public employers and not for private interests.

Those Pools that provide health benefits to local government employees and their families are all comprised of governmental entities that would be excluded from the fee were they to provide health benefits through their own separate health plan, under both the governmental entity exclusion and the self-insured employer exclusion. In many cases, cities and towns are too small to effectively self-insure some or all health benefits for their own employees. Thus, when cities and towns join together to provide health coverage through a Pool, they enjoy economies of scale, which helps to lower the cost of the coverage for both the municipalities and their employees. They also enjoy enhanced stability by having a larger risk pool.

On behalf of cities and towns throughout the country who have joined together to form public entity health Pools, we submit this comment letter to request an express exclusion for these Pools in the final rule. Although we believe Pools fit within the self-insured employer exclusion (or VEBA exclusion for those Pools that are VEBAs), they are instrumentalities of governments and thus are not included in the governmental entity exclusion under the Proposed Rule. We are concerned that without an express inclusion in the definition of governmental entities not subject to the fee or an express exclusion from the fee as self-insured employers, the Pools or the municipal employers covered under a pooled arrangement could be interpreted as being covered entities subject to the fee.1

We believe that the overarching intent of Congress is to exclude governmental entities that self-insure their employees’ health benefits from the health insurer fee. This is evident by the existence of both the governmental entity exception and the self-insured employer exception. These exceptions should apply whether the governmental entity provides the self-insurance alone or does so jointly with other governmental entities through a Pool.

II. Recommendations

We recommend that Treasury define governmental entity in the final rule to expressly include a Pool through which political subdivisions jointly self-insure their employees’ health benefits. Alternatively, we recommend that Treasury specifically include Pools, and the governmental entities that self-insure their employees’ health risks through Pools, in the self-insured employer exclusion.

1. Governmental Entity Exclusion

Treasury should expressly include Pools in the definition of governmental entity. ACA § 9010(c)(2)(B) broadly excludes any governmental entity from the definition of covered entity. However, the Proposed Rule narrows the definition of governmental entity to not include instrumentalities of states or local political subdivisions. 78 FR at 14042.

In the discussion of instrumentalities in the preamble to the Proposed Rule, Treasury refers to instrumentalities within the meaning of Rev. Rul. 57-128. That revenue ruling confirmed the tax-exempt status for federal employment tax purposes of an interstate association of several state insurance departments. In the ruling, the IRS applied a six factor test in determining whether the association was an “instrumentality of one or more states or political subdivisions.” All Pools satisfy this six factor test, and therefore are either instrumentalities of their public entity participants or are intergovernmental agencies in their own right under state law. Thus, it appears that Pools may not be exempted from the definition of covered entity as “governmental entities” under the Proposed Rule.

Pools are comprised of counties, municipalities, school districts, authorities and other local political subdivisions and are established under state intergovernmental cooperation laws. Their sole purpose is to provide health benefits to the employees and employees’ dependents of their municipality participants. As a result, they have been recognized by the IRS as performing an essential government function on behalf of their participants — with all of their income accruing solely to their participating governmental employers — and are therefore exempt from taxation under Code § 115(1), in accordance with Rev. Ruling 90-74, 1990-2 C.B. 34.

Not excluding Pools from the definition of covered entity because they may also be deemed governmental instrumentalities is inconsistent with the rationale for their Code § 115 tax exemption, as expressed in Rev. Ruling 90-74, which states in pertinent part that:

Political subdivisions insure against casualty risks and other risks arising from employee negligence, workers’ compensation statutes, and employee health obligations. Insuring against these risks satisfies governmental obligations. Any private benefit to employees from insuring against these various risks is incidental to the public benefit.

* * *

[T]he income of an organization formed, operated, and funded by one or more political subdivisions (or by a state or one or more political subdivisions) to pool their risks in lieu of purchasing insurance to cover their public liability, workers’ compensation, or employees’ health obligations is also excluded under section 115(1) if private interests do not, except for incidental benefits to employees of the participating states or political subdivisions, participate in or benefit from the organization.

(Emphasis added). See Rev. Rul. 90-74, 1990-2 C.B. 34. Based on this published ruling, the Service has issued numerous section 115 private letter rulings to state or municipal health insurance funds for active and/or retiree health benefits.

Thus, as governmental instrumentalities or agencies that perform an essential government function, Pools should not be treated any differently under ACA § 9010 than the governmental entities that use them to provide health benefits to the governmental entities’ employees. Pools are funded solely by local taxpayers and governed by public officials on a tax-exempt, non-profit basis. Like the governmental entities that use them, Pools should not be subject to the health insurer fee. We therefore respectfully request that the final rule expressly include this type of governmental “instrumentalities” in the definition of governmental entity.

We note that this approach would be consistent with the definition of government entity in the Code § 4980H employer shared responsibility proposed rule, which defines government entity as expressly including any “agency or instrumentality” of “a state or political subdivision thereof.” See 78 Fed. Reg. 241. We see no reason why the health insurer fee should depart from the commonly used definition of government entity.

2. Self-Insured Employer Exclusion

We strongly support Treasury expressly including Pools in the definition of governmental entity excluded from the health insurer fee. Alternatively, Treasury should expressly include governmental entities that use Pools, and the Pools themselves, in the definition of self-insured employer.

Section 9010 and the Proposed Rule provide that the term “covered entity” does not include any employer to the extent that the employer self-insures its employees’ health risks. ACA § 9010(c)(2)(A); 78 Fed. Reg. at 14042. The Proposed Rule defines self-insured employer as an employer that sponsors a self-insured medical reimbursement plan within the meaning of Treas. Reg. § 1.105-11(b)(1)(i), including plans that do not involve shifting risk to an unrelated third party, as described in Treas. Reg. § 1.105-11(b)(1)(ii). 78 Fed. Reg. at 14042.

The local governments that comprise a governmental risk-sharing Pool jointly fund their employees’ health benefits plans on a pooled basis in which they share the risk and do not shift the risk to a licensed health insurer or other unrelated third party. The government participants are inextricably bound to the Pool and each other by the intergovernmental obligations they assume for the establishment and funding of the Pool itself. With ultimate governing authority and financial accountability for each Pool vested in its public entity participants, those Pools are not unrelated third parties (or health insurers).

As explained earlier, the way Pools operate and how they are funded make their participating governmental employers “self-insured employers” within the meaning of Treas. Reg. § 1.105-11. For that reason, we respectfully request that the final rule clearly provide that governmental employers who self-fund their benefit plans on a pooled basis, and the Pools in which they participate, both fall within the self-insured employer exclusion and thus are not covered entities subject to the health insurance fee.

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We appreciate the opportunity to comment on the Proposed Rule. If you have any questions, please contact Carolyn Coleman, Director, Federal Relations, 202.626.3023, coleman@nlc.org or Erin Rian, NLC-RISC Program Manager, 202.626.3122, erian@nlcmutual.com.

Sincerely,

Clarence E. Anthony

Executive Director

National League of Cities

Washington, DC

FOOTNOTE

1 We note that as governmental entities, Pools are not MEWAs under ERISA § 3(40) and thus, should not be included within the definition of “covered entity” as MEWAs.

More issuers are lining up to redeem Build America Bonds early after interest subsidy payments were reduced as a result of across the board spending cuts by Congress.

A review of event notices by The Bond Buyer showed eight issuers have indicated in the last month that they are likely to take advantage of extraordinary redemption provisions to refund BABs, half of them school districts located in Ohio. In May the state’s capital city, Columbus, said it planned to refinance approximately $368.7 million of BABs issued in 2009 and 2010, making it one of the first issuers to make such a redemption of BABs because of the so-called sequestration cuts.

Issuers Begin Calling BABs Due to Sequestration

In March, $85 billion of the federal budget cuts went into effect and cut the 35% interest subsidy rate the Treasury Department had promised to pay issuers by 8.7%. In April, issuers began announcing their intent to redeem BABs, cutting off a stream of interest income to investors.

Market analysts have said they expect issuers to continue to examine whether the options to refinance their BABs are economically beneficial and produce a savings.

“There was an enormous variation in the way call language was written in these deals,” said Chris Mier, managing director of analytical services at Loop Capital Markets. “But the ones with the par call language are being called.”

Mier said there has been some investor frustration with these calls. While it is the right of the issuer to decide about the cuts, most “investors feel they got sandbagged by the Treasury Department because of the risk of sequestration or the cut was clearly not properly disclosed by the federal government,” he said. “The federal government acted like this was never going to happen and here it has happened.”

The Board of Education of the Brunswick City School District in Ohio notified bond holders on the Municipal Securities Rulemaking Board’s EMMA system May 29 that they had the option to authorize the provision on $15.46 million of BABs but had not chosen to do so yet.

The district said it received a notice from the Internal Revenue Service on May 13 about the reduced interest payment on the bonds. The district said that it had already received a reduced payment from the Treasury consistent with the sequestration cut but that it would not affect its ability to pay the interest payment due on June 1.

The BABs were used to renovate and construct school and transportation facilities at eight different schools within the district, according to the official statement. Peck Shaffer & Williams LLP was bond counsel. Stifel Nicolaus was underwriter.

The Austintown Local School District in Youngstown, Ohio adopted the extraordinary redemption provision on May 29 but has not determined whether it will proceed to sell, issue and deliver the refunding bonds to all or any part of the $12.655 million in BABs. Those bonds were used to pay the local share of school construction under the state of Ohio Classroom Facilities Assistance Program, the official statement said.

RBC Capital Markets was underwriter. Squire, Sanders & Dempsey LLP was bond counsel.

The Keystone Local School District in Lagrange, Ohio also notified bond holders on June 4 about the possibility to refinance $5.8 million of Series 2010B BABs. On June 3, the Board of Education of the School District adopted a resolution acknowledging the reduced interest subsidy payment and its option to redeem the bonds. The district  also has not determined if it will proceed to refinance the bonds. Squire, Sanders & Dempsey LLP was bond counsel. Robert W. Baird & Co. Inc. was underwriter.

The Eaton Community City School District in Preble, Ohio announced its intent to authorize the redemption of $3.77 million of BABs on May 29 to its bond holders. RBC Capital Markets was underwriter. Peck, Shaffer & Williams LLP was bond counsel.

Separately, the Washington County Housing and Redevelopment Authority in Woodbury, Minnesota announced its intent to refund $7.7 million of recovery zone economic development bonds issued in 2010.

The city of Manhattan, Kan., said it was contemplating exercising its extraordinary optional right to redeem $33.14 million of Series 2009-2 BABs.

The Independent School District in South Washington County, Minn., announced to bond holders on June 3 that the extraordinary redemption provision had been triggered on $4.365 million of qualified zone academy bonds.

And finally, the Rock Island County Metropolitan Mass Transit District announced that the Board of Trustee met on June 18 to consider redemption of $10.29 million of Series 2010B BABs.

BABs expired at the end of 2010. Almost $188 billion of BABs were issued since they were created in 2009 as part of the American Recovery and Reinvestment Act.

by: JENNIFER DEPAUL

Escaping the largest U.S. municipal failure could leave Jefferson County, Ala., in an even deeper hole.

The county’s plan to emerge from bankruptcy protection hinges in part on the sale of $1.9 billion of new debt this fall to refinance debt tied to its troubled sewer system. But some observers call terms of the new debt onerous.

Jefferson County, Ala., taxpayers stand to repay nearly $6.9 billion over the term of a debt deal.

The proposal for the refinancing, which has been approved by a majority of county commissioners, includes a set of bonds that schedule larger debt payments in the later years of the financing. About $474 million are a type of debt called capital-appreciation bonds. Such bonds have been derided by California’s treasurer as “terrible” for their backloaded payments, and Michigan has banned their sale by municipalities.

All told, Jefferson County taxpayers would stand to repay nearly $6.9 billion over the four-decade term of the financing, more than three times the amount the county initially plans to borrow. That is perhaps billions more than they would pay under a plan whose payments would be more evenly distributed, said a potential investor.

Municipal bonds sold to fund water and sewage projects often cost the issuer no more than two times the initial amount borrowed after about 30 years. At current interest rates, a home buyer with good credit can expect to pay less than double the cost of a home over the life of a 30-year mortgage.

But, more-traditional financing for Jefferson County’s sewer system “would have required higher initial sewer rate increases,” said Jefferson County Commission President David Carrington. “Our rates need to be reasonable.”

Jefferson County plans to pay for the new debt with sewer revenues, which will come from rate increases for its sewer-system customers. Sewer bills are expected to increase about 7% annually for the first four years under the deal, according to the county’s agreement with debtholders.

Some observers wonder if the county will be able to meet the obligations stacked up in later years. “It’s future taxpayers that bear the risk of the higher payments down the road,” said Richard Ciccarone of McDonnell Investment Management, whose firm purchases municipal bonds and oversees an $8 billion portfolio of them.

The new debt is needed to complete an agreement signed this spring between Jefferson County officials and investors holding $3.1 billion of debt linked to the sewage-system upgrade. The deal, which helps the Alabama county put behind it the largest municipal bankruptcy in terms of debt outstanding in U.S. history, came after hedge funds and other creditors forgave $1.2 billion of sewer debt. The new bonds would refinance much of the remaining debt. The county filed for Chapter 9 bankruptcy protection in November 2011.

The county’s proposal to sell the debt could be formally approved by a judge as early as November. If the plan is allowed to proceed, the debt is likely to be sold to investors as early as then. In addition to the capital-appreciation debt, the $1.9 billion package includes $1.42 billion of bonds that pay interest periodically, according to county documents. Jefferson County has the option to buy back some of the bonds after 10 years.

With capital-appreciation bonds, buyers agree to forgo regular interest payments in favor of receiving accreted payments near the end of the bond’s maturity. The bonds were designed to help rapidly growing areas in states such as Texas and Florida where school districts need to borrow money fast to expand their campuses, but they want to make sure future residents share in the cost burden.

Because the bonds push payments to future taxpayers, California Treasurer Bill Lockyer called capital-appreciation bonds “terrible deals” that are the “equivalent of payday loans.” He proposed a statewide moratorium this year. Some California school districts using capital-appreciation bonds will repay 10 times or more than the original amount they borrowed, the treasurer said.

The Jefferson County proposed repayment ratio is higher than a typical muni sewer bond. The Detroit water and sewer department sold about $660 million in debt last year but will only pay about two times that amount back to bondholders over the 26-year life of its debt, Mr. Ciccarone said. That ratio was similar for some 30-year debt sold by the Birmingham, Ala., waterworks board earlier this year.

Robert Brooks, a finance professor at University of Alabama, said he found Jefferson County’s proposed refinancing deal troubling because the projected sewer revenue growth rate it assumes to pay for the bonds—which for many years is at least 3%—seems ambitious, because the sewer system has only had declining revenue in recent years.

“Those numbers certainly couldn’t be based on history,” he said. “Three percent seems unreasonably high.”

By KELLY NOLAN and KATY STECH

When New York City threatened to declare bankruptcy in 1975, the idea so terrified everyone that it forced the city, its workers and its recalcitrant bankers to sit down and find ways to share the pain.

Now another large city, Detroit, appears to be on the brink of filing for bankruptcy, but there is little talk of sharing the pain. Instead, the fiscal crisis in Michigan is setting up as a gigantic clash between bondholders and city retiree.

The city’s proposals, which could give some bondholders as little as 10 cents on the dollar, are making some creditors think they would be better off in bankruptcy. They see the specter of a federal judge imposing involuntary losses as less ominous than it was for New York.

“The haircut is so severe,” said Matt Fabian, a managing director of Municipal Market Advisors, “I think it’s scaring them into bankruptcy, rather than away from bankruptcy.”

But city retirees, facing the prospect of sharply reduced benefits whether in bankruptcy or under Detroit’s restructuring proposal, think they stand squarely on the moral high ground because despite the poverty of many current and retired members, they have already offered big concessions.

“It’s not the employees that are costing the city money,” said Edward L. McNeil, an official with the American Federation of State, County and Municipal Employees who is leading a coalition of 33 unions that will be affected by any restructuring of Detroit’s debts, which total roughly $17 billion. Just last year, he said, those unions offered concessions that could have saved the city hundreds of millions of dollars a year. But Detroit “botched the implementation,” he said.

And Michael VanOverbeke, interim general counsel for the general workers’ retirement plan, said bondholders were investors hoping for returns, who should expect “a certain amount of risk.”

“Planning for retirement and working for employers was not an investment into the market,” he added. “These are people who are on a fixed income at this point in their life. They can’t go back to work and start all over again.” He said it was unthinkable to cut retirees’ pensions outside of bankruptcy.

A bankruptcy in Detroit would have no precedent, despite an unusual flurry of municipal bankruptcies after the financial crisis. Rhode Island hurriedly passed a law giving municipal bondhholders priority over other creditors, including retirees, just before the small city of Central Falls filed for bankruptcy. That helped Central Falls resolve its bankruptcy quickly, but no one thinks Michigan could pass such a law. In Jefferson County, Ala., a large majority of the financial trouble grew out of debt issued to rebuild a sewer system, not pensions or other employee benefits. The rights of public workers and bondholders are in conflict in the bankruptcy of Stockton, Calif., but that case is not yet far enough along to be of any guidance to Detroit.

With talks on labor issues scheduled for Thursday, municipal bond market participants say one of their main concerns is that the city’s proposal would flatten the traditional hierarchy of creditors, putting say, a retired librarian on par with an investor holding a general obligation bond. That does not square with the laws and conventions of the municipal bond market, where for decades small investors have been told that such bonds are among the safest investments and that for “general obligation” bonds cities could even be compelled to raise taxes, if that’s what it took to make good. The “full faith and credit” pledge was supposed to make such bonds stronger than the other main type of muni — revenue bonds, which promised to pay investors out of project revenue.

Public finance experts have warned that broad societal problems could follow a loss of faith in municipalities’ commitments to honor their pledges. In a major report on the state of the muni market last year, the Securities and Exchange Commission warned that communities would find it increasingly costly to raise money, throwing into question the time-honored practices of building and financing public works at the local level.

Detroit’s proposal shows how much things have changed since the days when the municipal bond market consisted of two types of debt and little else. The emergency manager, Kevyn D. Orr, issued a complicated list of debts with a wide range of gradations, with general obligation bonds now inferior to revenue bonds.

Mr. Orr classified Detroit’s general obligation bonds into two groups — secured and unsecured — with the secured ones backed by outside sources of money, like state aid or federal block grants. The unsecured bonds are those that rely only on Detroit’s “full faith and credit” pledge. As a practical matter, much of Detroit’s bond debt is insured, so bondholders will feel no immediate pain as the city moves forward with its planned defaults. But the bond insurers have the right to do battle in the bondholders’ place, and other market interests are likely to join them.

Mr. Fabian said bondholders knew perfectly well that Detroit was broke and could not raise taxes and fees enough to cover all its bonds, but were still shocked by the proposed treatment.

“It’s not that people just want to get more money out of Detroit,” he said. “It’s the violence that’s being done to the city’s capital structure. It creates a new paradigm for investing in Michigan bonds.”

In the past, he said, the ratings agencies included the various debt structures in their evaluations of municipal bonds. An “unlimited-tax general obligation bond,” for instance, might be rated one or two notches higher than a “limited tax” version of the same bond. Investors would look at the rating, know what they were getting and pay more for the safer debt.

“Michigan is saying all that will go out the window,” Mr. Fabian said. “In effect, they’re saying that structure only matters when you don’t need it” — when everything is normal and the debt is being repaid.

“And when you need to rely on those legal differences, then they don’t matter,” he added. “It’s distressing.”

Municipal market participants are also rattled by a big, sudden increase in Mr. Orr’s measurement of Detroit’s pension shortfall, which he is also classifying as unsecured, leaving workers and bondholders to compete for whatever pool of money is left over. As of June 30, 2011, the city’s most recent actuarial snapshot showed that its two big pension funds were in pretty good shape — short by just $644 million, because the city had issued securities called “certificates of participation” in 2005 and 2006, and put the proceeds into the pension funds.

But Mr. Orr’s report said that estimated shortfall had been “substantially understated” through aggressive assumptions and other distortions. After correcting those, the two funds’ shortfall was closer to $3.5 billion.

And as for those certificates of participation, issued to produce money for pensions, they turn out to be among Detroit’s shakiest debts. The city already skipped a payment due last Friday, and Mr. Orr said the city had found “certain issues related to the validity and/or enforceability” of the debt. His report did not specify what the issues were, but said further investigation might be warranted.

The report said that to some extent, the trustees who sit on Detroit’s pension boards had worsened the pension trouble by promising workers “ad hoc sweeteners” and diverting investment income to other uses. As state-appointed emergency manager, Mr. Orr has authority to remove pension trustees.

But Mr. VanOverbeke said the trustees were not going anywhere. In fact, they have already set aside $5 million for a legal challenge in case Mr. Orr puts them “in a position that they would not have the resources necessary” to protect the pensioners, Mr. VanOverbeke said.

“It wasn’t put aside to do battle,” he said. “They were set aside so that as fiduciaries they can make the appropriate decisions and take the necessary actions as it is deemed appropriate.”

Broker-dealers charged billions of dollars in excessive markups and markdowns on municipal bond trades from 2005 to 2013, according to a study by the Fairfax, Va.-based Securities Litigation and Consulting Group, Inc.

The SLCG, which provides consulting services and expert witnesses to law firms, companies, banks, brokerage firms, and individuals involved in class-action suits and other litigation, used the Municipal Securities Rulemaking Board definitions of markups and markdowns for its study. The MSRB defines markups as the difference between the prices charged to the customer and the prevailing market price. Markdowns are the difference between prices paid the customer and the prevailing market price.

Using the MSRB’s EMMA website, SLCG researchers Geng Deng and Craig McCann sampled 13.7 million dealer trades with customers with a par amount of $3.9 trillion — about 30% of the fixed coupon muni bond trades during more than six-years — and found that 21% of those trades included markups that either were more than twice the median markup for similar trades or were more than 0.5% larger than the markup charged on recent trades of the same bond.

“We estimate that investors were charged $10.65 billion in municipal bond markups between 2005 and 2013 in our sample — $6.45 billion in trades on which excessive markups appear to have been charged,” the study states. “We have determined that between $1.84 billion and $6.45 billion of excessive markups and markdowns have been charged since 2005 on our subset of publicly municipal bond trades.”

Extrapolating the data in their sample to cover the entire $3.7 trillion municipal securities market, the authors estimate that dealers charged $20 billion of markups from 2005-2013, about $10 billion of which were excessive.

The study provides some examples, including a recent deal involving debt issued by the City of Commerce, Calif. On Jan. 17, 2013 a customer bought $1.45 million of bonds for $101.36 that had just been sold four minutes earlier for $99.00,” the study states. Compared to the average inter-dealer trade price that day of $99.22, the investor paid a $30,909 markup — almost 30 times the median.

Broker-dealers have wide discretion to charge the markups when they sell the bonds to investors. But the study argues this results in a transfer of taxpayer wealth to the brokerage community that could be eliminated by routinely disclosing markups.

The MSRB and the Financial Industry Regulatory Authority have written rules designed to prevent excessive markups and FINRA has levied fines when firms have flagrantly broken the regulations.

MSRB Rule G-17 on fair-dealing states brokerage firms must deal fairly with all parties in a transaction. Rule G-30 on prices and commissions prohibits either selling or purchasing securities at rates that are not “fair and reasonable.”

FINRA also has very similar rules.

In April 2012, FINRA found that David Lerner Associates, Inc. charged excessive markups on sales of municipal bond sales and mortgage obligations. In 2011, FINRA and Morgan Stanley entered into a settlement under which the firm paid a $1.0 million fine and $371,000 in restitution for excessive markups and markdowns on both corporate and municipal bonds after violating FINRA rules 2110 and 2440, as well as G-17 and G-30.

McCann said he and Deng had been considering a study of municipal bond markups over the past two or three years and that there was plenty of academic literature out there but none that put their findings into really concrete terms.

“Something that was missing was an estimation of how big the markups were,” he said.

The study concludes that if dealers’ markups were accessible to the market, the markups would soon drop to much lower rates.

“Sunshine would eliminate much of the municipal bond markup abuses we have identified,” the report states. “Dealers are already required to determine that the prices and markups charged are fair. This can only be done by reference to prevailing market values, typically grounded in the dealer’s contemporaneous cost. Prevailing market values and markups are already estimated by dealers every time they execute a trade. If dealers disclosed to investors what markup was being charged, the markups charged on municipal bonds would quickly drop to markups found on other securities. This sunshine would benefit both taxpayers and investors.”

Commenting on the report, Bond Dealers of America said: “The BDA is supportive of increased transparency in the market, especially through enhancements being considered by the MSRB to their EMMA system, which will only serve to better educate the investing public.  However, it is necessary to point out that without taking a closer look at individual transactions, general statements in the aggregate indicating that investors are being taken advantage of can be misleading and damaging to the market as a whole and furthermore, there is no clear consensus that the retail investor is getting anything but fair and reasonable prices in the fixed income market.”

The BDA added that spreads exist in distressed bonds and that supply and demand move bond prices. The study examples include some distressed bonds.

Michael Decker, co-head of municipal securities at the Securities Industry and Financial Markets Association, also critiqued the study.

“I think it’s flawed in several ways,” Decker said.

The methodology the authors used to cull markup figures from EMMA is unclear, said Decker. Additionally the study appears to make no distinction between trades of bonds in traditional brokerage accounts vs. those in fee-based accounts, where markups will naturally be higher. Decker added that in the muni market, where securities are infrequently traded, the price a dealer sells a security at may have no bearing on the cost the firm paid for it weeks or more earlier. Lastly, he said, markups are one aspect of pricing regulated by the MSRB rules, but the MSRB does not regulate markups alone.

by: KYLE GLAZIER

CHICAGO – Detroit’s announcement Friday that it will default on some of its bonds, including a $39.7 million pension certificate payment due Friday, could have major repercussions for the municipal market, analysts and bond attorneys said.

The moratorium means the city, at least in the early stages of negotiations with its debtors, intends to put some of its so-called unsecured general obligation bonds on par with its lowest-secured debt, a treatment that one market participant called “an amazing step.” Unsecured GOs, in the city’s view, are those with only a full faith and credit general fund pledge and not a specific lien on a revenue source such as state aid.

News of the pending default triggered a fresh round of downgrades from Standard & Poor’s and Fitch Ratings.

Detroit emergency manager Kevyn Orr unveiled a 134-page restructuring proposal Friday as part of a first round of negotiations with creditors that will start Monday and last through July 12. The negotiations follow a warning from Orr that the fiscally distressed city faces a 50-50 chance of pursuing bankruptcy.

The report says the city will stop making payments on what it calls its unsecured debt, which includes $530 million of GOs. That includes default on a $39.7 million June 15 payment to holders of the city’s $1.4 billion of pension certificates, widely considered among the city’s least-secured obligations.

It’s not clear yet whether the city will default on its next GO payment.

“If we are able to restructure and get a deal in place, then we start paying on the new regime,” Orr told local reporters after the creditor meeting. “We can’t continue paying with the debt service we have going forward.”

Orr is proposing issuing $2 billion of notes to pay off holders of $11.4 billion of unsecured debt on a pro-rata basis — a move that would generate less than a dime on the dollar for investors.

Nearly all of Detroit’s bonds are insured, so bondholders will likely continue to get paid regardless of the city’s defaults. “In the event that debt service payments by the city of Detroit are interrupted, National will ensure that its policyholders receive all of their principal and interest payments on time and in full,” said Kevin Brown, spokesman for National Public Finance Guarantee Corp., which wraps nearly $2.5 billion of Detroit bonds.

The city’s secured bonds, which total about $7.1 billion, would likely fare better under the plan. Treatment of that debt is “subject to negotiation with holders,” the report said. The city is considering floating new bonds to pay off current investors with changed payment terms aimed at generating debt service relief for the city, according to the report.

The report also featured a dramatic increase in the city’s estimated unfunded liability in the city’s two pension funds, which had been considered one of Detroit’s healthiest assets. The new figure puts the unfunded liability at $3.5 billion, up from $600 million. The increased liability could allow Orr to remove current fund trustees.

The city’s unsecured bonds total about $2.5 billion, including $1.4 billion of pension certificates, $161 million of limited-tax GOs and $369.1 million of unlimited-tax GOs backed only by a full faith and credit pledge.

Unsecured debt in general totals $11.4 billion. That includes $5.7 billion of other post-employment benefit liabilities, and $3.5 billion of unfunded pension liabilities.

The notion that Detroit may treat holders of some of its GO bonds the same as its OPEB liability could rattle the muni market, some said.

“It’s a very different way to think about debt,” said Matt Fabian, managing director of Municipal Market Advisors.

“Detroit is attempting to dissolve its capital structure and put its GO bonds on par with its pension certificates and the OPEBs,” he said. “It’s an amazing step.

“It implies that the state sees no distinction in parity between GOs for any city or their OPEBs or their lowest parity pledge,” he said, noting that Orr is a representative of the state. “From this perspective, buying a GO bond from an issuer is similar to having a simple contractual obligation, and losing all sense of incremental security from the GO.”

The proposed treatment will only emphasize a growing realization in the muni market that not all GO bonds are created equal. “It seems safe to say that municipal investors will buy bonds with their eyes wide open and know what the security features are,” Michael Ross, managing director at Raymond James, said in an email.

Bankruptcy attorney James Spiotto at Chapman and Cutler LLP said it’s too early to predict the ultimate treatment of the city’s various obligations. A Chapter 9 bankruptcy court could view the obligations the same way Orr has, putting the general fund GOs backed only by Detroit’s full faith and credit pledge on par with its OPEBs, Spiotto said.

“There’s a possibility of that, and that’s the concern you’re hearing,” Spiotto said. “The market anticipates that your full faith and credit pledge means more.

“The question is how will the market digest that and what will be the adjustment,” he said. “Will it be viewed as an aberration, or will the market need more assurances for payments on GOs such that they have additional backup?”

The city’s secured bonds include $379 million of GOs, both unlimited and limited-tax, and $878 million of payments due through 2035 on the city’s interest-rate swaps hedging the unsecured pension COPs.

Another $5.9 billion of water and sewer revenue bonds are also treated as secured debt. Orr said Friday he would likely lease the departments to a new regional authority that would then sell new bonds to pay off current investors.

Orr also wants to lease the city’s the parking system, the popular Belle Isle park, and possibly the Joe Louis Arena. The lighting department was recently transferred to a new bond-issuing authority.

In a statement, Gov. Rick Snyder, who appointed Orr, a former Jones Day bankruptcy attorney, to the post in late March, said there are “no easy answers.”

“The plan Kevyn discussed with creditors today requires shared sacrifice among all involved, but most importantly focuses on a restructuring designed to return Detroit to solid financial footing,” he added.

by: CAITLIN DEVITT

CHICAGO – Detroit’s threat to default on up to $2 billion of bond debt will shine a light on a beleaguered sector of the municipal market — monoline bond insurers that wrap nearly all the city’s bonds.

“This is an important opportunity for bond insurance companies to prove their worth and validate the importance of their industry,” Richard Ciccarone, chief research officer at McDonnell Investment Management LLC. “It’s a real opportunity for the stronger insurance companies.”

Three of the six insurers who wrap the city’s debt pledged to cover missed payments after Detroit emergency manager Kevyn Orr announced Friday a moratorium on some debt payments.

The fiscal condition of the insurers could play a role as negotiations play out over the next month, market participants said.

Financial Guaranty Insurance Corp., for instance, recently worked out a plan with all its clients that has it covering only 30% of its claims up front, with the balance paid off after the claim matures, according to Matt Fabian, managing director, Municipal Market Advisors.

The remaining insurers, however, are expected to make 100% payments on the possible losses.

The collapse in the monoline bond insurance business since the 2008 financial crisis left Assured Guaranty Ltd. as the only active insurer until the recent launch of Build America Mutual. Moody’s Investors Service in January downgraded Assured to A2 from Aa3, but noted that its capital adequacy remained strong.

National Public Finance Guarantee, after winning key ratings upgrades in May, has also signaled an intention to return to writing new business.

“Many of the bonds are insured, and that makes it easier for the bondholders,” Ciccarone said. “It also makes a case for a comeback for those insurance companies that can stick around in distressed situations that they can cover it on your behalf.”

Orr announced Friday that the city will stop making payments on debt that does not have a lien on a specific revenue pledge, a total of $11.4 billion. That includes more than $9 billion of employee retirement obligations, as well as general obligation bonds not secured by a specific revenue source.

The defaults began Friday when the city withheld a $39.7 million debt service payment due on $1.4 billion of pension certificates.

The certificates, like nearly all of Detroit’s bonds issued before 2010, carry insurance by one of the six insurers. FGIC and Syncora Guaranty Inc. insure the pension COPs.

Syncora said Monday it had received claims notices on the pension certificates that it insures, which include Series 2005A and 2006B.

“The company will pay such claims as, when, and in the amounts due, under and in accordance with the terms of its insurance policies,” the firm said in the release. “The company continues to assess the situation in Detroit, Michigan.”

A spokesman for Syncora declined to provide more details, saying the firm does not comment on individual credits.

FGIC did not return phone calls by press time.

The pension COPs have generally been considered among the city’s least-secured debt, backed only by a contractual pledge to pay. In the event of a default, the insurers or bondholders have the same recourse as pensioners, which is to sue the city, and if they win, to get a judgment lien against the city that forces it to raise taxes to pay off the obligation.

Fabian said the expectation that insurers will cover losses does increase their value, though the amount of distressed credits on their books could pose a problem.

“They’re paying on Jefferson County, Detroit, Stockton,” Fabian said. “These are all very manageable claims, but when you’re talking about influencing investor behavior you have to look at both sides.

“This [Detroit default] proves their value,” Fabian said. “But the issue for the insurers has always been in pricing the value. How do you price it?”

He added that with Detroit’s debt, there is lots of reinsurance, and so it’s difficult to pin down exactly how much each firm insures. “The numbers are blurry,” he said.

A spokesman from National Public Finance Guarantee,  a subsidiary of MBIA Inc., reiterated the company’s pledge to cover bond payments after Orr’s announcement.

“In the event that debt service payments by the City of Detroit are interrupted, National will ensure that its policyholders receive all of their principal and interest payments on time and in full,” spokesman Kevin Brown said in an email Friday.

National wraps nearly $2.5 billion of Detroit debt, including $2.4 billion of revenue bonds — most of them water and sewer — and $101 million of unlimited-tax GO bonds.

Like National, Assured Guaranty has repeatedly assured bondholders of its pledge to cover payments after the city was taken over by the state in mid-March.

After Friday’s announcement, Assured issued a statement to reassure bondholders, while noting that the bulk of the Detroit bonds it covers are secured by special revenues.

“As always, Assured Guaranty is committed to honoring its unconditional and irrevocable guaranty to holders of its insured obligations, a commitment backed by Assured Guaranty’s substantial claims-paying resources of $12 billion,” a spokesman said in an email.

Assured insures $2.2 billion of the city’s debt, the bulk of which is water and sewer bonds, and $355 million of GO bonds. The firm said in an email that the $1.8 billion of revenue bonds are “secured by a pledge of ‘special revenues’ and therefore timely payment of debt service should be insulated from any financial difficulties of the city.”

Assured also wraps another $320 million of GO general fund bonds that are not considered secured.

The city has $963 million of unlimited-tax and limited-tax general obligation bonds. Of that, roughly $205 million of bonds issued in 2008 are uninsured.

There is additional debt issued in 2010 and 2012 that is also uninsured — the junk-rated city could not buy insurance by that point — though those are backed by a pledge of state aid payments and are considered secured debt.

The city also has $5.9 billion of water and sewer bonds, all of which is insured except for $476 million with a 2041 maturity.

Another roughly $200 million of revenue bonds, including parking and convention center debt, carries insurance.

Detroit has not yet decided whether it will make its next general obligation bond payment, said Orr spokesman Bill Nowling.

“We have a moratorium on our debt payments,” Nowling said. “We’re going to evaluate those on a payment to payment basis. We let our creditors know [Friday] on the payment that was due that we would not be making it.”

Nowling added the city doesn’t think it’s technically in default because it has a 30-day grace period on all debt service payments.

by: CAITLIN DEVITT

The bankruptcy of the most populous county in Alabama moved closer to resolution this week with an agreement providing that investors will lose 20 percent of the money they invested in bonds that were rated AAA. The big loser financially is JPMorgan Chase, which underwrote many of the securities — and paid bribes to get the business.

Large municipal bond disasters have been rare, but I suspect there will be more. The Jefferson County bankruptcy may serve as a precedent for forcing bondholders to take losses in bankruptcy. Despite lots of legal protections, loans to municipal governments can be just like loans to people and companies: if the borrower truly can’t afford to pay what was promised, it won’t be paid.

Jefferson County’s problems involve corrupt politicians and bad luck, but they also include a longstanding reluctance to face facts about the county’s sewer system — and a bond market that failed to face the facts about the county and kept lending money long after it was prudent to do so.

The corruption involved was breathtaking. More than 20 people, including politicians, contractors and influence peddlers, have been convicted. JPMorgan escaped criminal charges, but the Securities and Exchange Commission penalized it for paying bribes through local middlemen.

That corruption was important and no doubt raised the financing costs for the county. But the basic financial decisions about the structure of the county’s debt were different only in scale from what many other municipalities did.

The disaster provides an example of how derivative securities can be oversold. Not all risks can be hedged, and certainly not at acceptable costs, but that is something Wall Street salesmen tend to overlook when they make their pitches. When such contracts are written, you can be sure that the Wall Street firm will make sure it will come out O.K., even if that increases the risk that the customer will not.

The county’s sewer debt used to be long-term, fixed-rate debt. The county would have been better off if that had not changed. But Wall Street persuaded it, and a lot of other municipalities, that such debt was too costly. The county could save some money by issuing what the salesmen called synthetic fixed-rate debt.

And what is that? The county issued long-term variable-rate debt, where the interest payments would fluctuate based on short-term market rates. Just doing that would have left the county at risk if interest rates surged, so JPMorgan also entered into an interest rate swap. That provided that the county would pay a long-term rate to JPMorgan, which would pay a short-term rate to the county.

The net cost of that was a little lower than the cost of fixed-rate debt would have been.

There was an important catch: the swap payments were not based on what the county actually had to pay. They were based instead on indexes that might, or might not, move in the same way that rates moved on the county’s actual debt. It was not really “fixed rate,” the title notwithstanding.

Another risk, probably never considered, was that the monoline insurance companies, which routinely guaranteed munis for a fee, would collapse.

Those risks were not necessarily large, and if Jefferson County had not structured 90 percent of its debt that way — rather than the 10 or 20 percent some advisers recommend — they might not have become crucial. But in the credit crisis, a lot happened that had not been expected.

Jefferson County issued two types of variable-rate debt, both of which blew up.

The largest was auction-rate debt. That debt paid rates that were set every week at auctions. The risk to investors was that an auction could fail and they would be stuck with the bonds. If that happened, the county would pay a penalty rate, often twice the London Interbank Offered Rate, known as Libor.

When auctions began to fail, that penalty rate was not enough to attract investors, but it was high enough to raise the financing costs for the county significantly. The interest rate swap did not protect it because it was based on an index, not on the actual cost the county was paying. Suddenly the “fixed rate” went up.

The second type was known as variable rate demand bonds, or V.R.D.O.’s to the cognoscenti. Their rates fluctuated based on an index rate, but the holder had the right to sell them every week. If no one else would buy, there were banks that had promised to buy them.

The catch was that the banks were not in it for the long haul. The V.R.D.O.’s might have 30-year maturities. But if the banks were forced to bail them out and could not find other buyers, the interest rates rose and the debt turned into three-year debt. The banks were protected, but the county was not.

Turning for a moment from finance to the real world, these bonds were financing a sewer system that was managed badly for decades. Wealthier areas found ways to stay out of it. In the late 1990s, the county was forced to take over what a court-appointed receiver later called “municipal systems that had never been properly operated and maintained.” But it still could not force some people within its service area to hook up to its system.

Some people used the sewers without paying, and when they were caught, they were not forced to pay what they owed. When a consultant told the county commissioners a decade ago that the county would have to raise rates rapidly, the commissioners simply ignored the report and did not mention it when they borrowed more money.

And the investors were not paying much attention. They were told they did not need to because the bonds were insured by one of three monoline insurance firms, FGIC, XL Capital Associates and FSA, and therefore had AAA ratings.

The records do not show whether those monoline insurers did any real research before they issued the guarantees. If they did, they did not seem to have noticed how poorly the system was run.

The bonds were backed only by sewer system revenue, but there was a covenant in them in which the Jefferson County commissioners promised to keep rates adequate to meet the system’s obligations. For many years, they ignored that promise. In 2009, after the bonds defaulted and it was obvious that rates had to be raised substantially if the county was going to meet its obligations, the commissioners did the opposite. They voted to reduce rates. In 2011, the county went into bankruptcy.

Four people who served on the five-member county commission have since been convicted of taking bribes and sentenced to prison, and a fifth was convicted of obstructing justice by lying about gifts she received from investment bankers. She received probation and testified against her former colleagues.

Under the deal disclosed this week, JPMorgan agrees not to be paid for many of the bonds it holds. Including fines, forgone fees the county owed it and forfeited bonds, this has cost the bank more than $1.5 billion before taxes. The bank has already taken losses, and a JPMorgan spokesman said the settlement would have no significant financial effect on the bank.

Under the deal, normal investors are to be offered a choice of receiving 80 cents for every dollar of bonds they own, and forfeiting the right to get any more, or 65 cents while retaining the right to receive additional payments from the monoline insurers. Two of them are paying claims now, but the other is not. The investors would probably be better off to take the 80 cents.

There is optimism that those payments can be financed by selling new bonds. Those bonds would almost certainly be rated as junk, but the presumed yields, ranging up to 6.75 percent on some bonds where the interest will not be paid until maturity decades from now, are thought attractive enough to draw in investors. Sewage rates will rise and might have to rise further if market interest rates go up before this can be completed, some months from now. But they will not rise as much as would have been necessary without forcing bondholders to take losses.

There are other municipalities where crises are looming, even without rampant corruption.

Cities and states are legally required to pay pensions to retired workers and to pay bondholders, along with paying for continuing government functions. But if there is not enough money for all of that — and in some cases, where population is shrinking, there almost certainly will not be — don’t bet that the judges and politicians will conclude that the retirees and bondholders should face no losses while basic government operations are devastated.

Municipal bonds are beginning to look tempting — but investors who buy munis in haste can unwittingly hand over their first year’s worth of income to their broker.

Fortunately, with a few simple steps, you can control that risk and maximize your net return.

Intriguingly, the health of many municipalities is improving even as tax-free bonds offer relatively attractive returns. Yields on the highest-quality, widely traded munis, triple-A-rated, 10-year “general obligation” bonds, have risen by 0.45 percentage point since May 1, according to Daniel Berger, senior market strategist at Municipal Market Data.

While U.S. Treasury yields have risen recently, “muni yields have truly skyrocketed,” says George Friedlander, chief municipal strategist at Citigroup. “We’re approaching the levels where retail investors will start to raise their hands again. The pent-up retail demand is very strong.”

But you must proceed with caution, or you will get fleeced. Unlike on stocks, you don’t pay a commission when you buy a municipal bond. Instead, you pay a “markup”—the difference between your broker’s cost and the price you pay.

Unfortunately, most brokers don’t disclose their markup. According to regulators and industry experts, you are likely to hear something like this instead: “I can get you this bond for a yield of 2.989%. You’d have to earn 4.83% on a taxable bond to equal that.”

Because they focus too much on yield and not enough on price, “most retail investors have no idea how much they’re getting charged on these trades,” says Edward Reinoso, chief executive of Castleton Partners, an asset manager in New York specializing in municipal bonds.

Markups can be monstrous. Securities Litigation and Consulting Group, a research firm in Fairfax, Va., recently analyzed nearly 14 million trades of long-term, fixed-rate munis over a period between 2005 and April of this year.

The SLCG study shows that on one out of 20 trades, people who bought $250,000 or less in municipal bonds paid a markup of at least 3.04%—or approximately a full year’s worth of interest income at today’s rates. By comparison, you will pay less than $10 in commission to buy a stock at most online brokers, or 0.004% on a $250,000 purchase; a typical mutual fund charges management fees of about 1% a year.

Craig McCann, founder of SLCG, estimates that investors paid at least $10 billion in what he considers excessive markups—at least twice the normal cost to trade a given bond—since 2005. “That’s more than a billion dollars a year needlessly transferred from investors to dealers’ pockets,” he says.

To be sure, of the approximately 1.2 million issues outstanding, only about 14,000 trade at all on any given day, according to the Municipal Securities Rulemaking Board, a regulatory body that oversees the muni market.

Brokers rightly point out that it can be difficult and costly to find any particular bond on a given day. Federal rules require that markups be “fair and reasonable” but don’t define those terms exactly.

Still, there is no reason why you should pay a much higher markup than someone else recently did for a similar-size trade in the same security.

The MSRB maintains a website, Electronic Municipal Market Access, or Emma, that shines some much-needed sunlight into this shadowy world.

Around 11:17 a.m. this past Tuesday, emma.msrb.org shows, a customer sold $100,000 in bonds issued by New York’s Triborough Bridge and Tunnel Authority; the customer received a price of $105.26. Around 3:15 p.m., the dealer that bought those bonds resold them for $108.26 — a spread of $3, or 2.8%, over the previous price. On Feb. 27, a customer sold $25,000 worth of the same bonds at $109.769 to a dealer who flipped them the next day for $113.213 — a fat markup of 3.1%. (Emma doesn’t identify any trader by name.)

“[Brokers] respond if they know you’re looking over their shoulder,” says Ernesto Lanza, the deputy executive director of the MSRB. “If you’re buying a bond, look at all the ‘customer bought’ trades to see what other customers paid. Then say to your dealer, ‘Try to match this.’”

That is what Phil Potter, an electrical engineer who lives in the Los Angeles area, does. “Just because the yield sounds good doesn’t mean you aren’t overpaying,” he says.

Using the Cusip, a nine-character mix of numbers and letters unique to each bond, Mr. Potter searches on Emma for the last few trades. If Charles Schwab, the broker where he buys munis, quotes a markup of more than 1.5% over those levels, Mr. Potter calls Schwab’s bond desk and tries to negotiate.

If the firm won’t budge, Mr. Potter walks away. But, he says, about 20% of the time he does get a better price.

“We always endeavor to show the best price to our clients,” responds Patrick Luby, a managing director in Schwab’s fixed-income department, “and in some cases, when clients ask, we’re able to improve the price even further.”

Then, and only then, will Mr. Potter buy. You should do the same.

Last weekend’s Intelligent Investor column, on the often prohibitive costs of buying municipal bonds, set off a thundershower of comments and emails. We can reduce them to a few key questions:

1. Can I avoid the potentially high cost of trading individual munis by buying a mutual fund?

2. Why buy individual munis at all if you can buy a fund instead?

3. Is it more expensive to sell than to buy an individual muni?

4. Why not buy closed-end muni funds (which often trade at discounted prices) instead of individual munis?

Let’s answer each of these in turn.

1. Yes, to a point. A large, well-run mutual fund will generally incur lower trading costs than an individual buying some of the same bonds. The fund can buy wholesale while individuals have to buy retail, which typically is more expensive.

Recent research by Securities Litigation & Consulting Group, a financial-research firm in Fairfax, Va., shows that small lots of munis (batches of $250,000 or less) can be 18 times more expensive to trade than large lots of $1 million. But even the biggest funds with the most astute managers still have to pay trading costs.

While you can minimize your trading costs by buying a no-load mutual fund or commission-free exchange-traded fund, you can’t eliminate them. They will come out of the fund’s return in small increments whenever it buys or sells a bond.

2. The question of whether you should buy a fund or individual munis is complex. You can make a plausible argument either way.

“Bonds better than funds”: If you hold an individual muni to maturity, you needn’t have any fears of losing any principal if interest rates rise. (We’re assuming the issuer doesn’t default, and we’re leaving inflation aside.) In a fund, however, rising rates will take an immediate bite out of your net asset value. While it can be expensive to buy or sell municipal bonds one by one, they don’t charge annual management fees; mutual funds do. The average muni-bond mutual fund, according to Morningstar, charges 0.96% in annual expenses. Even if you pay a fat 3% “markup” or trading cost to buy an individual muni, you’ll break even relative to a mutual fund if you hold the bond for at least three years. Hold the bond for 10 years or more, and it will be much cheaper than the average bond fund. Buy a new-issue bond in its initial offering and you shouldn’t pay any trading costs at all, say market participants.

“Funds better than bonds”: If you assume that you need a minimum of 10 bonds for basic diversification and at least $100,000 per bond to get trading costs down, it can take $1 million to build a feasible portfolio of individual munis – although many investors, including Phil Potter, whom I profiled in the column, have done it for less. For people who aren’t comfortable plunking several hundred thousand dollars at once into a few bonds, a fund might be preferable – even if it ends up costing more. A fund also offers wider diversification than you will likely get in a roll-your-own portfolio. Another factor: Even though rising rates will take a chunk out of your principal at a mutual fund, the fund can reinvest the incoming interest payments at higher yields as rates go up – reducing what bond managers call “reinvestment risk.” Small investors can’t always reinvest their interest coupons at the latest, best rate.

3. Overall, trading costs tend to be somewhat lower for sellers than for buyers of munis, according to the SLCG report and other analysis. For small trades, however, is much more expensive than buying. That’s why you shouldn’t buy individual munis at all if you don’t plan to hold until maturity (or an early redemption or “call”).

Richard Green, a finance professor at Carnegie Mellon University, recommends asking your broker to tell you the “interdealer price,” or the latest level at which the bond traded in the wholesale market among brokerage firms. Then ask what markup you will have to pay above that. As your broker tells you, check what he says against the latest price reported on Emma, the pricing website maintained by the Municipal Securities Rulemaking Board. If the price is more than 1% to 1.5% above the latest Emma price, don’t buy.

“It’s like walking into the car dealership with the invoice price in your hand,” says Green.

4. The many people who suggested buying closed-end funds instead of individual munis were, in my opinion, too blasé about the risks of closed-ends. (One reader commented, “The ONLY way to buy Munis is thru Muni Open or Closed End Funds…”)

Closed-ends are the Pushmi-Pullyus of the fund world. Their shares trade throughout the day like a stock, while the funds generally publish the value of their portfolios only once a week. Because their share price is set by supply and demand, closed-ends can often trade for more than the net asset value, or NAV, of their portfolios (a “premium” price); the shares can also trade for less than the NAV (a “discount”).

Many investors are attracted to closed-end funds by the discount – after all, it isn’t every day you can get something for provably less than it is worth. According to Morningstar, the 203 municipal closed-ends that it tracks trade at an average discount of 4% – meaning you have to pay only $96 for every $100 worth of munis that you buy.

But closed-ends have liabilities, too – literally.

All but 15 of the muni closed-ends on the market are “leveraged,” meaning they engage in the risky strategy of borrowing money to juice returns. That has paid off over the past decades of declining interest rates but could – make that will – backfire once rates rise. And the average muni closed-end charges a bloated 1.16% in annual expenses, with fully two dozen of them charging an extravagant 1.5% or more. Finally, more than 20 of these funds trade at premiums, not discounts – meaning that you pay more than $100 to buy $100 worth of bonds.

Bear in mind, then, that if you buy a closed-end muni-bond fund and interest rates spike upward, you are likely to be hit by a double whammy: The value of the underlying portfolio will fall, and the share price is likely to plunge (meaning that the discount will get deeper, and you might have to sell for much less than the assets are worth).

Until discounts get a lot wider, closed-end funds aren’t exactly a cheap back door into the muni market.

Illinois paid a premium to sell $600 million of sales-tax backed municipal bonds Tuesday, days after the state’s general credit rating was downgraded by two rating companies.

Illinois sold a 10-year bond at a yield of 2.94%, 0.75 percentage point more than triple-A-rated debt on a benchmark scale kept by Thomson Reuters Municipal Market Data, as of Monday’s close.

The so-called Build Illinois bond sale received a top triple-A rating from Standard & Poor’s, and the second highest investment-grade rating of double-A-plus from Fitch Ratings. Market participants said the state paid a premium on the sales-tax bonds because of its fiscal troubles.

Legislators in Illinois again failed to pass pension overhaul recently. Last week, both Fitch Ratings and Moody’s Investors Service cut the state’s rating on its general-obligation bonds down a notch because of the state’s inaction.

“The Illinois label is radioactive for some investors,” said Brian Battle, director of trading at Performance Trust Capital Partners in Chicago.

But Mr. Battle said the protections on Tuesday’s sales-tax bond are fairly strong.

The sales-tax revenue that repays the debt is kept in an account separate from the state’s treasury. The amount of sales taxes available to repay the bonds exceeds debt payments by around 20 times.

Illinois’ sales-tax bond sale comes against a tough bond-market backdrop. Muni prices slid again Tuesday, mirroring selling in Treasurys.

Meanwhile, investors yanked $1.5 billion out of muni mutual funds and exchange-traded funds last week, the largest outflow since mid-December 2012, according to Lipper FMI. Flows in and out of muni mutual funds are viewed as a proxy of demand.

Over the past two weeks, the yield on a benchmark 10-year muni has increased from 1.99% to 2.26%, as of Tuesday’s close, according to MMD. Prices and yields move inversely.

Justin Land, senior vice president and portfolio manager at Wasmer, Schroeder & Co. in Naples, Fla., said the state will face a bigger test in about two weeks, when it sells a $1.25 billion general obligation deal.

The success of that sale may hinge on whether or not legislators are able to get anything accomplished on the pension in a special session Gov. Pat Quinn has called for next week.

“People are not very optimistic,” Mr. Land said of the special session. “I will be very curious to see how it goes,” he said of the state’s next bond sale.

Mr. Land said Wasmer Schroeder, which oversees about $4.7 billion in fixed-income assets, didn’t buy Illinois sales-tax bonds Tuesday.

Proceeds of the sales-tax bond deal will refinance older debt with higher interest rates.

John Sinsheimer, director of capital markets for Illinois, wasn’t available for comment.

By KELLY NOLAN

The Federal Reserve has spent trillions of dollars trying to revive U.S. housing prices, and at long last a recovery is underway. So it’s more than a little surprising that amid this progress the New York Fed would suddenly lend its intellectual imprimatur to a dubious proposal for government to use eminent domain to seize underwater mortgages.

Yet there it was Monday on the New York Fed website: “Paying Paul and Robbing No One: An Eminent Domain Solution for Underwater Mortgage Debt,” a research paper by Cornell law professor Robert Hockett. The title is certainly arresting since it promises an economics free lunch.

Mr. Hockett notes with alarm in the paper that home prices “still linger close to 30 percent below peak levels,” and he avers that government must act to keep pushing prices back up. His solution?

He wants politicians to identify mortgages worth more than the homes, seize them via the power of eminent domain out of private trusts, refinance them with government help, repackage them into new securities, and sell those securities to new investors. He muses that the money to buy the mortgages could come from the feds (read: taxpayers) or “private investors” or both.

This might please underwater borrowers who would immediately pay less for their loan, and the politicians would take credit for the windfall. But the not-so-free lunch would be financed by the original mortgage investors, who would suffer losses without recourse. There’s also the little issue of higher interest rates for future borrowers as lenders price in this new political uncertainty into mortgage contracts.

Eminent domain is supposed to be used for public purposes, with adequate compensation to the private parties whose assets are seized. But in this case government would seize private assets—with uncertain compensation—for someone else’s private gain.

We couldn’t help but notice that Mr. Hockett’s idea closely resembles the eminent-domain pitch made by Mortgage Resolution Partners, a private investment firm out of San Francisco. MRP could be a big winner in such a scheme as the repackager of the seized mortgages into new securities in return for a fee. The firm has pitched the idea to the likes of Chicago and San Bernardino County, without success.

And wouldn’t you know, Mr. Hockett turns out to have been on the payroll of none other than Mortgage Resolution Partners. After we made a query, MRP Chairman Steven Gluckstern explained in an email Tuesday that MRP paid Mr. Hockett “a nominal, one-time honorarium” to help the company “with some legal analysis based on his previous published work in related areas.”

One problem: The Fed didn’t disclose Mr. Hockett’s ties to MRP when it posted his research paper. We called the New York Fed on Monday asking about Mr. Hockett and MRP, and only several hours later did the bank get around to disclosing the connection on its website.

New York Fed spokeswoman Andrea Priest emailed us that Mr. Hockett had been an “unpaid visiting scholar” at the bank from 2011 to 2012, adding that the bank has also published work critical of his ideas. She declined to explain on the record who brought Mr. Hockett to the Fed or the reason for the initial failure to disclose his ties to MRP.

For his part, Mr. Hockett explained the oversight to us Tuesday by noting that “I guess because I told everybody about that this past summer, that I had been paid in early 2012.” He added that “I’ve been unassociated with MRP particularly in a pecuniary way ever since then, and of course that’s all over the press and television and radio interviews last summer. I suppose it just doesn’t occur to me anymore.”

Perhaps the Fed was out of this media loop, and in any case our point isn’t to play conflict-of-interest gotcha. The real problem is that the Fed would lend its credibility to a scheme for governments to seize private mortgages for someone else’s private gain. The central bank used to be known for sensible regulators, not as the venue for every crackpot notion to favor some investors over others.

The Fed has already bent too far to boost housing more than other parts of the economy with its trillion-dollar purchases of mortgage securities. This is credit allocation, but at least those purchases are plausibly related to the central bank’s monetary policy mandate.

The Fed goes well beyond that mandate when it starts advertising proposals to urge politicians to seize private mortgage assets. Mr. Hockett’s research paper follows New York Fed President William Dudley’s 2012 decision to join the lobbying of Fannie Mae regulator Edward DeMarco to allow principal writedowns on Fannie loans. Mr. Dudley was echoing pleas by the Obama Treasury—a highly inappropriate foray into politicized housing regulation by a supposedly independent central banker.

Housing prices are recovering—in some places at a rate that suggests speculation more than economic fundamentals. Mr. Dudley and his fellow Fed Governors ought to be focusing now on how to exit from their extraordinary interventions without further distorting the market or undermining the larger economy. They’ve already meddled far too much in the housing market.

 

Goldman Sachs is making its second foray into an experimental method of financing social services, lending up to $4.6 million for a childhood education program in Salt Lake City.

This “social impact bond,” in which Goldman stands to make money if the program is successful but will lose its investment if it fails, will support a preschool program intended to reduce the need for special education and remedial services. The upshot, in theory, is that taxpayers will not have to bear the upfront cost of the program.

Goldman is being joined in this effort by the Chicago investor J.B. Pritzker, who is providing a subordinate loan of up to $2.4 million, bringing the total financing to $7 million. The loans will be announced at an event in Chicago on Thursday.

“Social impact bonds are an entirely new way of financing things that have traditionally been paid for either through philanthropy or by taxpayer dollars,” said Alicia Glen, head of Goldman’s urban investment group.

Though the effectiveness of this type of financing remains unproved, it has gained a prominent adherent in New York City, which allowed Goldman to invest nearly $10 million in a jail program last year. The city was the first in the United States to test social impact bonds.

For Goldman, which could gain a public-relations benefit from the investment, Salt Lake City has become an important business center. The city is home to Goldman’s second-largest office in the United States, and the Wall Street firm held its annual meeting there in May.

The loans are going to the United Way of Salt Lake, which oversees the Utah High Quality Preschool Program. The investment’s success will be measured by the level of cost savings when children do not need to use special education services, which are financed by the state.

The loans carry an interest rate of 5 percent, which is paid along with the principal if the program is successful. In the best case, Goldman and Mr. Pritzker would make additional “success fees.”

“We’re creating something sustainable that has a focus on returns,” Mr. Pritzker said. “This titillates my interest in business and engages me.”

This type of financing, which was first used in Britain in 2010, has raised eyebrows. Data on the New York investment, focused on men incarcerated at Rikers Island, is not yet available.

“I think it’s distressing the degree to which a new industry has been built around social impact bonds before it’s ever been proven viable,” said Mark Rosenman, a professor emeritus at Union Institute and University in Cincinnati. “We ought to work it to fruition in a couple places before we start promoting it.”

Still, governments around the country are beginning to embrace social impact bonds. Six state and local governments were chosen this week by the Rockefeller Foundation and the Harvard Kennedy School’s social impact bond technical assistance lab to receive help in developing such programs after 28 governments applied.

Janis Dubno, a senior policy analyst at the nonprofit Voices for Utah Children, who came up with the idea for the Salt Lake City transaction, said the intention was to shift “resources from remediation to prevention.”

The deal is “a proof-of-concept transaction,” Ms. Dubno, a former investment banker, said. “What we would like to do is demonstrate that this kind of structure can be put into place.”

BY WILLIAM ALDEN

(Reuters) – Standard & Poor’s on Monday removed the near-term threat of another credit rating downgrade for the United States by revising its outlook to stable from negative, citing an improved economic and fiscal outlook.

The change effectively means there is less than a one-third chance of a downgrade in the next two years.

S&P said a key factor to its revision in the U.S. rating outlook was the agreement reached by the U.S. Congress to avoid the ‘fiscal cliff’, which had threatened some $600 billion in automatic tax increases and spending cuts.

S&P cut the U.S. sovereign credit rating in August 2011 to AA-plus from the highly coveted top grade of AAA, citing political brinkmanship and gridlock in Washington that delayed an otherwise routine raising of the nation’s debt ceiling.

“We did get some movement from both sides and we think that is encouraging, at least to the point of convincing us that the dynamics in Washington are not likely to get substantially worse in the medium term,” Nikola Swann, S&P’s lead sovereign analyst for the United States, said in a webcast with reporters.

Moody’s Investors Service and Fitch Ratings give the U.S. credit their highest rating but both have negative outlooks.

The U.S. Treasury Department, which had argued that S&P’s initial downgrade was misguided, welcomed the latest action. “We’re pleased that they are recognizing the progress in the U.S. economy and fiscal results,” Treasury Under Secretary Mary Miller told reporters.

S&P said it does not expect the debate later in 2013 regarding a raising of the debt ceiling to result in “a sudden unplanned contraction in current spending – which could be disruptive – let alone debt service.”

The current rating already factors in a “lesser” ability of U.S. elected officials to move quickly and effectively to deal with public finance pressures.

S&P estimates the government will need to authorize a further increase in the amount of debt it can issue near the end of the fiscal year in September.

“We think that this (debate) is likely to not be any more dramatic than was the equivalent vote in August of 2011,” said Swann.

The non-partisan Congressional Budget Office announced on May 14 that the U.S. federal budget deficit is shrinking faster than previously thought.

The CBO cut the deficit forecast for the current fiscal year by $203 billion from estimates made in February of $642 billion, making it the smallest budget shortfall since 2008.

The deal struck by Congress on New Year’s Day 2013 meant much of the threatened tax hikes did not come to fruition.

“The news is better on the tax side,” John Chambers, chairman of S&P’s sovereign ratings committee, said on the webcast.

Chambers said the boost in tax revenues was due to investors taking profits on investments sooner than they might otherwise have done because of uncertainty over whether tax rates on capital gains might rise if no agreement were to be reached. The tax rates by and large did not rise in the end.

Another factor helping the U.S. fiscal position were the automatic spending cuts, known as sequestration. They were meant to be so severe that Republics and Democrats would be forced to reach an agreement on a budget to avoid them. They failed, resulting in cuts going into effect on March 1.

“In the meantime we think that policymakers and elected official have a bit more time to get the fiscal house in order,” said Chambers.

S&P said it expects the U.S. debt-to-GDP ratio to stabilize around 84 percent over the next three to five years. Economic growth is expected in the 2 to 3 percent range, on average, over the same period.

Financial market reaction to S&P’s decision was muted.

Initially, the news led to gains in U.S. stock prices, although they proved short-lived. The U.S. dollar added value against the euro and yen, extending gains already in place from European and Asian trading hours. Prices for U.S. Treasuries fell and in the case of the 30-year bond, the yield hit a 14-month high before receding.

“The strong stock market has created tax revenues, which is certainly positive, and the economy continues a slow but steady growth path, so while we continue to print money, the overall debt numbers have stabilized and I think that’s what the S&P is reflecting,” said Tim Ghriskey, chief investment officer at Solaris Group in Bedford Hills, New York.

Fitch affirmed its AAA rating in January, effectively stepping back from its threat to downgrade the U.S. credit after a deal was reached to avoid the fiscal cliff.

Moody’s has maintained that it is looking for improvement in the ratio of the United States’ debt to gross domestic product and setting a downward trajectory on the overall level of debt.

“Few people actually take notice of the rating on the government’s debt. The change makes sense, though, since the trajectory of the deficit has improved,” said Brian Jacobsen, chief portfolio strategist at Wells Fargo Funds Management in Menomonee Falls, Wisconsin.

“Of course, S&P should not have downgraded the debt to begin with. If the credit rating is supposed to assess the probability of default, it’s silly to give the U.S. government anything but a AAA,” said Jacobsen.

Jefferson County, Ala., contains the city of Birmingham, above. The county’s $4.2 billion municipal bankruptcy case is the largest such filing in the country’s history.

Jefferson County, Ala., took a big step toward resolving its historic bankruptcy case on Tuesday, saying it had reached an agreement to refinance most of the debt at the heart of its financial breakdown.

The refinancing would save the county hundreds of millions of dollars and position it to emerge from bankruptcy in a matter of months, according to people briefed on the negotiations. But the terms must still be approved by a federal bankruptcy judge, and the county must clear several other hurdles before it can emerge from bankruptcy. Lawyers for the county are scheduled to present details of the agreement in federal bankruptcy court in Birmingham on Wednesday.

The deal, according to the people briefed on the negotiations, covers about $2.4 billion of Jefferson County’s total $3.078 billion in sewer debt, which was issued to pay for significant repairs needed to bring the county into compliance with federal clean water laws.

The interest due on the sewer debt shot up during the financial turmoil of 2008, and the repayment schedules accelerated sharply, leaving the county unable to pay. The repairs went unfinished as well.

The county also had other debt outstanding when it declared bankruptcy, for a total of $4.2 billion, making it the biggest municipal bankruptcy in United States history.

Governmental bankruptcies are rare and usually involve small single-purpose authorities and districts, not large, complicated counties with a lot of debt. Experts in public finance have been watching Jefferson County closely to see what kind of legal precedent it will set. Some were concerned that the successful application of Chapter 9 bankruptcy rules to municipal debt could cast a pall over the municipal bond market.

Residents of the county, for their part, have worried that they would bear the brunt of the bankruptcy, through lower property values or higher taxes or rates paid for county services.

The refinancing agreement covers debt held by creditors that include JPMorgan Chase, which holds about $1.22 billion of the sewer debt, the biggest block; three bond insurers; and seven hedge funds, according to a term sheet circulated in a meeting of the county commission on Tuesday.

The terms call for these creditors to receive about $1.84 billion for the $2.4 billion of debt they now hold. The concessions were weighted most heavily toward JPMorgan, the term sheet said, “to increase the recovery of other sewer creditors.”

The bank is giving up $842 million, or about 70 percent, of the face value of its debt, according to people briefed on the negotiations. Just before declaring bankruptcy in 2011, the county abruptly rejected a previous package of concessions that called for JPMorgan to give up about $750 million.

JPMorgan was widely expected to make big concessions as part of any bankruptcy settlement, because some former officials of the bank were found to have been involved in improprieties in connection with a county debt refinancing in 2002 and 2003. That refinancing involved a complex package of variable-rate bonds and derivatives called interest-rate swaps.

A lawsuit by the county against JPMorgan over the improprieties, still active in state court, would be resolved as part of the proposed agreement. In 2009, JPMorgan agreed to forgive all the termination fees the county owed on the swaps, or about $647 million, to settle a complaint from the Securities and Exchange Commission. The bank also paid the county $75 million under the same settlement.

Despite those concessions, residents of Jefferson County have still often complained that they were treated inequitably because several of their elected officials went to prison as a result of the refinancing, while no one from the bank was convicted of a crime. They have railed in particular against the possibility that their sewer rates would go up to allow the county to pay sewer debt that many now see as illegitimate.

On Wednesday, the federal bankruptcy judge, Thomas B. Bennett, is also scheduled to hear arguments in a lawsuit arguing that much of the debt was issued in violation of the state Constitution and should be voided, not restructured or repaid.

In addition, the Bank of New York Mellon, as trustee for small creditors, has asked Judge Bennett for a full independent review of the sewer system’s finances, as well as what it has called “poor planning, gross incompetence, waste, graft, corruption or fraud in connection with the construction, repair or rehabilitation” of the sewer system since 1997.

The term sheet indicated that the sewer fees for county residents would indeed rise, by 7.41 percent a year for the first four years of the refinancing deal. After that, they could rise by as much as 3.49 percent a year, depending on variables like inflation and new federal clean-water regulations.

Still, members of the county commission said the new agreement was significantly better than what they could have won without the bankruptcy filing. The five-member commission approved the terms in a 4-to-1 vote.

If the refinancing goes forward, the county’s public creditors on the sewer debt will be offered a choice: either 80 cents for every dollar of sewer debt they now hold, if they relinquish all other claims, or 65 cents on the dollar with the right to pursue their own claims, either against the county or its bond insurers.

The bankruptcy of the most populous county in Alabama moved closer to resolution this week with an agreement providing that investors will lose 20 percent of the money they invested in bonds that were rated AAA. The big loser financially is JPMorgan Chase, which underwrote many of the securities — and paid bribes to get the business.

Large municipal bond disasters have been rare, but I suspect there will be more. The Jefferson County bankruptcy may serve as a precedent for forcing bondholders to take losses in bankruptcy. Despite lots of legal protections, loans to municipal governments can be just like loans to people and companies: if the borrower truly can’t afford to pay what was promised, it won’t be paid.

Jefferson County’s problems involve corrupt politicians and bad luck, but they also include a longstanding unwillingness to face facts about the county’s sewer system — and a bond market that failed to face the facts about the county and kept lending money long after it was prudent to do so.

The corruption involved was breathtaking. More than 20 people, including politicians, contractors and influence peddlers, have been convicted. JPMorgan escaped criminal charges, but the Securities and Exchange Commission penalized it for paying bribes through local middlemen.

That corruption was important and no doubt raised the financing costs for the county. But the basic financial decisions about the structure of the county’s debt were different only in scale from what many other municipalities did.

The disaster provides an example of how derivative securities can be oversold. Not all risks can be hedged, and certainly not at acceptable costs, but that is something Wall Street salesmen tend to overlook when they make their pitches. When such contracts are written, you can be sure that the Wall Street firm will make sure it will come out O.K., even if that increases the risk that the customer will not.

The county’s sewer debt used to be long-term, fixed-rate debt. The county would have been better off if that had not changed. But Wall Street persuaded it, and a lot of other municipalities, that such debt was too costly. The county could save some money by issuing what the salesmen called synthetic fixed-rate debt.

And what is that? The county issued long-term variable-rate debt, where the interest payments would fluctuate based on short-term market rates. Just doing that would have left the county at risk if interest rates surged, so JPMorgan also entered into an interest rate swap. That provided that the county would pay a long-term rate to JPMorgan, which would pay a short-term rate to the county.

The net cost of that was a little lower than the cost of fixed-rate debt would have been.

There was an important catch: the swap payments were not based on what the county actually had to pay. They were based instead on indexes that might, or might not, move in the same way that rates moved on the county’s actual debt. It was not really “fixed rate,” the title notwithstanding.

Another risk, probably never considered, was that the monoline insurance companies, which routinely guaranteed munis for a fee, would collapse.

Those risks were not necessarily large, and if Jefferson County had not structured 90 percent of its debt that way — rather than the 10 or 20 percent some advisers recommend — they might not have become crucial. But in the credit crisis, a lot happened that had not been expected.

Jefferson County issued two types of variable-rate debt, both of which blew up.

The largest was auction-rate debt. That debt paid rates that were set every week at auctions. The risk to investors was that an auction could fail and they would be stuck with the bonds. If that happened, the county would pay a penalty rate, often twice the London Interbank Offered Rate, known as Libor.

When auctions began to fail, that penalty rate was not enough to attract investors, but it was high enough to raise the financing costs for the county significantly. The interest rate swap did not protect it because it was based on an index, not on the actual cost the county was paying. Suddenly the “fixed rate” went up.

The second type was known as variable rate demand bonds, or V.R.D.O.’s to the cognoscenti. Their rates fluctuated based on an index rate, but the holder had the right to sell them every week. If no one else would buy, there were banks that had promised to buy them.

The catch was that the banks were not in it for the long haul. The V.R.D.O.’s might have 30-year maturities. But if the banks were forced to bail them out and could not find other buyers, the interest rates rose and the debt turned into three-year debt. The banks were protected, but the county was not.

Turning for a moment from finance to the real world, these bonds were financing a sewer system that was managed badly for decades. Wealthier areas found ways to stay out of it. In the late 1990s, the county was forced to take over what a court-appointed receiver later called “municipal systems that had never been properly operated and maintained.” But it still could not force some people within its service area to hook up to its system.

Some people used the sewers without paying, and when they were caught, they were not forced to pay what they owed. When a consultant told the county commissioners a decade ago that the county would have to raise rates rapidly, the commissioners simply ignored the report and did not mention it when they borrowed more money.

And the investors were not paying much attention. They were told they did not need to because the bonds were insured by one of three monoline insurance firms, FGIC, XL Capital Associates and FSA, and therefore had AAA ratings.

The records do not show whether those monoline insurers did any real research before they issued the guarantees. If they did, they did not seem to have noticed how poorly the system was run.

The bonds were backed only by sewer system revenue, but there was a covenant in them in which the Jefferson County commissioners promised to keep rates adequate to meet the system’s obligations. For many years, they ignored that promise. In 2009, after the bonds defaulted and it was obvious that rates had to be raised substantially if the county was going to meet its obligations, the commissioners did the opposite. They voted to reduce rates. In 2011, the county went into bankruptcy.

Four people who served on the five-member county commission have since been convicted of taking bribes and sentenced to prison, and a fifth was convicted of obstructing justice by lying about gifts she received from investment bankers. She received probation and testified against her former colleagues.

Under the deal disclosed this week, JPMorgan agrees not to be paid for many of the bonds it holds. Including fines, forgone fees the county owed it and forfeited bonds, this has cost the bank more than $1.5 billion before taxes. A JPMorgan spokesman said that losses had already been accounted for and that the settlement would have no significant financial effect on the bank.

Under the deal, normal investors are to be offered a choice of receiving 80 cents for every dollar of bonds they own, and forfeiting the right to get any more, or 65 cents while retaining the right to sue the monoline insurers, all of which are in financial difficulty. They would probably be better off to take the 80 cents.

There is optimism that those payments can be financed by selling new bonds. Those bonds would almost certainly be rated as junk, but the presumed yields, ranging up to 6.75 percent on some bonds where the interest will not be paid until maturity decades from now, are thought attractive enough to draw in investors. Sewage rates will rise and might have to rise further if market interest rates go up before this can be completed, some months from now. But they will not rise as much as would have been necessary without forcing bondholders to take losses.

There are other municipalities where crises are looming, even without rampant corruption.

Cities and states are legally required to pay pensions to retired workers and to pay bondholders, along with paying for continuing government functions. But if there is not enough money for all of that — and in some cases, where population is shrinking, there almost certainly will not be — don’t bet that the judges and politicians will conclude that the retirees and bondholders should face no losses while basic government operations are devastated.

A big bet by hedge funds and private-equity groups on the largest municipal failure in U.S. history is close to paying off after a deal on Tuesday that should enable Jefferson County, Ala., to exit bankruptcy.

The county’s biggest creditor, J.P. Morgan Chase & Co., will shoulder a loss of about $840 million as part of the agreement between Jefferson County officials and holders of $3.1 billion of debt linked to a troubled sewage system.

Under the deal, $1.2 billion of the county’s debt would be forgiven and a group of investors will help with refinancing some of the remaining debt. The desire by the hedge funds and other distressed-debt investors to earn a return on their money was crucial in reaching an agreement that had eluded other creditors, people close to the matter say.

Jefferson County residents will see their sewer rate increase by about 7% for each of the next four years to help pay for the sewer system’s debt going forward, according to the agreement. “We’ve got to get out of bankruptcy,” Commission President David Carrington said.

A bankruptcy-court judge is expected to review the proposed deal at a hearing in Alabama on Wednesday, but he won’t need to approve it until the county proposes a formal bankruptcy-exit plan. County officials said they hope the county can emerge from Chapter 9 protection by the end of the year.

A group of seven investment firms, including Claren Road Asset Management LLC and Stone Lion Capital Partners LP, bought around $900 million of sewer debt. Some firms purchased the debt at a discount to its original price after the county filed for bankruptcy in November 2011, according to people familiar with the situation.

Tuesday’s deal could enable some of the firms to make money in two ways, these people said: When the county refinances its current debt, it will use the cash to pay off the old debt held by the investment firms. In some cases, the firms would be paid more than they bought the old debt for. Some of the firms also have agreed to backstop a portion of the refinancing, and can earn fees for that support.

“We are pleased that our clients played an important and constructive role in driving a consensus among the parties,” said Soren Reynertson, a managing general partner at GLC Advisors & Co., which advised a group of hedge funds during the bankruptcy.

The county’s lawyer, Kenneth Klee, said that the deal will save the county $200 million more than the last serious debt-restructuring proposal that circulated—but ultimately failed—in September 2011.

The agreement is the result of months of negotiations between county officials, banks, bond insurers and the investment firms.

If approved, the deal would close a painful chapter in the history of Alabama’s most populous county, which includes Birmingham. It also could embolden other municipalities to seek to slash their debt through the bankruptcy process.

Jefferson County’s financial woes were partly the result of questionable debt deals to finance repairs to an aging sewer system.

Some former county officials and others involved in some of those transactions were sentenced to prison.

J.P. Morgan paid fees and penalties to settle federal securities charges related to its role in the deals.

As part of the deal struck Tuesday, the New York bank has agreed to the take the largest haircut—roughly $842 million on the $1.2 billion of sewer debt the bank owns, Mr. Carrington said.

A settlement eluded county officials and creditors through months of negotiations leading up to the county’s bankruptcy filing in November 2011.

But people involved in the most recent talks said a few things had changed since then. One of the biggest factors was the involvement of the investment firms. Hedge funds sometimes buy up debt on the cheap in corporate restructurings, but their involvement in the Jefferson County case is likely the biggest bet hedge funds have ever made on municipal debt.

Massachusetts is tapping into the popularity of environmental improvement to sell $100 million of bonds it has labeled “green bonds.” The sale is expected to wrap up Tuesday, and the state plans to use proceeds to pay for environmental endeavors, such as improving water quality, increasing energy efficiency and cleaning up pollution.

State officials say they hope to attract new investors for the Massachusetts bonds, which could mean lower rates for taxpayers. The state was inspired by a similar program from the World Bank, which has issued $3.5 billion in green bonds since 2008. The Massachusetts bonds were being offered late Tuesday morning to yield between 3.20% and 3.85% for 20-year bonds.

Using municipal bonds to finance environmental projects is not unusual, but calling them “green bonds” plays into investors’ desire to have more specifics about where their money goes. According to Thomson Reuters, more than $1.7 billion worth of municipal bonds have been sold this year with explanations that their proceeds would be used to fund environmental facilities. These bonds have been sold by states, or issued by various authorities and linked to specific projects.

Massachusetts is first to call the new debt “green bonds,” according to information provider Ipreo, whose database goes back to 2000.

The proceeds will be kept in an account separate from other state bond proceeds and Massachusetts said it plans to post quarterly updates on the use of green bond proceeds to its investor website. It also plans to post a final list of projects funded from the sale when all the proceeds have been spent. Massachusetts told investors in its bond offering documents that it plans to use the proceeds for environmental projects, but it has no legal requirement to do so, said a spokesman for the state.

“There has been a ton of interest in the product,” said Colin MacNaught, assistant state treasurer for debt management. “We think we’re offering something that fills a void in the market.”

Julie Egan, portfolio manager at Community Capital Management, which plans to participate in the sale, said she would be surprised if proceeds were used for other purposes given how they are being described.

Otherwise, the Massachusetts green bonds are no different from other debt sold by the state. The bonds carry the state’s general-obligation pledge, meaning they are backed by its full faith and credit and not tied to any one specific project. The green bonds share the state’s overall credit rating of double-A-plus.

That’s similar in structure to the World Bank green bonds: they carry triple-A ratings like any other World Bank bond and the bank itself bears responsibility for paying back investors, not any particular project, said Peter Coffin, president of Boston-based Breckinridge Capital Advisors. The World bank “green bonds” have been used to fund projects devoted to climate change.

Coffin says interest in environmentally friendly investing is on the rise. His firm began focusing on what it calls its “sustainable strategy” three years ago, and now oversees more than $150 million in that area. Overall, the firm manages more than $18 billion.

For those clients, Coffin said his firm will buy corporate bonds from companies deemed socially and environmentally responsible, the World Bank bonds and other municipal bonds similar to the Commonwealth of Massachusetts sale.

“We think it’s good that the commonwealth is highlighting the fact that these are sustainable investments that the state is making,” Coffin said. “We think more municipalities should do the same.”

Another option for green investors: mortgage-backed securities issued by Ginnie Mae Fannie Mae and Freddie Mac, according to the Weston, Fla.-based Community Capital, which oversees about $2 billion and focuses on sustainable investing. Some state housing authorities offer mortgage programs that reward more energy efficient homes, and investors can also screen securities for mortgages from areas recognized for developing walkable neighborhoods.

Securities tied to federal agencies like the Small Business Administration also might fit into a green bond portfolio.

Barbara VanScoy, co-founder and chief impact investment officer at Community Capital, called the Massachusetts sale a “sign of progress” for bond buyers interested in sustainable investments.

“Most of the time, there’s not a lot of transparency or disclosure in these types of issues,” Ms. VanScoy said. “So even though we know that they’re financing projects that are environmentally sustainable, a lot of times it’s not disclosed.”

If the green bonds grow on investors, MacNaught said the state could sell more in the future.

“This isn’t sort of a hit and run, where it’s one bond sale,” he said. “We’re trying to determine if there’s enough capital, enough investors, where green bonds can be a small part of the state’s capital program going forward.”

Massachusetts is also wrapping up a sale of about $575 million of additional general-obligation bonds on Tuesday.

What do you get when you throw out the chief reason investors buy municipal bonds—their tax-free status?

Apparently, a truckload of buyers.

This year through Monday, issuers have originated $19.6 billion in taxable municipal bonds, nearly double the amount of the same period a year ago, according to investment researcher Municipal Market Advisors.

Taxable munis, unlike their tax-exempt cousins, aren’t shielded from federal, state or local taxes.

Some investors still might find the bonds worth a look. But most small investors should be wary.

Despite the lack of tax benefits, issuers have found no shortage of buyers. The bonds are popular among institutional investors and mutual funds that can’t take advantage of tax breaks. One example: The Build America Bonds program, through which state and local governments issued $181 billion worth of bonds before its expiration in December 2010.

Nowadays, the chief issuers are organizations that want to use the money for purposes that aren’t permitted with tax-exempt bonds, such as to bolster an underfunded pension plan.

Some organizations also have issued the bonds to refinance their debt. Harvard University, for example, issued about $402 million in taxable muni bonds in May.

But in their persistent search for income, some small investors are grabbing the bonds, too, says Jim Colby, senior municipal strategist at Van Eck Global, which manages five tax-exempt municipal-bond exchange-traded funds.

“I don’t doubt for a moment that some of these bonds are finding their way into individual accounts,” Mr. Colby says.

In the past 12 months, for example, about $107 million has poured into the $1.1 billion PowerShares Build America Bond BAB -0.33% ETF, one of the biggest taxable-muni-bond ETFs, according to investment researcher IndexUniverse.

So what is the problem, you ask?

For starters, though the bonds typically have a higher yield than their tax-exempt peers, this year that premium has fallen sharply.

Just a year ago, the spread between the yield of a typical tax-exempt municipal bond and that of a taxable one was about one percentage point, says Matt Fabian, managing director of Municipal Market Advisors. Now, that premium can be as small as half a percentage point.

That means, at least for taxable accounts, small investors will be hard-pressed to find a taxable muni that leaves them with more money than a tax-exempt alternative.

For example, someone in the 39.6% federal tax bracket who could earn 3% with a tax-exempt bond would need to find a taxable bond yielding nearly 5% to make the switch worth it, before factoring in state or local taxes or the 3.8% investment surtax.

Second, funds—the easiest avenue for investors to get exposure to the taxable-muni market—have very long average maturities, which makes them vulnerable to interest-rate changes.

The PowerShares ETF, for example, has a yield of 4% and costs 0.28% annually, or $28 per $10,000 invested. The SPDR Nuveen Barclays Build America Bond ETF BABS -0.15% yields 4% with a 0.35% expense ratio, or $35 per $10,000 invested.

To estimate how a one-percentage-point rise in rates would hurt bond prices, investors calculate a measure called “duration.” A fund with a duration of two years, for example, would lose 2% if interest rates rose by one percentage point immediately.

Both Build America Bond ETFs have a duration of more than 10 years, meaning that their values will drop by more than 10% if interest rates rise one percentage point.

“It’s too risky. You only get a 4% yield for a lot of interest-rate risk,” says Timothy Strauts, an ETF analyst at investment researcher Morningstar.

To be sure, in some specific cases, taxable munis could still make sense.

For one thing, tax-exempt munis don’t have an edge in tax-advantaged vehicles, like individual retirement accounts. Inside an IRA, income is already tax-deferred.

And next to high-grade, long-term corporate bonds, taxable-munis—which many regard as safer investments—look like a deal.

For example, the yield of the PowerShares ETF is only slightly below that of the Vanguard Long-Term Corporate Bond ETF, which yields 4.5% and has a longer duration.

Finally, President Barack Obama’s latest budget proposal calls for a cap on the amount of muni income exempt from federal taxes for some high earners, which if passed would lessen the advantage of tax-exempt munis.

Taxable munis can sometimes look like a relative value compared with other bonds. But that just reflects the fact that all bonds, no matter what slice you take, are high priced, Mr. Strauts says. If and when rates rise, long-term bonds of all stripes will suffer, he says.

As with all parables, the Great Bond Bubble eventually will end with a memorable lesson. Here’s hoping you will read about it in the papers rather than in a portfolio statement.

California, Massachusetts and New Jersey Most Financially Capable; Mississippi, Arkansas and Kentucky Near Bottom.

The FINRA Investor Education Foundation (FINRA Foundation) today released the results of America’s State-by-State Financial Capability Survey. The survey findings are available at www.usfinancialcapability.org, which features a clickable map of the United States and allows the public, policymakers and researchers to delve into and compare the financial capabilities of Americans across all 50 states and the nation as a whole. The survey results were released today at an event featuring FINRA Foundation Chairman Richard Ketchum; U.S. Securities and Exchange Commission Chair Mary Jo White; Consumer Financial Protection Bureau Director Richard Cordray; Cyrus Amir-Mokri, Assistant Secretary for Financial Institutions, U.S. Department of the Treasury; and Stacey Stewart, U.S. President of United Way Worldwide.

The State-by-State Financial Capability Survey, which surveyed more than 25,000 respondents, was developed in consultation with the U.S. Department of the Treasury, other federal agencies and the President’s Advisory Council on Financial Capability.

The State-by-State Survey found a significant disparity in financial capability across state lines and demographic groups:

Citizens of California, Massachusetts and New Jersey who were surveyed are the most financially capable. Those states ranked in the top five among all states in at least three of five measures of financial capability.

Mississippi stood out as the least financially capable state, placing in the bottom five in four out of five measures. Arkansas ranked in the bottom five in three out of five measures, and Kentucky ranked in the bottom five in two out of five measures.

Younger Americans, especially those who are 34 and under, are more likely to show signs of financial stress, including taking a loan or hardship withdrawal from their retirement account or making late mortgage payments.

Younger Americans are more likely than older Americans to have unpaid medical bills. Of those surveyed, 31 percent of Americans aged 18-34 reported having unpaid medical bills compared to 17 percent for Americans aged 55 or older.

“This survey reveals that many Americans continue to struggle to make ends meet, plan ahead and make sound financial decisions—and that financial literacy levels remain low, especially among our youngest workers. No matter how you slice and dice it, this rich, new dataset underscores the need for us to continue to explore innovative ways to build financial capability among consumers,” said FINRA Foundation Chairman Richard Ketchum.

The five measures of financial capability used to rank the states measure how well Americans are managing their day-to-day finances and saving for the future. The national averages among survey respondents for these key measures are below.

Fewer than half (41 percent) of Americans surveyed reported spending less than their income.

Over a quarter (26 percent) of Americans reported having unpaid medical bills.

More than half of Americans (56 percent) do not have rainy-day savings to cover three months of unanticipated financial emergencies.

Over a third of Americans (34 percent) reported paying only the minimum credit card payment during the past year.

On a test of five basic financial literacy questions, the national average was 2.88 correct answers.

The state-by-state results break down financial decisions and literacy by gender, age bracket and region, and highlight how a lack of financial capability has disadvantaged many Americans. The State-by-State Financial Capability Survey includes a wealth of data revealing how Americans make ends meet, plan ahead and manage financial products.

The State-by-State Financial Capability Survey collected data on financial behaviors across all 50 states and the District of Columbia. The FINRA Foundation will make the extensive and multi-dimensional information in this study available to policymakers and researchers, allowing them to look at individual financial behavior from various angles and utilize the state-specific data to tailor new programs and policies to promote greater financial capability.

The data were collected through an online survey of 25,509 American adults (approximately 500 per state, plus D.C.), over a four-month period, July – October 2012. The sample used in this study was weighted by age, gender, ethnicity and education. The full data set, questionnaire and methodology are available at www.usfinancialcapability.org.

 

The fees that bankers are paid to underwrite municipal bonds have been declining since financial markets started their recovery in 2009, prompting some dealers to focus on lower quality or more complex deals to boost profitability.

Through May 23, state and local governments have paid underwriters on average $5.16 per $1,000 of bonds sold this year, according to Thomson Reuters data.

That number has come down almost 17% since it peaked at $6.21 in 2009, when deals were riskier to underwrite and fewer banks were competing for business following the financial downturn.

The spread has steadily declined in the years that followed, dropping to $5.94 in 2010, $5.62 in 2011, and $5.52 last year.

Underwriters and other market participants attribute the squeeze in spreads mostly to low issuance of new bonds, which has heightened competition.

“We saw a noticeable difference in takedowns beginning in the middle of 2011,” said Todd Frazier a managing director and head of the pricing group at Public Financial Management Inc., referring to underwriting fees. “It’s no coincidence that in 2011 the market was down about 40%. I think underwriters felt the need to bring in business and to maintain market share.”

David Manges, a managing director and municipal trading manager for BNY Mellon Capital Markets, said dealers will continue to drive for market share as long as they’re making money.

“They’re going to drive to find deals on the competitive side, and on the negotiated side, bankers will push to get market share by reducing spread,” he said.

While underwriters compete on rate as well as spread, he said, it’s often easier to cut the spread before they cut the rate, since the rate has to be attractive enough to sell to investors.

“As underwriters compete for the issuers’ attention, one of the things they’ll talk about is their willingness to reduce spread to produce the lowest rate,” Manges said. “The lower the spread, the better the deal for the issuer.”

Matt Fabian, a managing director at Municipal Market Advisors, said the declining spreads may also reflect a more aggressive stance by financial advisors and issuers in general.

“This is a seller’s market, after all,” he said.

On the underwriting side, Fabian said that dealers are feeling competition because there is less issuance, with most of that issuance coming from larger issuers doing refunding deals.

Out of the $377 billion of municipal bonds sold last year, only $145 billion was new money.

In 2011, new money also totaled close to $145 billion, out of the total $286 billion of issuance. Before that, new money issuance surpassed $200 billion every year since 2002, according to Thomson Reuters.

Refunding bonds tend to be relatively short-termed, with maturities around 10 to 15 years.

This means the underwriting spread on these deals tends to be lower.

“As you shorten the maturity of these bond issues and the duration of total cash flows, the takedowns will also be compressed for that reason,” said Herman Charbonneau, executive vice president and manager of public finance at Roosevelt & Cross.

The “takedown” is one component of the underwriter’s discount, and is the compensation to the underwriter for distributing the bonds.

Charbonneau said that on deals today, he rarely sees a takedown over $5.00.

Other components of the underwriting spread include the structuring or management fee, compensation for risk, and any related expenses.

“So you’re looking at a relatively complex situation, where some of the decline is a decline in takedowns, generated by competitive considerations, and some of it is generated by the relatively short maturity of many refunding issues,” Charbonneau said.

In addition to the decline in the takedown component, the risk component of the underwriter’s fee has also contributed to the overall decline in underwriting spreads.

Underwriters take on some amount of risk related to interest rate fluctuation during the short period it takes them to underwrite the securities.

“With yields as low as they are and having dropped consistently now for the past three or four years, that risk component has dropped to a pretty slight margin,” Manges said.

In order to make up for lower spreads on some deals, underwriters may try to focus on other deals consisting of lower quality bonds where they can get slightly higher fees.

On the higher quality bond issues, underwriters will be more aggressive and tend to squeeze down on their takedown fee as they seek business and make proposals or bids to issuers, Charbonneau said.

“Elsewhere in the market where you’re trying to deal with the issuance of low quality bonds that are, say, at the bottom of the investment grade category, the work that you do as an investment banker has higher value,” he said. “There’s more of a skilled component that goes into the structuring of those issues and into the marketing process so you can charge a little bit more there.”

Focusing on issues where the skill component of the work makes a greater contribution to its profitability can help keep up their takedown and structuring fees, Charbonneau said.

“The lower the credit rating, the more speculative the credit, the higher the takedowns are, and that hasn’t changed,” said Frazier.

“I don’t think you can create those deals,” he said, “but certainly as they come up there is more competition among underwriters for those deals, but no more so than on any other deal.” MMA’s Fabian calls it a balance.

“A dealer needs enough lower risk bonds that, even with less compensation, will trade easier and pose less risk to their balance sheet,” he said. “But dabbling in riskier stuff isn’t a bad idea if done in moderation.”

Although underwriters have been receiving less compensation for their work, it doesn’t mean their work is any less valuable.

“At PFM, we maintain a database of takedowns and make sure the quality of the underwriting isn’t affected by lower takedowns,” Frazier said. “We haven’t seen that yet.”

He added that for the industry, the concern is that the broker dealer community will be pared down because underwriting becomes a less profitable business.

“A smaller universe of broker dealers over time may not be healthy,” Frazier said. “Long term, we want to maintain healthy competition.”

Though spreads have been declining, they have yet to come to close to the all-time low of $4.89 in 2008, according to  available data going back to 1986.

In fact, prior to the sudden drop in spreads before the financial downturn, followed by a spike after, spreads had been steadily decreasing since 1986, when the average spread was $12.92.

Spreads came down between $7.00 to $10.00 averages in the 1990s, $4.00 to $6.00 averages after 2000, to the $5.20 average today.

“It’s low,” Charbonneau said. “It’s not a small decline — and every decline has some impact on profitability, but it’s not catastrophic.”

Breaking down the average spread among deal types, competitive issues offer greater fees than negotiated issues.

In 2012, the average underwriting spread among competitive deals was $6.17 and among negotiated deals it was $5.40.

Through May 23, the average competitive spread has come down to $5.29, but it’s still higher than the average negotiated spread of $5.12.

“This is because there’s more risk involved on a competitive deal than a negotiated deal,” said Peter Stare, a senior vice president at First Southwest.

In a negotiated deal, Stare said, the underwriter is not committing to underwrite the bonds until they have gone through the order period and have a balance of, for example, around 10%.

For a competitive deal, however, apart from any bonds sold in a presale, the underwriter is basically committing to underwrite the entire amount, taking on more risk.

He added that this recent decline in spreads is somewhat cyclical.

“I think we see this happen when spreads get tight and we experience a difficult market,” Stare said.

“It’s been pretty easy to be tight on spreads in the past couple years because we’ve basically been in a bull market,” Stare said. “but if the market starts to back up dramatically and people are still bidding the spreads that they’re currently bidding and start taking losses, then I think we’ll start to see spreads widen out.”

If interest rates start to go back up substantially, Stare said there’s a possibility that some underwriters may reevaluate whether it’s worth it to continue underwriting deals at such low spreads.

“It’s strictly a numbers game. If we get a protracted bear market in municipals, then I think you’ll have some people rethink whether they want to be in the market or you’ll see spreads widen out.”

However, he doesn’t think that rates will go up any time soon.

In addition to a rise in interest rates, Roosevelt’s Charbonneau said other reasons why spreads would stay down is if the average quality of bonds being sold in the marketplace rises, or if lower quality bond issuance is limited.

Manges said that spreads will stay low or go lower until one of two things ¬happens: either interest rates start to rise or there is a credit problem with some issuer or sector of issuers that makes it more difficult to place their bonds.

“Spreads can stay here or they can go lower. It’s a matter of competition,” Manges said. “Underwriters will continue to push to buy deals by reducing their spreads and they will do that until it proves to be unprofitable.”

by: TONYA CHIN

A Maryland Democrat and an Illinois Republican are circulating a letter to colleagues asking for their support in preserving the tax-exempt status of municipal bonds.

Rep. Dutch Ruppersberger, D-Md., and Rep. Randy Hultgren, R-Ill., sent their fellow lawmakers an email and a hard copy draft letter addressed to House Speaker John Boehner, R-Ohio., and House Minority Leader Nancy Pelosi, D-Calif., expressing concerns about proposals to eliminate or cap tax exemption.

“Eliminating or capping the current deduction on municipal bonds would severely curtail state and local governments’ ability to invest in themselves,” they wrote. “It would increase borrowing costs to public entities and shift costs to local residents through tax or rate increases.”

The Maryland Association of Counties voiced concern to Ruppersberger, a former county executive, that the idea to cap or eliminate tax exemption was gaining traction on Capitol Hill and at the White House, a congressional aide said. They asked Ruppersberger to investigate ways to preserve municipal bonds.

The one- page Dear Colleague letter notes that proposals to cap or eliminate tax exemption appeared in President Obama’s fiscal year 2014 budget, the Simpson-Bowles report and a recent Government Accountability Office report. Obama suggested capping tax exemption at 28% rate, while the Simpson-Bowles and GAO report suggested eliminating tax exemption altogether.

“Neither capping nor eliminating the deduction on municipal bonds is a smart solution to our country’s economic and fiscal challenges,” the letter said. “It is our hope that you will reject proposals to alter the tax-exempt status of municipal bonds. While we agree that we must reduce government spending and our country’s unsustainable debt, we should not be eliminating a vital tool for job growth and economic development.”

The letter also highlighted that municipal bonds have funded more than $1.9 trillion in infrastructure construction including for schools, airports, roads and public transit in the past decade and more than $179 billion in infrastructure spending in 2012. The lawmakers called it “irresponsible to jeopardize” funding for teachers, firefighters, hospital workers and police officers who work in infrastructure-related industries.

The letter comes one week after the collapse of a bridge along Interstate 5 in Washington state, spurring debate about whether Congress should be spending more money on infrastructure.

Ruppersberger and Hultgren sent an email version of the letter to all 435 members of the House and 625 hard copies to House committees and leadership offices.

The final letter will be sent to Boehner and Pelosi once a sufficient number of signatures have been collected, aides said.

New York Governor Andrew Cuomo’s plan to fix the Long Island Power Authority, which left thousands of customers in the dark for weeks after Hurricane Sandy, isn’t winning over municipal-bond investors.

On May 21, eight days after Cuomo announced the plan, tax-exempt LIPA bonds callable in nine years traded at an average yield 2.2 percentage points above top-rated bonds, data compiled by Bloomberg show. That was the most in at least three months.

Enlarge image

Sandy struck the region Oct. 29, knocking out power to 1 million LIPA customers, or 90 percent, as falling trees downed transmission lines and substations flooded. Photographer: Victor J. Blue/Bloomberg

Under the Democratic governor’s proposal, which requires legislative approval, Newark, New Jersey-based Public Service Enterprise Group Inc. (PEG) will take over LIPA operations on Jan. 1, and as much as half of the authority’s $7 billion of municipal debt will be refinanced. LIPA’s electric rates, which are among the nation’s highest, will be frozen through 2015 and state regulators will review any increases.

“To start off with saying we’re not going to have any rate increases for three years when there’s a lot of capital needs — the math doesn’t work for me,” said Howard Cure, director of muni research at New York-based Evercore Wealth Management LLC (EVR), which oversees $4.7 billion.

Knockout Blow

Sandy struck the region Oct. 29, knocking out power to 1 million LIPA customers, or 90 percent, as falling trees downed transmission lines and substations flooded. A week later, 200,000 customers still were without power.

Last week, Moody’s Investors Service lowered the ratings on LIPA bonds backed by customer revenue one step to Baa1, three levels above junk, and gave the debt a negative outlook. The political and media scrutiny following Sandy will make it difficult for the utility to improve its finances and operations, particularly if those actions would require rate increases, Moody’s said in a statement.

LIPA has “little if any cushion for the unforeseen events that seem to occur every year,” Moody’s said.

“We are disappointed by Moody’s actions considering the aggressive steps LIPA” has taken to raise liquidity, Mark Gross, a spokesman for the Uniondale, New York-based nonprofit municipal electric provider, said in an e-mailed statement.

“We continue to work with federal and state government towards full and timely” Federal Emergency Management Agency reimbursement for Sandy expenses as well as funds for projects protecting against future storms, he said.

Reimbursement Request

LIPA has received $257 million of the $800 million it expects from FEMA reimbursement, Gross said.

Any delay in FEMA funds is “problematic,” said Laura Schumacher, a Moody’s analyst in New York.

LIPA has about $335 million of cash on hand, representing about 37 days of liquidity as of Dec. 31, the rating company said. Taking into account $100 million of commercial paper, the number of days of cash on hand rises to 48.

According to a commission convened by Cuomo to investigate LIPA’s handling of the storm aftermath, the key to the utility’s failings was a “dysfunctional” management structure.

The authority, which was set up in 1985, owns Long Island’s electrical lines and contracted with London-based National Grid Plc (NG/) to operate them. Under such divided management, LIPA let consultants guide spending and failed to replace aging poles or trim trees as recommended in state studies.

‘Better Way’

“LIPA has been a problem for a very long time, and it was on full display during Hurricane Sandy,” Cuomo said when he announced his plan. “We need a new and better way.”

Public Service Enterprise Group would take over LIPA’s operations, leaving it a holding company with no day-to-day responsibilities. PSEG will control capital and operating budgets, storm preparedness and response, call centers, computer systems and customer service.

To help relieve LIPA’s $7 billion debt burden, the plan calls for a new entity to issue bonds backed by a new customer charge. The securities would be structured to have higher ratings, lowering borrowing costs and generating savings.

“The state is claiming rates will go down,” Cure said. “I’m a little dubious in that the users of the utility are still paying the securitized debt.”

Cure said some investors have shown interest in LIPA bonds, and speculated that they are looking to buy securities that will be paid off in the restructuring.

Rate Independence

The proposal would remove management dysfunction while providing improved oversight, Rich Azzopardi, a Cuomo spokesman, said in an e-mailed statement.

“Rating agencies are primarily focused on LIPA’s board retaining its authority to set rates and comply with bond covenants, which our proposal does,” Azzopardi said. “This should provide great comfort to bondholders.”

The proposal would also eliminate a franchise tax of about $26 million annually that LIPA pays the state, and would cap payments LIPA makes in lieu of taxes to municipalities starting in 2015 at 2 percent per year. The Department of Public Service would review rates and capital spending.

“It’s hard to imagine politics not getting involved,” Cure said. “There’s a lot of pressure on both parties to give some rate relief.”

Most public power agencies can set rates independently, said Jeff Panger, a Standard & Poor’s analyst in New York.

“The current proposal, if it comes about, will constrain the rate-setting autonomy and flexibility that LIPA has beyond what is generally seen by other public-power entities,” he said.

LIPA’s total average electric rate of 18.2 cents per kilowatt hour is among the nation’s highest, according to a 2011 report by the Brattle Group, a consulting firm based in Cambridge, Massachusetts.

Debt Cost

One of the primary drivers is the cost of servicing $6.7 billion of debt LIPA issued in 1998 to finance the acquisition of the Long Island Lighting Co., an investor-owned utility. Lilco spent $6 billion to build the Shoreham nuclear power plant in Suffolk County from 1973 to 1984. The site never opened because of community opposition.

State Senator Michael Ranzenhofer, a Republican whose district sits between Buffalo and Rochester and who heads the chamber’s authorities committee, said he’s reviewing Cuomo’s proposal and shares the same concern as the rating companies.

“There’s the concern with LIPA being able to manage its finances and pay off its debt,” Ranzenhofer said in a May 22 telephone interview. “We need to move quickly, but also deliberatively, to make sure that the proper actions are taken.”

Columbus Issue

In the broader market, municipalities led by Columbus, Ohio, are set to offer $1.9 billion of debt in next week’s holiday-shortened calendar, the slowest period since January.

Columbus plans to offer about $369 million of general obligations to refinance higher-cost debt as municipal yields are the highest in six weeks.

At 1.88 percent, yields on benchmark 10-year munis are still below the 2.02 percent interest rate for similar-maturity Treasuries.

The ratio of the two yields, at 93 percent, has been below 100 percent on all but one day since May 2. The lower the figure, the more costly munis are compared with federal obligations.

In spring 2013, Masters of Public Policy students at The George Washington University conducted research on local policy options for food truck regulations for the NLC. This blog post is based on their preliminary report, which will be made available to NLC members as a policy toolkit in the coming months.

Food trucks have expanded rapidly in both numbers and popularity over the past few years, and many cities are finding themselves ill-equipped to deal with these vendors from a regulatory perspective. Communities across the country, from Los Angeles to Philadelphia, are part of a burgeoning movement to find ways to better manage and regulate mobile vending.

City ordinances related to mobile vending were largely written decades ago, with vendors such as ice cream trucks, hot dog carts and sidewalk peddlers in mind. Needless to say, food trucks are not your mother’s mobile vending experience. Most use large vehicles equipped with high-tech cooking equipment and sanitation devices to provide sophisticated, safe cuisine usually prepared to order (rather than pre-cooked).

So, what policy options do local governments have to regulate food trucks and incorporate food trucks into the fabric of a city?

City-specific solutions are definitely in order, but there are an emerging set of best practices to help tailor regulations so that both the city and the vendors realize the full spectrum of economic and social benefits that food trucks can bring to a community.  Our evaluation produced some overall recommendations for NLC members, including:

Conduct town hall forums and private meetings with core stakeholders

Encourage dialogue and the building of relationships among competing stakeholders

Identify private vacant lots to create partnerships for mobile vendors to gather and sell

Designate public spaces specifically for mobile vending

In addition to the above recommendations, pilot programs can be a useful way to determine what regulations to adopt. Las Vegas currently has a pilot program in place that sets aside a certain number of downtown parking spaces as food truck parking only, and has a lottery system in place for those spaces.

Regulations can also incorporate strategies that steer food trucks to underserved areas of a city to address equity concerns, encourage economic development and alleviate food deserts. Cities such as Denver and Cincinnati have recognized the need for a targeted approach that brings food trucks to parts of the city outside of the core business district. Denver has considered several issues that might impact or encourage economic development, including whether food truck clustering combats food deserts, where restaurant options are constrained and the ability of food trucks to activate underutilized space (like surface parking lots). Cincinnati has seven mobile food truck zones in strategic places around the city.

Due to their low start-up and upkeep costs, food trucks are proving to be an innovative way for entrepreneurs to create viable businesses, particularly as recent economic conditions have made it more difficult to start and operate a conventional restaurant.

The National Restaurant Association reports that they generated approximately $650 million in revenue in 2012– about 1 percent of total U.S. restaurant sales. And a recent research report by the Intuit Network predicts that food trucks will generate between 3 and 4 percent of total restaurant revenue – about $2.7 billion – by 2017, a fourfold increase from 2012. A 2011 survey by the research firm Technomic showed that 91 percent of respondents believe the food truck industry has staying power and is not a passing trend.

At a recent Food Truck Association event in Washington, D.C., food truck supporters had plenty of praise for the modern mobile vending industry. John Gaber, an urban planning professor at the University of Arkansas, noted that “food trucks are great things for communities; they provide more ‘eyes on the street’ for public safety and compliment the surrounding brick-and-mortar businesses.”

How will your city tap into these potential new sources of economic growth, entrepreneurship, equity, redevelopment, public safety, and community “flavor”?

by Emily Pickren

“We want to be good leavers,” our attorney said.

He was one of the few lawyers who could represent us. Others were conflicted, because our employer paid retainers to so many law firms across New York City. I liked how our guy used the royal “we.” It felt like he had joined our wealth management team, and we could prevail against overwhelming odds.

In some ways, he really was one of us. He helped us negotiate signing bonuses at the new shop. He advised us not to tell clients or to warn sales assistants before we left. He did an excellent job protecting our interests.

Good news: My team left clean in 2006. Nobody got sued.

Bad news: Several clients were furious we did not confide in them beforehand.

“I don’t like surprises,” said one.

“Who’s watching my money now that you’re not there?” asked another.

The most painful comment came from one who had become a friend through the years: “Why didn’t you trust me enough to say something?”

She didn’t follow us to the new shop. So much for clients being friends.

Bottom line: Breakaway advisers are caught between a rock and a hard place. We can play by the rules and avoid litigation. Or we can level with clients and suffer the consequences.

The choices–what it takes to be a good leaver–may be clear before advisers resign. But afterwards, departures devolve into brutal, sloppy affairs, with no holds barred.

The bosses at my old shop called our cell phones every few hours. “It’s not too late to work things out. You pick the time and place, and we’ll meet you there.” Coffee. Dinner. Weekend meetings. They suggested any number of convenient venues.

Cynically speaking, I believe they were distracting us to buy time. Because as they made nice on the phone, they were simultaneously lining up and dispatching the buzzards.

You know what I mean. Buzzard brokers build their businesses on the AUM carcasses of departing colleagues. Sure, managers sprinkle around the accounts. But they assign the biggest, most profitable relationships to advisers who are really, really good at retaining assets.

For years I laughed at a guy who scribbled notes on napkins during top-producer dinners. A slip here or a war story there, he was recording information, circling, waiting for the day when somebody would leave and their revelations would come in handy.

The wake of buzzards, I soon learned, was no laughing matter. They can damage relationships for years. And their claims undermine the trust so critical to our business.

Take municipal bonds. Advisers sometimes work for a piece of the bid-ask spread. The sales credit is hidden and often negotiable between adviser and trader. “He’s been ripping you off for years,” a buzzard told my clients. “You’re losing out on better yields.”

“Not true,” I said, defending myself. I offered to run data on trading history, yields and commissions to prove my honesty. The clients never pushed, and these claims and counter claims degenerated into classic cases of he said, she said.

The false claims infuriated me, and I came up with an idea how to respond.

I had spotted three union members striking outside a restaurant on 52nd Street, making a fierce racket. I asked them to drive their 12-foot inflatable rat to my old shop and chant the name of one especially heinous buzzard. Before they could do it, my partner’s cooler head prevailed. I wound up saving “Operation Union Rat” for one of my novels.

Hindsight is 20-20. I now wonder if advisers should have a frank talk with their clients long before considering a move. Because the relationship status between advisers and their firms, well, “It’s complicated,” as they say on Facebook.

A disclosure might go something like this: “In my business, people change firms all the time, either for money or a better fit. While I have no intention of leaving now or in the future, departures are a way of life in the wealth management industry. If that happens, I can’t tell you in advance.”

When I finally decided to leave my firm, it was far too late to have this discussion because of legal constraints. I trusted most clients would follow me, and it turned out most did. But I had no way of knowing as I plowed forward into the unknown.

Norb Vonnegut built his private wealth-management career in New York City and now writes thrillers about financial malfeasance.

The Supreme Court has agreed to decide whether a town board in upstate New York violated the First Amendment by starting its sessions with a prayer.

The case comes from Greece, a town near Rochester. For more than a decade starting in 1999, the town board began its public meetings with a prayer from a “chaplain of the month.” Town officials said that members of all faiths and atheists were welcome to give the opening prayer.

In practice, the federal appeals court in New York said, almost all of the chaplains were Christian.

“A substantial majority of the prayers in the record contained uniquely Christian language,” Judge Guido Calabresi wrote for a unanimous three-judge panel of the court, the United States Court of Appeals for the Second Circuit. “Roughly two-thirds contained references to ‘Jesus Christ,’ ‘Jesus,’ ‘Your Son,’ or the ‘Holy Spirit.’”

Two town residents sued, saying the prayers ran afoul of the First Amendment’s prohibition of the government establishment of religion. The appeals court agreed. “The town’s prayer practice must be viewed as an endorsement of a particular religious viewpoint,” Judge Calabresi wrote.

In 1983, in Marsh v. Chambers, the Supreme Court upheld the Nebraska Legislature’s practice of opening its legislative sessions with an invocation from a paid Presbyterian minister, saying that such ceremonies were “deeply embedded in the history and tradition of this country.”

The new case is Town of Greece v. Galloway, No. 12-696.

May 16 (Reuters) – Charles Schwab Corp has temporarily reversed its requirement that clients waive their right to bring class-action lawsuits, adding a new twist in a battle closely watched by the securities industry and plaintiffs’ attorneys.

“Effective immediately, Schwab is modifying its account agreements to eliminate the existing class-action lawsuit waiver for disputes related to events occurring on or after May 15, 2013 and for the foreseeable future,” the San Francisco-based brokerage company said in a statement that was posted on its website on Wednesday.

Schwab still believes that arbitration is the best forum for clients to resolve disputes with the firm, but said it was backing off the litigation ban in deference to clients who are uncertain about their rights as it fights to defend its original ban.

Schwab’s right to stop clients from bringing coordinated court actions was challenged last year by the Financial Industry Regulatory Authority, the securities industry’s principal regulator. A FINRA hearing panel in February ruled that Schwab’s policy does violate FINRA rules but was consistent with federal law and recent Supreme Court interpretations of the Federal Arbitration Act.

FINRA is appealing the decision to the National Adjudicatory Council, its in-house appellate body.

“Given that the process will likely take considerable time to resolve, and may leave clients with a degree of uncertainty about their dispute resolution options in the meantime, we have elected to remove that uncertainty until the legal and regulatory process is completed,” Schwab wrote in its statement.

Consumer advocates, along with class-action lawyers, have blasted Schwab’s efforts to limit the lawsuits, saying many ordinary investors cannot afford to pay on their own for the cost of arbitration hearings.

In its statement, Schwab noted it will continue to pay arbitration fees for any investor who pursues an arbitration claim under $25,000 against the company.

Public Citizen, a consumer watchdog group that has been circulating a petition asking Schwab to rescind the class-action ban, congratulated the company for its “responsible” decision. It said many of its 19,000 supporters who signed the petition also are Schwab customers who spoke directly to the firm.

Schwab last year asked its almost 9 million clients to sign new account agreements that agreed to waive their class-action rights. The revised policy followed settlements of such suits in which the firm agreed to pay $235 million for misleading marketing of its YieldPlus money-market fund between May 2006 and March 2008.

Several U.S. legislators led by Senator Al Franken of Minnesota last month urged the Securities and Exchange Commission to prevent all broker-dealers from mandating that clients bring disputes only through arbitration forums.

(Reuters) – Florida’s statute of limitations can apply not only to court proceedings, but to securities arbitration cases between investors and their brokers, the Florida Supreme Court ruled Thursday.

The ruling, in favor of Raymond James Financial Services Inc, could, at least in Florida, empower securities arbitrators to cut the time investors have to file a complaint with Financial Industry Regulatory Authority from six years to four years or even two years. And other states could follow.

The decision clarifies a longstanding question about whether FINRA arbitrators can apply a Florida law to determine whether a case is filed in a timely manner. Many securities arbitrations are filed in Florida due to the state’s large number of retirees.

A group of investors, who filed an arbitration against Raymond James in 2005, argued the law applies only to court cases, according to an opinion by Florida Supreme Court Justice Barbara Pariente.

“We are very pleased with the result and believe the court made the correct interpretation,” said Paul Matecki, general counsel for Raymond James, in a statement.

The Florida Supreme Court decision could spur high courts in other states to question whether their state statutes of limitations should apply to arbitration cases, said Jonathan Uretsky, a New York-based securities lawyer who represents brokerages

That could, in some cases, shrink the amount of time that investors have to file, say lawyers.

Brokerage customers typically agree to resolve their disputes in FINRA’s arbitration forum when they sign agreements to open their accounts.

Investor cases are typically eligible for FINRA arbitration if they are filed within six years from the event giving rise to the case, such as the sale of a stock.

Florida law, however, imposes a four-year deadline to file a negligence case, and a two-year deadline to bring a claim under Florida’s securities fraud law, according to the opinion.

The Florida case stems from a Raymond James broker’s alleged investments in high-risk equities on behalf of the investors between 1999 and 2005, according to the opinion. The broker allegedly did not diversify the risky investments, causing significant losses. The investors also alleged that Raymond James failed to adequately supervise the broker.

Raymond James tried to dismiss the investors’ case, arguing that they filed too late.

“We think it’s an unfortunate decision for investors in Florida for those who have claims that arise under Florida law,” said Scott Ilgenfritz, president of the Public Investors Arbitration Bar Association, a group of lawyers who represent investors in securities arbitration cases. The group filed an amicus brief, or “friend of the court” brief opposing Raymond James’ position.

Lawyers who represent brokerages are relieved. “The convoluted argument that has been made by claimants’ lawyers to the contrary is nothing other than a transparent attempt to force a respirator on untimely claims that died a long time ago,” said Terry Weiss, a securities lawyer for Greenberg Traurig LLP in Atlanta.

Numerous industry groups, including the Securities Industry and Financial Markets Association (SIFMA) and Financial Services Institute, filed amicus briefs, or “friend of the court” briefs, in the case supporting Raymond James.

“Statues of limitations ensure fairness to defendants confronted with stale claims,” said Kevin Carroll, SIFMA associate general counsel, in a statement.

Detroit emergency manager Kevyn Orr’s restructuring plan released this week “puts default squarely on the table” and signals that a Chapter 9 bankruptcy filing is a strong possibility, Moody’s Investors Service warned in a comment Thursday.

“The plan is negative for Detroit bondholders because it indicates that the city requires ‘significant and fundamental debt relief’ to help shore up its finances, a clear indication that a default or bankruptcy is a real option,” Moody’s analyst Genevieve Nolan said in the comment.

Orr released the 44-page restructuring report Monday, 45 days after taking over the city, as required under state law. As expected, the report paints a grim picture of the city’s fiscal position. It also says restructuring long-term obligations is central to the city’s survival.

Orr outlines four restructuring options for its bonds: reducing principal, pushing off near-term debt payments, reducing interest rates, and financing “cash recoveries” for bondholders by issuing new debt.

Moody’s notes that Orr said the city will use a “fair and equitable” standard to determine repayments. “While not specifically defined in the recovery plan, this language has been used in relation to other bankruptcy proceedings to manage creditors’ expectations on recovering their assets in bankruptcy, setting the stage for reductions to all stakeholders, including bondholders,” Nolan writes.

All three major ratings agencies maintain junk-level ratings on Detroit. Moody’s rates the city’s general obligation and pension debt Caa1 and its limited-tax GO debt Caa2. The rating level incorporates the risk of bankruptcy or default.

The GO bonds and pension debt, both of which are paid from the general fund, total just under $3 billion. The pension bonds total $1.8 billion, including interest-rate swaps, and make up 20% of the city’s bonds, while general obligation bonds total $1.1 billion and make up 12% of the bond obligations.

Moody’s rates the city’s $6 billion of senior-lien water and sewer bonds, which make up 68% of the city’s bonds, Baa3 with a negative outlook.

Nearly all of the city’s debt carries bond insurance.

Moody’s notes that salaries, wages, and overtime account for 33% of the 2012 budget, while debt service makes up 12%, benefits make up 18%, and other expenditures 32%. The city is deferring its pension payment, which otherwise would make up roughly 5% of the budget.

“The relative burden on each of the stakeholders, such as city employees, pension beneficiaries and bondholders, will be determined by the implementation of the EM’s recovery plan,” Nolan said.

In his report, Orr says that Detroit’s very survival relies on being able to bring down its long-term obligations. “Without a significant restructuring of its debt, the city will be unable to break the cycle of damaging cutbacks in essential municipal services and investments,” Orr writes.

The report provides the first glimpse of Orr’s restructuring plans. He is expected to unveil more details in the next 60 to 90 days.

Municipal bonds typically can be purchased individually or in mutual funds and other portfolios. Here are the essential tax elements of muni investments.

The interest paid on most muni bonds isn’t taxable at the federal level — a benefit that also applies to fund shareholders.

Bond interest frequently also is exempt from state income tax for local residents. This includes thousands of Arizona bonds that are double-exempt.

Any capital gains earned when investors sell a bond for more than they paid are taxable. Tax-deductible losses also are possible. Capital gains or losses typically result from changes in the general level of interest rates, which affect bond prices.

Because they pay tax-free interest, muni bonds and bond funds aren’t suitable for Individual Retirement Accounts, 401(k) programs and other tax-sheltered plans.

Municipal bonds pay tax-free interest — that’s one of those constants on which conservative investors could always count, regardless of how tumultuous the financial markets became.

Even the latest fiscal-cliff tax deal left muni bonds and bond mutual funds pretty much alone. If anything, the legislation enhanced their appeal by excluding muni-bond interest from the new Medicare investment surtax that now applies to high-income individuals.

But muni-bond proponents — including officials representing various Arizona cities, counties and state agencies that issue debt — are starting to wonder whether Congress is getting ready to take them to the woodshed next. With huge federal deficits continuing, there’s a strong sense that some sort of comprehensive tax-reform deal could get hammered out. If so, muni investments could be stripped of at least some of their favorable tax status.

“That risk is about as high as I’ve seen it in the 20 or so years I’ve paid attention to these issues,” said Michael Decker, a managing director at the Securities Industry and Financial Markets Association, a trade association in Washington, D.C. “It’s a political environment where everything is on the table … there are no sacred cows.”

Decker spoke last week in Phoenix at a muni-bond conference hosted by law-firm Ballard Spahr, Fitch Ratings, RBC Capital Markets and the Bond Buyer, an industry publication. The event attracted about 100 municipal officials, attorneys, investment bankers and others. The specter of tax reform was a hot topic.

Both political parties see something desirable in attacking muni bonds, observers say. Many Republicans are skeptical of offering tax-free subsidies to municipal entities, especially as an inducement to borrow more, while Democrats note wealthier Americans are most likely to buy bonds and thus reap the tax benefits. About 4 percent of households report (but generally don’t pay tax on) municipal interest, according to Internal Revenue Service statistics.

Because muni bonds pay slightly lower yields than comparable taxable bonds issued by corporations and other entities, they make more sense for people higher up the income ladder.

A tax attack on munis isn’t a certainty, nor are the details known at this stage. The Simpson-Bowles deficit-reduction commission called for no more tax-free bonds to be issued going forward. Other proposals range from capping the tax benefits for people in high-income brackets to disallowing tax-free financing done to help private enterprises.

A recent White House proposal would tax muni interest for people above the 28 percent bracket, meaning someone paying taxes at the top 39.6 percent rate would pay 11.6 percent on muni interest.

Chris Mauro, head of municipal research for RBC Capital Markets and another speaker at the Phoenix conference, said he doesn’t expect any legislation in the current year that would impair the favorable status of municipal bonds. But he said that threat now hovers over the market and represents one more risk that investors must factor in.

Tax reform, if it passes, wouldn’t apply to tax-free bonds only. Other changes could affect deductions for charitable contributions, mortgage interest, state income taxes and many more provisions.

Infrastructure impact

If Congress did strip away at least some of the tax-free status of munis, some investors would dump their bonds, pushing down prices and pushing up yields. The higher yields then needed to lure investors amid diminished tax appeal would raise borrowing costs for cities, counties and state agencies, with implications for taxpayers in those jurisdictions.

Given budget pressures, many municipal entities already have put capital-infrastructure projects on hold as they have grappled to bring operating costs in line with reduced revenues. Projects that have been tabled include roads, bridges, water-treatment plants, sewer systems, schools and a host of other infrastructure deals that typically have been financed by bond sales.

“Investment in infrastructure has been put on the back burner,” said Gary Yaquinto, executive vice president of the Arizona Investment Council. “Arizona is a new state but has aging infrastructure, much of it nearing capacity.”

Prior to the recession, many Arizona cities were busy building infrastructure to stay ahead of projected population growth, but more recently the focus has been on rehabilitating and maintaining what already was built, said Jeff DeWitt, chief financial officer for Phoenix.

Eventually, though, officials at many Arizona municipalities still expect to dust off blueprints for bridges, roads, water-treatment plants and other projects and finance them at least partly with money raised in the bond market.

Kristine Ward, assistant director of finance and accounting for the Arizona Department of Transportation, said her agency faces an estimated $63 billion funding gap through 2035. The financing pressures have been exacerbated by federal-revenue shortfalls and by declining state-tax revenue whenever gasoline prices shoot up and motorists cut back on driving. Pump prices above $3.50 a gallon seem to be the catalyst for that, she said.

Scope of the market

Phoenix ranked as Arizona’s largest municipal-bond issuer with $7.1 billion of outstanding debt as of a mid-2012 study by the Arizona Department of Revenue, with the Arizona Department of Transportation fifth at $2.2 billion. The other top-five debt leaders were Salt River Project, the Arizona Health Facilities Authority and the Maricopa County School District.

Cities, counties, state agencies and other issuers look at muni-debt issuance differently today from the way they did in years past, when population and economic growth were more robust. The debt total for all Arizona municipalities roughly doubled from $20.7 billion in fiscal 2002 to $41.2 billion in 2009 but has increased only marginally since then. It actually declined a bit last year to $43.3 billion from $44 billion one year earlier, according to a mid-2012 report from the Arizona Department of Revenue.

And while Arizona entities did sell $5.5 billion of new bonds in the latest fiscal year, more than half went to refinance existing debt at lower interest rates, much like homeowners have obtained new mortgages to cut their monthly housing payments.

Nearly all sizable muni-bond issuers in Arizona have maintained top ratings of either double-A or triple-A, despite the challenging economic environment. In general, investors “have a fair degree of confidence in Arizona,” said Jaime Durando, a managing director at RBC Capital Markets.

Favorable factors

While municipal officials wouldn’t welcome tax reform, in some respects it could come at a reasonably good time, all things considered.

Much of the Arizona infrastructure built in anticipation of population growth is still fairly new and in good shape, said Steve Murray, a senior director covering Southwestern states for rating-agency Fitch.

Also, the general level of interest rates is so low that borrowing costs are still historically very cheap. Tax reform would cause prices to drop and yields to rise but it’s uncertain how sharp the reaction might be, and it would be starting from a very low interest-rate level.

Even amid a lengthy and powerful stock-market rally, munis and other types of bonds are holding their own. Bond mutual funds in general have added about $1 trillion in net new cash flow from investors over roughly the past five years — at the same time that stock funds have lost about $500 billion in net cash, according to Investment Company Institute data.

Investors continue to favor conservative assets including muni bonds, and an aging population suggests that trend will continue.

Claims under scrutiny

Hundreds of Arizona cities, counties and state agencies issue municipal bonds, and officials must be careful not to make public statements that are misleading or conflict with what they provide to investors in disclosure documents.

In separate cases, the Securities and Exchange Commission recently asserted fraud against officials representing Harrisburg, Pa., and the state of Illinois for making statements about their financial situations that were incomplete, outdated or otherwise didn’t mesh with what they told muni-bond investors. Both Illinois and Harrisburg are having financial difficulties.

In the Harrisburg situation, the SEC for the first time asserted fraud for comments made outside of disclosure documents, said Anastasia Khokhryakova, a partner at law-firm Ballard Spahr, speaking in Phoenix.

Although not citing any Arizona examples, Khokhryakova said any municipalities could face liability over comments made by officials that conflict with what’s provided in their bond-disclosure documents. As smart practices, she suggests municipalities adopt formal policies to communicate with the public, designate an official spokesperson and provide ongoing training.

— Russ Wiles

June 5, 2013  University Club of San Francisco

San Francisco, California

The Seminar is Open – Complimentary to all Members of the Municipal Securities Community.

This event is closed to the press.

• SIFMA travels to San Francisco for a presentation by MSRB Regulation staff of their most pressing rulemaking initiatives including:
• duties of underwriters to issuers; retail order periods;
• bond ballot initiatives and
• Rule G-37; and more.

The program will also include FINRA and the IRS on municipal securities compliance and enforcement matters.

The Seminar is Open – Complimentary to all Members of the Municipal Securities Community.

Register at:

https://mbrservices.net/ConferenceRegistration/MeetingRegistration.aspx?meetingid=1124

We cordially invite you to attend the SIFMA Compliance & Legal Society St. Louis Regional Seminar to be held at The Hilton Frontenac on Wednesday, June 5th, 2013. This one day seminar will feature presentations by leading securities regulators and industry professionals.

Topics Include:

• Working with Aging Clients-Competency, Elder Abuse and supervising “complex products”
• Banking business within broker/dealers—dealing with multiple regulators
• Public Finance/Financial Advisors
• Investment Advisors-regulatory, legal and supervisory matters
• Cyber Risk/Data Protection
• NASAA and State regulatory developments

Register at:

http://www.sifma.org/cl-stlouis2013/home/

Reps. Gwen Moore, D-Wis., and Steve Stivers, R-Ohio, have sent a letter to new Securities and Exchange Commission chairman Mary Jo White urging her to make sure that the SEC’s final definition of municipal advisor reflects their bill, which is pending before the House Financial Services Committee.

“We were dismayed in December 2010 when the SEC released the proposed definition of municipal advisor,” Stivers and Moore wrote. The pair are sponsors of H.R. 797, which would clarify Section 975 of the Dodd-Frank Act and define MAs as those engaged with issuers to provide financial advice for compensation. The bill contains exceptions for dealers seeking to be underwriters and those providing related advice, as well as bankers, swap dealers and governmental board members.

“The proposed rule went far beyond the scope of Section 975 by encompassing entities and activities that Congress never intended to fall under the definition of municipal advisor,” they told White in their letter.

The legislation takes the same tack as a bill sponsored by former Rep. Bob Dold, R-Ill., that passed the House during the last Congress but failed to move forward in the Senate.

The Stivers/Moore bill enjoys the support of dealer groups but has been criticized by non-dealer financial advisors and others who fear it creates a way for banks to circumvent Dodd-Frank.

“We’ve been actively engaged with Reps. Stivers and Moore since the beginning of this Congress on the issue and we appreciate their writing to the commission,” said SIFMA spokesman Andrew DeSouza.

But a market participant who asked not to be named said the letter is dishonest in claiming that Congress never intended for certain participants to fall under the definition. “They’re trying to recreate congressional intent after-the-fact,” he said. “They’re trying to create an after-the-fact record.”

The Stivers/Moore letter references the “extensive stakeholder input” that went into the legislation, but the market participant said not a single member of the National Association of Independent Public Finance Advisors was formally included in the process. Nathan Howard, an attorney at Kodner, Watkins & Kloecker LC, who works with non-dealer muni advisors, said there is no record of congressional intent  and the bill would create an end-run around the SEC.

“HR 797 prohibits the commission from effectively protecting the interests of state and local government issuers by preventing the commission from regulating entities if they do not receive compensation specifically for their municipal advisory activities, which is contrary to the commission’s longstanding philosophy, that can be put simply as, if it looks like a duck, walks like a duck and sounds like a duck, it’s a duck,” Howard said.

An SEC spokesman declined to comment on the letter, saying the commission will respond to Stivers and Moore. However, John Cross, the SEC’s top muni official has said publicly that he would prefer that the SEC be allowed to complete its rulemaking process on MAs before Congress enacts legislation that might possibly force it to go back to the drawing board.

Market participants are clamoring for the SEC to finalize the MA definition. The Municipal Securities Rulemaking Board also has been waiting for the definition, which has held up its efforts to author new rules and rule changes for MAs.

Originally expected to come out in 2011, then 2012, then the first quarter of 2013, the final definition is still waiting for approval by the SEC commissioners. “Three years after the enactment of Dodd-Frank, it is vitally important that Section 975 be implemented so that state and local governments gain the protections of the regulatory umbrella Congress intended,” Moore and Stivers wrote to White.

White is slated to appear before the House Financial Services Committee on Thursday at an oversight hearing on the SEC’s budget, operations and agenda.

Kyle Glazer

The Bond Buyer

President Obama’s budget, introduced in April, includes proposals to attract private investment in partnership with government for upgrading the nation’s infrastructure. As he said in his State of the Union address, “what our businesses need most [are] modern ports to move our goods, modern pipelines to withstand a storm, and modern schools worthy of our children.”

State and local governments are crucial for achieving the president’s goals. Three-quarters of all U.S. public infrastructure projects are built by state and local governments, and tax-exempt municipal bonds are the primary means to finance them. Unfortunately, the president’s budget includes a provision to limit the tax-exempt status of these bonds.

This would make it more costly for governments, and ultimately taxpayers, to improve America’s roads, ports, bridges, schools, hospitals, and even its water and wastewater systems.

The municipal bond market has functioned effectively for much of U.S. history, and one important reason was the agreement reached between states and the federal government a century ago that the interest on these bonds would never be subject to the income tax. Tax exemption was an integral part of the debate on the adoption of the 16th Amendment, which authorized the federal government to tax income.

Because municipal bonds have a strong repayment record—much higher than corporate bonds—they provide a safe and reliable investment income for U.S. citizens. More than 60% of municipal bonds are owned by individuals, directly or through mutual funds. The federal tax exemption makes them attractive to all investors, especially those whose income is taxed at high rates.

That would all change if the president’s proposal—which would cap the tax exemption at 28% for the top 2% of income earners. Consider someone in the 39.6% bracket earning $100,000 in municipal-bond interest; he currently pays no federal income taxes on that interest. After a 28% cap, he will pay $11,600 in federal income taxes—and demand a higher return to offset the tax burden.

Limiting the tax exemption would reduce investor demand for municipal bonds and raise the interest states and localities would have to offer to attract the investments they need. Had the tax-exemption limit been in place from 2003-2012, it would have cost state and local governments an additional $173 billion of interest on infrastructure investments, according to an analysis by the Securities Industry and Financial Markets Association. These added costs mean higher taxes.

Worse, the tax cap proposed by the president would apply to interest income on bonds that people have already purchased. That will disrupt the bond market, because the value of bonds held by all investors will decline. The change to 100 years of tax policy also would introduce an unwelcome uncertainty into an efficient public-private system. Investors would demand higher rates simply to protect them from future tax shocks.

One estimate by Citigroup Municipal Strategists puts the tax-risk premium alone at 30-40 basis points, and we’ve already had a demonstration of what could occur. Further analysis by Citigroup showed that the municipal bond market experienced dramatic rate increases of between 20 and 50 basis points depending on the quality of the bonds in December. The increase was directly related to proposals made during the fiscal-cliff debate to cap the municipal-bond tax exemption.

Washington’s renewed focus on rebuilding and improving the nation’s infrastructure is welcome, and so is the search for new ways to meet the challenge. However, any new tools must be in addition to—not instead of—the primary financing mechanism that state and local governments have used to meet the needs of their citizens. Let’s not dismantle something that works.

Ms. Ganeriwala is treasurer of Virginia and president of the National Association of State Treasurers.

 

Why invest in the $3.7 trillion municipal bond market? Tax exemption, low default risk, and an investment that lends money to state and local governments to build roads, schools, and hospitals, among other essential needs, are among some of the compelling reasons. And the returns:  the average weekly value of the Bond Buyer 20-bond GO Index over the last 20 years (1993-2012) is 5.0%. Generally, municipal bond investors’ interest income is exempt from taxation, so for an investor in the 35% federal tax bracket and with a 5% state income tax buying in-state bonds, that 5.0% translates into a taxable equivalent yield of 8.3%, a very attractive return for so little credit risk. Now in 2013, with the 39.6% federal bracket back in place and a new tax on investments in effect, the value of tax-exempt interest is even larger.

As with any investment, however, investors need to weigh the risks against the returns and determine if a particular investment meets their specific needs.  To be sure, one of the primary concerns of investors in any “fixed-income” instruments like municipal bonds is the effect of rising interest rates on a bond’s market value.

Some investors may be concerned that a spike in interest rates could mean losses for municipal bond investors.  In the bond markets, prices move inversely to interest rates.  If rates spike, investors would see their bonds’ market values drop.   Bond funds are typically active traders of bonds and their assets are also marked to market daily, so market values in these funds would fluctuate with interest rates.  The measurement of the sensitivity of a bond’s price to changes in interest rates is known as “duration,” and duration generally is higher for longer-term bonds.

For buy and hold investors in individual bonds, this won’t matter, as they will continue to receive principal and interest payments as they come due, and their bonds will generally mature at par.  Investors who don’t plan to hold a bond until maturity need to weigh the risks and rewards of investing in a particular bond given their investment time horizon.  A very low interest rate environment leaves little to no room for interest rates to fall further, but plenty of room for rates to rise.  How quickly that may happen and how the market may react are important pieces of the overall investment picture. The Financial Industry Regulatory Authority, or FINRA, recently issued a useful report outlining considerations for bond investors in low interest rate environments like the current one.

Moreover, many investors have been staying out of the fixed income markets because of the currently low market yields or the fear of rising rates. Households hold far more of their assets in bank deposits, money market funds and other “cash-like” investments which currently yield close to 0% than they do in municipal bonds. When interest rates do finally go back up, investors’ cash holdings will yield more, and some investors may be incented to return to the bond markets. Still, investors should consider duration risk as an element of examining investment alternatives.

Amid the concerns, this basic fact bears repeating:  issuers of municipal bonds have an outstanding record of meeting interest and principal payments in a timely manner.  The long-term default rate for rated, investment-grade municipal securities is 0.15%.  Unless the credit picture for state and local governments changes in an unexpected and fundamental way, investors who hold their bonds to maturity have a very high likelihood of seeing their investment perform just as expected.

In the interest rate discussion, it should not be lost that this is the best time in generations for state and local governments to borrow money and issue bonds to fund infrastructure and other important projects.  Year to date municipal bond issuance through the end of March was 4.8% higher than issuance in the first three months of 2012, and issuance for the full year 2012 was over 28% higher than issuance in 2011.  That’s good for our municipalities and the people who live – and work – in them.

Michael Decker

Managing Director, Co-Head Municipal Bonds

SIFMA

May 7 (Reuters) – Moody’s Investors Service said on Tuesday that the number of defaults among the U.S. municipal bonds it rates has risen since the financial crisis but still remains low.

The economy has been recovering but many local governments are buckling under a combination of stresses on their budgets, with places such as Stockton, California, in bankruptcy.

“Revenue and spending pressures from the sluggish economic recovery, including soaring pension costs, have intensified credit stress faced by local governments,” Moody’s said in its annual report on municipal defaults.

In 2012, there were five Moody’s-rated defaults and 23 since the beginning of the recession in 2008, with an average of 4.6 defaults per year, up from 1.3 in the 1970-2007 period.

“We expect states and the vast majority of local governments to continue to do the hard work of rebalancing and adjusting their budgets,” it said. “Given long-term demographic trends, cuts in federal spending, and substantial underfunding of pensions and other entitlements, this hard work is by no means over, and will need to continue for some time.”

During and after the recession, state and local revenues plunged to record lows. At the same time, the financial crisis ravaged the returns on public pension investments, the primary source of funding for most retirement systems. Revenues are now back at pre-recession levels and many pensions have made reforms, but the federal government is embracing spending cuts that threaten both the grants cities and states receive and their revenue in general.

The five defaults among Moody’s rated issuers last year included two towns, Stockton and Wenatchee, Washington. KidsPeace, a non-profit in Pennsylvania, and American Opportunity for Housing in Colinas, Texas, along with California’s Oakdale Sewer Enterprise, also defaulted.

Particularly, there has been a rise in speculative-grade rated governments and risks remain in healthcare, Moody’s said. Multi-family housing bonds are stressed by historically low interest rates, which can hurt housing projects’ cash flow and threaten debt repayment, Moody’s said.

Last August the Federal Reserve Bank of New York said defaults are more numerous than rating agencies such as Moody’s report. Combining data on unrated and rated bonds, researchers at the bank found that from 1970 to 2011, there were 2,521 defaults, compared with just 71 listed by Moody’s.

Usually, bonds sod by smaller municipalities or authorities and carrying higher risk of default do not have ratings from Moody’s, Standard & Poor’s or Fitch Ratings.

Moody’s said defaults in 2012 came close to reasonable expectations, but that “over the longer term – and even since the advent of the financial crisis in 2008 – have been so infrequent as to suggest that our rating distribution on the whole may be too low.”

Still, it said it has actively lowered ratings in recognition that credit risk has increased.

Analyst Meredith Whitney predicted a large cascade of defaults two and a half years ago. Even though her forecasts did not came true, they cast a pall over demand for bonds. Last month, a Securities and Exchange Commissioner raised the possibility of a municipal “Armageddon” related to recent bankruptcies and the looming rise of interest rates.

Commissioner Dan Gallagher said the bankruptcies could set legal precedents ending the long-held tradition of fully repaying bondholders when a local government goes under.

“Local government defaults are necessarily high-profile events because of their rarity, of course, but also because of their consequent power to set precedents and expectations ranging from loss recovery rates to bankruptcy case law,” Moody’s said.

The foreclosure crisis hit hardest in cities like Newark, New Jersey. Lenders preyed on low-income areas and made loans to people who had little ability to pay them back. Since 2008, 6,810 homes have been foreclosed in Newark, and citywide, homeowners have lost roughly $1.8 billion in home values, according to a report from the grassroots advocacy group New Jersey Communities United. This wave of vacant properties increased costs for maintenance and public safety by approximately $56 million. Blight increases danger in a city; last July, five residents, four of them children, died in a fire that started in one of Newark’s vacant properties. Foreclosures also damage the value of neighboring homes. Another 9,000 Newark residents are “underwater” on their homes, meaning they owe more on their mortgage than what their homes are worth.

The situation has made politicians and activists in Newark desperate, enough to explore a controversial idea: using eminent domain to seize mortgages from the lenders and renegotiate them at the market rate. Eminent domain laws enable municipal, state or federal governments to take property for a public purpose; in this case, the public purpose would be foreclosure prevention and the reduction of potential blight.

While the eminent domain option has been discussed in several cities hit hard by the foreclosure crisis—including Chicago and San Bernardino, California—no city has stepped forward to implement such a scheme. And that’s because the way eminent domain has been envisioned, especially by the well-connected company trying to sell many cities on the idea, is legally dubious and incredibly risky for the municipality. Properly structured, eminent domain as a foreclosure prevention tool might work. But there are other ways to stop the proliferation of blight in Newark, none of which involve enriching a third party.

The biggest problem with eminent domain is that mortgages are costly, and city budgets, particularly in communities with foreclosure problems, are strapped. So inevitably, they would have to bring in a private partner to acquire the working capital needed to buy the mortgages before resetting them. This ultimately may save the communities money in the long run, from avoided foreclosure costs and more property tax revenue. But in the near term, they’re going to need some money.

So far, only one group has stepped forward as a viable partner, an organization called Mortgage Resolution Partners (MRP), run by several Democratic operatives from California. MRP has attempted to activate their eminent domain plan in several cities around the country, but it’s not clear whether the deal makes sense for anybody.

First of all, MRP is only interested in dealing with performing mortgages, where the borrower is current on the loan. These are not the people most in need of help from foreclosure. They actually have some options already: The federal HARP program, which extends refinancing options to underwater borrowers, has proven attractive enough to banks (who make money in fees off the new loan and often lock in rates higher than the going average) to become successful, with over 1 million refinances made. While this doesn’t give underwater borrowers the cheapest possible interest rate, it does often save them hundreds of dollars a month and makes the loans more affordable. It’s borrowers who have missed payments that are most at risk of foreclosure. But MRP doesn’t want to help them.

It’s also questionable whether performing mortgages are condemnable. If borrowers have been paying for years, why does it serve community needs to take those mortgages over? There’s certainly a somewhat higher risk of foreclosure on an underwater mortgage, but the benefit seems to go to the individual borrower rather than the city, which puts the concept in legal jeopardy.

Moreover, under eminent domain, the government entity must offer a “fair value” for the entity it condemns. And there’s a big difference between fair value for a house, and fair value for a mortgage. In this case, if a borrower is dutifully paying their mortgage every month, expectations are high that they will continue paying it. The owner of the mortgage would be unlikely to consider a discounted rate as a fair deal, when the borrower is able to pay full price. Therefore, the only legal way for the government to acquire the mortgage at fair value would be to pay it off in full, a much higher price than the value of the house. MRP, a for-profit company, is obviously more interested in buying the mortgage at a deep discount, taking a cut (reportedly 5.5 percent) when they reset the loan for the borrower and turning a profit. As financial writer Yves Smith, who has criticized this rendering of eminent domain, noted recently, “The mortgages must be stolen.” What’s more, if the borrower were to default on the new loan, MRP would take none of the risk, which would all be borne on the municipality.

There may be ways to structure eminent domain that make sense for both the municipality and investors. But the most-cited proposal on the table has made communities wary once they dig into the details. And this has given the mortgage lending industry time to counterattack. Not only did it threaten to essentially cut off lending to any community that engages in this kind of scheme, it got some back-up, incredibly, from the Federal Housing Finance Agency, the government overseer of mortgage giants Fannie Mae and Freddie Mac. Last August the FHFA sent a notice to the Federal Register that expressed “significant concerns” with eminent domain plans for mortgages, ominously asserting that “action may be necessary” to avoid any risks associated with the program. Perhaps in part because of these threats, the constitutional challenges sure to arise, and the high-risk, low-reward deal from MRP, San Bernardino, the first city to really explore this idea, gave up on it earlier this year.

Cities like Newark have other options to prevent foreclosures and the troubling rise of vacant properties. One of the biggest issues concerns what is known as a bank walkaway. In this scenario, banks pursue foreclosure (typically to collect foreclosure fees) and evict the homeowner, but instead of completing the process, and therefore taking responsibility for maintenance, property taxes and municipal fees, they walk away. Banks often don’t inform the former homeowner or the municipality that they stopped foreclosure, leaving the individual on the hook for any costs, and leaving the municipality confused about whom to hold accountable. This lack of information about abandoned foreclosures violates regulatory guidelines, but banks have accelerated this technique. According to a recent report, over 300,000 vacant homes nationwide are the result of bank walkaways. And one study of Newark showed that almost 43 percent of bank-owned properties in one neighborhood remain vacant.

To combat this, cities could make it cost-prohibitive to foreclose in this fashion. Newark already has a vacant property registration ordinance, which allows for fines of $1,000 a day for failure to register vacant properties or maintain them. New Jersey Communities United argued that the city should fully enforce that ordinance. A better solution would be to ensure that the ordinance gets assessed on the foreclosing bank, whether they abandon the foreclosure or not. A more punitive fee that would stop bank walkaways and force them to put those homes back into circulation could make banks think twice before foreclosing. In Los Angeles, the city attorney has sued several major banks for failing to maintain foreclosed properties. Only changing the financial incentives surrounding bank foreclosures will lead to a change in behavior.

The lack of support at the state and federal level for communities still suffering from the foreclosure crisis has understandably led municipalities searching for answers. But before jumping into eminent domain, cities can use their existing leverage to encourage better treatment of their citizens.

David Dayen is a freelance writer based in Los Angeles.

The Securities and Exchange Commission on Monday accused Harrisburg, Pennsylvania’s debt-laden capital, of violating federal antifraud rules for securities issuers by repeatedly giving misleading information that created risks for bond investors as the city’s finances were rapidly deteriorating.

Harrisburg, pulled to the brink of bankruptcy by a huge debt on its municipal trash incinerator, is also having trouble paying daily bills while it delays payments on general obligation bonds. As a result, it is Pennsylvania’s only municipality that is under a state takeover.

The S.E.C. said the charges against Harrisburg, a city of about 50,000, represent the first time a municipality has been accused of misleading statements that were not included in securities disclosures. The S.E.C. is scrutinizing state and municipal governments around the country in connection with offerings in the $2.7 trillion municipal bond market.

Among the misstatements or omissions by Harrisburg city officials were a 2008 audited financial report that did not mention a downgrade by Moody’s Investors Service of Harrisburg’s general obligation debt and a midyear financial report in 2009 that did not mention $2.3 million in debt guarantee payments for the incinerator, the S.E.C. said.

From 2009 to March 2011, the city did not file annual audited financial statements with municipal securities agencies, the S.E.C. said.

On Dec. 31, 2007, the city’s bonds and bond guarantees for its agencies totaled about $500 million, many times its revenue of about $61 million, the S.E.C. said.

The commission cited cooperation by Harrisburg officials in the investigation and the city’s actions to create policies and procedures to ensure that its financial statements are accurate. As a result, the S.E.C. did not impose a financial penalty, and the city did not admit to or deny the commission’s accusations in its settlement of the charges. Still, the S.E.C. ordered Harrisburg not to violate disclosure rules again.

“In an information vacuum caused by Harrisburg’s failure to provide accurate information about its deteriorating financial condition, municipal investors had to rely on other public statements misrepresenting city finances,” George S. Canellos, co-director of the S.E.C.’s enforcement division, said.

In collaboration with municipal leaders in a small group of cities, NLC has launched an innovative, two-year pilot program called Local Interventions for Financial Empowerment through Utility Payments (LIFT-UP) that seeks to help low-income families pay their utility bills and achieve financial stability.

Through LIFT-UP, NLC’s Institute for Youth, Education and Families will test a new model in which cities identify families who are in debt to city-owned utilities and offer them a restructured payment plan, payment incentives, and a variety of financial empowerment services. Cities participating in this pilot project include Houston, Texas; Newark, N.J.; Savannah, Ga.; and St. Petersburg, Fla.

The LIFT-UP initiative is supported by grants from the Center for Financial Services Innovation (CFSI) Financial Capability Innovation Fund II, the Ford Foundation, and the Annie E. Casey Foundation.

“Too many families are struggling to make ends meet and pay for basic necessities like electricity, water, and heat,” said Newark Mayor Cory Booker. “Connecting residents to financial coaching, while allowing for some restructuring of their utility debt, is a smart approach to financial empowerment. This effort has the added benefit of bringing in revenue we might not otherwise see. Privately-funded, publicly-run pilot programs like the LIFT-UP project are essential to innovation in municipalities across the country. I’m thankful to the National League of Cities for orchestrating this initiative and I look forward to working with my team to make it a success.”

“I am excited to see how LIFT-UP will be able to offer a helping hand to residents who are in debt to city-owned utilities, such as our water and sewer system,” said Houston Mayor Annise D. Parker. “At the same time, we will be able to provide counseling and education to help them keep out of financial trouble in the future. As we face a nationwide epidemic of personal debt crises, this program may help some in at least one arena, and hopefully enable them to stay out of debt in the future.”

Municipal Financial Empowerment Initiatives

Even before the recession, millions of Americans faced acute financial hardship, with insufficient income and assets to withstand unexpected crises such as job loss or large medical bills. Recognizing the disastrous consequences for children, families, and neighborhoods when these crises occur, city leaders have developed increasingly sophisticated financial empowerment (FE) strategies in recent years in an effort to help low- and moderate-income families stabilize their finances and begin to accumulate savings.

These strategies include outreach campaigns to connect residents with federal and state tax credits and benefits; efforts to reduce reliance on check cashers and payday lenders; matched savings initiatives; financial education programs; credit repair services; assistance finding employment; and individualized financial coaching.

Reaching Families in Debt

At the same time that cities are developing FE initiatives, however, city-owned utilities may be working at cross-purposes by aggressively seeking repayment of debts owed by low-income residents. This “disconnect” within local government represents a major missed opportunity to identify and assist struggling families.

While utility debt is not a large fraction of overall consumer debt, unpaid utility bills are a reliable indicator that families are in serious financial trouble since they typically must make these ongoing payments to maintain their housing.

Aggressive debt collection efforts not only exacerbate the problems that FE services are designed to address, but may also represent an ineffective approach to maximizing city revenues. Families’ ability to pay their utility bills and meet other financial obligations on an ongoing basis is directly linked to the success of local financial empowerment initiatives. In addition, municipal governments that turn to private debt collection agencies often pay high fees that limit the amount of net revenue collected.

“When families cannot pay their utility bills, it is often a sign that they are in deep financial distress,” said NLC President Marie Lopez Rogers, Mayor of Avondale, Ariz. “By connecting these residents with existing financial empowerment programs, LIFT-UP project cities will help them reduce debt and strengthen their ability to pay bills on time. The project will also provide cities with a sustainable way to increase revenues from utility payments.”

The LIFT-UP Model

Through the LIFT-UP initiative, NLC will test a new framework to align local financial empowerment services with municipal utility debt collection practices, identifying struggling families with the goal of helping them become financially secure.

By working with cities to pilot the LIFT-UP model, NLC will focus on:

1. Forging connections between utilities and FE agencies to identify eligible residents;

City-owned utilities will develop a streamlined identification and referral system to connect indebted residents with a financial counselor. The counselor will work with families to identify their financial needs and connect them to existing services.

2. Designing and testing a new mix of products and services that can financially empower indebted families, help them pay overdue bills, and prevent future accumulation of debt;

Each participating city already has in place a network of FE services that can be targeted toward struggling utility customers participating in the LIFT-UP program. In some cities, these services are offered by city agencies – such as Newark’s Financial Empowerment Centers – and in others they are available through partnering organizations.

3. Restructuring outstanding debt owed to city-owned entities and using behavioral economic approaches to facilitate debt repayment.

Financial counselors will work with participants and utility companies to negotiate a restructured debt repayment plan incorporating behavioral economic principles that incent repayment. For instance, local variations of the LIFT-UP model may provide participants with forgiveness of a portion of debt if regular payments are made, deposit funds into a savings account when customers repay a specified amount of their debt, or convert the customer’s debt into a credit union loan.

Throughout the initiative, NLC will provide each city with in-depth technical assistance and peer networking opportunities through site visits, cross-site convenings, conference calls, and partnerships with other national experts in the financial empowerment field.

Program Evaluation and Broader Project Implications

NLC has partnered with the Center for Financial Security at the University of Wisconsin-Madison, which will evaluate the effectiveness of the LIFT-UP model in improving participants’ ability to repay their debts, increasing on-time payment of their utility bills, reducing their debt levels, and decreasing city spending on utility shut-offs and debt collection.

If the LIFT-UP program is successful in achieving these objectives, it could affect the way other fee-collecting city agencies, such as public hospitals or municipal courts, structure their debt collection practices. This framework, developed in collaboration with cities that are leaders in the FE field, has the potential to create a “win-win” scenario that brings key services to struggling residents while bringing needed revenue to cities.

Details: For more information about the LIFT-UP initiative, contact Denise Belser at (202) 626-3028 or belser@nlc.org.

Municipal water, wastewater, and power utilities’ overstressed infrastructure are in the spotlight, as policy makers look for ways to close yawning gaps between their capital-investment needs and the revenues already identified to fund them.

Hurricane Sandy cast a harsh spotlight on the fragility of the nation’s utility grids, even in the nation’s most populous areas. But the shortcomings were no surprise to insiders: if current trends persist over the next five years, capital investment in water and wastewater systems will fall short of the needs by $109 billion, and power-grid spending will fall $25 billion short, according to the American Society of Civil Engineers.

Meanwhile, state and local policy makers are increasingly looking to their utilities — and their independent revenue streams — to help advance energy-efficiency and renewable energy goals despite the continued stress on local government budgets from the struggling national economy.

TOPICS TO BE COVERED

The Bond Buyer’s inaugural Municipal Utilities Conference will address these pressing issues, and bring together the state and local leaders who are at the forefront of designing solutions. Join us in Houston, May 16-17, at the Hilton Americas-Houston, to learn:

• Which utilities have emerged as national leaders in designing and funding capital investment programs to meet their communities’ needs, what are they funding, and how did they build the revenue base they need?
• How innovative financing structures, from full public-private partnerships to design-build contracts can help bridge the gap between needs and local utilities’ ability to pay for upgrades.
• Whether general government fiscal stress can spill over to the municipal utility sectors, and what happens in bankruptcy court if it does?
• If global climate change will really force a wave of capital spending to harden utilities against damage from future storms and flooding. How soon will the changes emerge, and what will that mean for bond sales and investor protections?

GROUP RATES AVAILABLE

Issuers & Public Power Employees ONLY $95, Institutional Investors $395, and All Other Professionals $895. Register today or contact Dan Tina at (800) 803-5797.

Register at:

http://www.bondbuyer.com/conferences/utilities/

Later this week, securities-industry representatives will jet out to Nevada and California to try and tamp out a brushfire they thought they’d extinguished last year. In meetings with officials in North Las Vegas; Richmond, Calif. and possibly other foreclosure-plagued cities they will once again argue against a plan in which cities would use their eminent-domain powers to seize mortgages so they can be refinanced at lower rates.

“I feel like I’m playing a game of Whac-A-Mole,” said Vincent Fiorillo, a portfolio manager with DoubleLine Capital, which has more than $50 billion invested in mortgage-backed securities. “This idea keeps coming back.”

Fiorillo belongs to the Association of Mortgage Investors, which, along with the Securities Industry Financial Markets Association, talked San Bernardino, Calif. and several neighboring cities out of adopting the eminent-domain scheme last year, saying it would be “immensely destructive to U.S. mortgage markets” and force lenders to avoid those cities in the future. Despite their efforts, Mortgage Resolution Partners, a firm affiliated with Evercore Partners, has signed up the city of Richmond and several others it won’t name to try and pursue the same plan.

John Vlahoplus, MRP’s chief strategy officer, said the program is designed to do what banks and loan servicers are unwilling or unable to do: Restructure mortgages with lower principal amounts and payments, taking advantage of state and federal incentives that can mount to as much as $100,000 per loan. The “public purpose,” necessary for any condemnation, would be is to prevent further foreclosures and erosion in property values, he says.

“These are toxic loans, and they are toxic for the community,” Vlahoplus told me.

Investors like Fiorillo disagree – vehemently. They say the moment for MRP’s plan, if it ever made sense, was in early 2009, when the percentage of loans in hard-hit cities like Richmond that were falling into delinquency and default peaked above 60%. Since then even in Richmond, where unemployment still runs above 13%, delinquencies have fallen to a fraction of their peak levels while private lenders – the only ones targeted by MRP’s proposal for political and legal reasons – have extended principal forgiveness to 20% of borrowers.

Another big problem with MRP’s plan, critics say, is despite protestations to the contrary the only mortgages the firm will be able to restructure are performing loans.  That’s because the plan relies on pulling loans out of private-label securities trusts at a discount and reselling them to agencies like Fannie Mae, Freddie Mac or the Federal Housing Administration.

“Even FHA has some underwriting standards,” said Tim Cameron, head of the asset management group at SIFMA, which represents big banks and asset managers. “If a city seizes a non-performing loan, they own it. The theory only works if they can refinance it.”

Vlahoplus says cities could still provide borrower relief by restructuring the loans themselves, possibly with financial assistance from the Treasury’s Hardest Hit  program.

Unanswered legal questions swirl around the entire proposal. Proponents say cities can seize any kind of property they want under eminent domain, even paper assets like stocks and bonds. Robert Hockett of Cornell Law School, considered the intellectual father of the MRP plan, told me “intangibles are quite commonly taken,” although he acknowledged there are no examples of residential mortgages being seized.

Second, the mortgages are claims embedded in trusts, typically governed by Delaware law and traded far from the cities doing the seizing. Investors like DoubleLine don’t own the underlying mortgages except through bonds issued by those trusts, and no one has ever used eminent domain to pluck individual mortgages out of a trust. The assumption is that would cause the entire trust structure to collapse, causing mayhem in the mortgage-backed securities market.

Hockett said property law is clear that local courts have jurisdiction over claims against real estate in their area, and investors who bought securities backed by those loans should understand that cities can seize them through eminent domain. The cities are actually trying to do these trusts a favor, he adds: By seizing loans that are in high danger of default because they exceed the value of the underlying home, Hockett says, cities would be improving the overall quality of the pool.

“The thought is the trustees would love to sell these out of the trust, but they can’t,” he said.

Fiorillo laughed at that suggestion. Hedge funds and managers like DoubleLine have been coining money on subprime loans for several years now specifically because defaults are plunging at the same time as the value of the underlying collateral rises. Since cities will likely only be able to seize performing loans, Fiorillo says, the plan really represents a transfer of wealth from one set of investors to another, with an otherwise current borrower getting lower payments in the deal.

“Just because you’re upside-down doesn’t mean you’re in need of forgiveness,” Fiorillo said. “You borrowed your money, you pay it back.”

Finally, there’s the question of how to value the loans. The Fifth Amendment requires cities to pay fair market value for property they seize, but nobody can explain precisely how a court in, say, Richmond can determine the value of one loan out of 1,000 or more in a given pool, which itself has been sliced and diced into a profusion of different securities. Investment banks assembled many of these pools with different types of loans in different regions as a sort of internal hedging mechanism; if all the performing loans in California are suddenly sucked out of the pool at a price a court there considers “market value,” that could have severe repercussions for the remaining value of the pool and all the securities backed by it.

Vlahoplus, a Harvard Law grad and Rhodes Scholar with years in the real estate securities business, said “this is just business. These are just financial assets.”

“How does DoubleLine determine the price of that loan? It uses financial models. And so will the city,” he told me. As for undermining the internal structure of the pool, he said, investors would be in no different shape than if the cities seized the houses themselves and extinguished the debt that way. In either case, the loans would be sucked from the pool.

(I asked both Vlahoplus and Hockett why cities don’t do exactly that. If, as they both maintain, even current borrowers who are underwater on their homes have a 70% chance of defaulting, why not rescue them from that situation by seizing their homes and renting them back to them at a lower monthly rate? They said that would leave on the table thousands of dollars in state and federal aid for mortgage restructuring. Investors, of course, cite current statistics to show that less than 20% of current borrowers in cities like Richmond are likely to default in the future and the number is dropping rapidly, so current borrowers don’t need help simply because they bought at the peak of the bubble and owe more on their homes than they are currently worth.)

It’s one measure of the success of MRP’s plan that it has driven investors like DoubleLine into Defcon 1 mode. Vlahoplus says investors have nothing to fear, because eminent domain will merely break up a financial and legal logjam that prevents private mortgage pools from restructuring loans. He says when it comes down to it, the cities – with MRP as advisor – will negotiate terms with the pools.

MRP has every incentive to do that: Under the terms of its proposals with Richmond and other cities, it stands to earn $4,500 for each loan it restructures. The firm is targeting only private mortgage pools, Vlahoplus said, because federal law preempts cities from seizing loans guaranteed by federal agencies like Fannie and Freddie.

Cameron of SIFMA said the reality is private pools are in many cases doing a better job than the agencies of restructuring these loans. Cities may get a rude shock when they try to seize private-label mortgages that are actually held in the trading portfolios of Fannie and Freddie, he said. He also ridiculed the idea of negotiating the sale of these mortgages when cities hold the gun of eminent domain to investors’ heads.

“It’s a non-starter,” he said. “Asset managers, as fiduciaries, have to go to court to make sure somebody doesn’t pick their pockets.”

“They say we’re threatening them,” he added. “No, it’s the obligation we have.”

The biggest reason to use bond portfolios made up of individual bonds for your clients is that you can create something that is specific to the client. Bonds funds tend to be more generic and don’t always work with clients’ objectives.

But with individual bonds you can be more flexible, making sure clients’ funds are there when they need them.

One thing to realize is that it’s important to be working with client portfolios that are large enough to provide a good amount of diversification. For example, a bond portfolio less than $250,000 can’t purchase enough different issues to provide that diversification.

What we’ve found is that as interest rates have declined, finding attractive yields is getting harder and harder. There’s not a lot of yield available from regular corporate bonds, or regular tax-free municipal bonds–the common ones tend to trade more like commodities. So we think that we can create value for our clients by using bonds that are different than regular corporate or municipal bond bullet structures.

One of the things that we found a lot of value in is collateralized mortgage obligations, which are backed by cash flows from mortgages. When borrowers make their mortgage payments, they pay both principal and interest. So instead of getting the entire principal back at the end as with regular bonds, investors receive staggered payments depending on how the underlying loans were prepaid, either through refinancing or someone selling their home to move.

The CMOs are backed by mortgages, which can be insured against losses. Also a process called tranching means that junior, or subordinated class bondholders absorb any losses first. Understanding these factors allows you to choose which CMO is the best value for the client.

We’ve also found value in a specific kind of structured note called “steepener” notes, which base their coupon on the spread between interest rates of different maturities. There’s also value in municipal bonds as long as you dig deeper to find what we call “story” bonds. These might look like bad investments on the surface, but when you dig into what the bond collateral is, they’re actually a great value.

It’s important that advisers do their homework and understand how to analyze all the factors that go into buying individual bonds. Having a good bond broker can also help. You need to understand the risks, so that if you’re taking higher risk you’re getting properly compensated with higher return.

Yields have been going down, but when they go up, the value of bond funds will fall. Investing in individual bonds can give clients some protection. In many ways it’s a timing issue. The value of the bond portfolio isn’t necessarily as important as the client’s money being there when they need it. Even if a bond falls in value, individual bond portfolios can be structured so the client still gets the cash flows they need.

Kerry Mayo

Voices is an occasional column that allows wealth managers to address issues of interest to the advisory community. Kerry Mayo is a financial planner with Clifton Park, N.Y.-based Capital Financial Advisors of New York.

Click here to see NACo’s presentation on the president’s FY14 Budget. http://www.naco.org/legislation/Documents/NACo-Presentation_FY14-Presidents-Budget.pdf

Click here to see a detailed table comparing the proposed FY 14 and actual FY 13 budgets:

http://www.naco.org/newsroom/countynews/Current%20Issue/4-22-2013/Pages/Crunching-budget-numbers-proposedFY14-vs-actualFY13.aspx

President Obama’s $3.6 trillion budget for FY14 includes proposals that would, if adopted by Congress, make big changes to the way counties do business across the country.

It recommends measures to achieve $25 billion in savings in FY14 through eliminating and consolidating programs, and cutting spending in others. It proposes reducing discretionary spending through the annual appropriations process from 8.3 percent of Gross Domestic Product (GDP) in FY12 to 7.3 percent in FY14 and 4.9 percent by FY23. It lays out a plan to cut the deficit by $1.8 trillion over the next 10 years, bringing it below 2 percent of GDP by 2023; when combined with the sequester, it would cut the deficit by $4.5 trillion.

The budget’s highlights – or lowlights – for counties include:

Cap on Municipal Bonds – It’s Back

As in last year’s proposal, the president’s FY14 budget would impose a 28 percent cap on the value of certain tax benefits, including tax-exempt interest. This would have the effect of partially taxing otherwise tax-exempt municipal bond interest and would apply to taxpayers in the 33 to 39.6 percent tax brackets. As proposed, the cap would apply to both newly issued and outstanding bonds beginning in 2014.

NACo will continue to oppose this and any other proposals to change the tax-exempt status of municipal bonds, which would raise borrowing costs and undermine an essential financing tool for county governments.

As an alternative approach to infrastructure investment, the president proposes establishing the America Fast Forward (AFF) Bond program. Similar to the Build America Bonds program that expired at the end of 2010, the AFF program would provide state and local governments that issue conventional taxable bonds with a subsidy payment equivalent to 28 percent of the interest on the bonds. The AFF bonds could be used for purposes currently eligible for tax-exempt bonds starting in 2014.

If AFF bonds are issued in 2014 and 2015 for school construction and new capital projects for 501(c)(3) nonprofit educational entities, issuers would receive a 50 percent subsidy payment. The AFF proposal does not address reduced subsidy payments due to sequestration, which is currently confronting Build America Bond issuers.

Community Development Block Grant – On the Chopping Block

The Department of Housing and Urban Development (HUD) budget proposes cutting Community Development Block Grant (CDBG) formula grants by $280 million, from $3.07 billion in FY13 to $2.79 billion under the president’s FY14 proposal. This is 37 percent below FY10, 17 percent below FY11 and 28 percent below FY12. It does, however, propose retaining the 20 percent for administrative costs. Additionally the budget proposes statutory changes to establish a minimum grant threshold for CDBG and eliminates the community-grandfathering provision for entitlement communities.

Who Needs SCAAP?

The Department of Justice budget proposes eliminating funding for the State Criminal Alien Assistance Program (SCAAP). In FY13, SCAAP provided $220 million (pre-sequestration) to help offset costs incurred by counties for jailing undocumented immigrants.

Public Lands County Payments Targeted for Reauthorization

The president’s FY14 budget for the Department of the Interior proposes legislation to extend mandatory funding for the Payment in Lieu of Taxes (PILT) program at $410 million, an increase of $8.8 million from the FY13 level. The budget also proposes an independent public evaluation of PILT to review the program, in both concept and practice, with the goal of developing options to put the program on a sustainable long-term funding path.

The U.S. Department of Agriculture (USDA) budget proposes a five-year reauthorization of the Secure Rural Schools and Community Self-Determination Act (SRS), starting in FY13, with mandatory funding. The FY14 payment is proposed at $278 million, a reduction of $68 million from FY12 levels. The USDA Forest Service has recently announced that funds already distributed under the most recent SRS extension or payments based on revenue generated in FY12 are subject to the FY13 sequester, and the agency will be requesting repayment of $17.9 million in SRS and “25 percent fund” payments that have already been disbursed. The National Governors Association, NACo and more than 50 members of Congress are pushing back against the White House Office of Management and Budget (OMB) and USDA over the legal authority of applying the sequestration cuts to FY12 SRS payments.

Water Loans Levels Drop Some More

The Environmental Protection Agency (EPA) receives $8.15 billion under the president’s FY14 budget numbers. This is a decrease of $348.1 million over FY13.

In what’s becoming a bad habit, the Clean Water State Revolving Funds (CWSRF) and Drinking Water State Revolving Funds (DWSRF) continue to decrease under the proposal. For FY14, the budget proposes $1.1 billion for CWSRF and $817 million for DWSRF. This is a decrease of $300 million and $56 million for each program, respectively. SRF programs provide water grants to eligible communities based on state water priority projects.

In the proposal, EPA stressed its increased focus on funding small, underserved communities for SRF funds.

Medicaid Mostly Spared

As predictable controversies swirl around the president’s proposals to slow the growth of Social Security and Medicare, cuts to Medicaid appear to be off the table. The budget documents for the Department of Health and Human Services (HHS) emphasize a commitment to implementing the Affordable Care Act (ACA) fully in 2014, including the expansion of Medicaid to non-elderly, childless adults with incomes below 133 percent of the federal poverty level. Keeping Medicaid stable may reassure skeptical states that the Medicaid expansion is not a “bait and switch.”

The budget does propose a few modest legislative proposals to trim the program, which would result in just over $22 million in savings. These include extending the ACA’s cuts to Medicaid disproportionate hospital share (DSH) payments into FY13. This is now a routine adjustment that prevents DSH payments from jumping back to pre-ACA levels at the end of the 10-year budget window, yielding a few billion dollars compared to current law.

The budget also asks Congress to delay the DSH cuts scheduled for 2014 to help states and county hospitals adjust to ACA implementation. The proposal calls for spreading the cuts out over 2016 and 2017 to maintain budget neutrality.

Transportation on Track

The budget proposes a total of $76.6 billion in discretionary and mandatory funding for U.S. Department of Transportation (DOT), an increase of 5.5 percent or $4 billion above FY12. Highway funding is consistent with the authorization levels contained in MAP-21 (the federal surface transportation act) with a $40.1 billion obligation level. Transit funding reflects the $10.9 billion authorization level contained in MAP-21: $8.59 billion for formula grants and $1.98 billion for capital grants.

The budget also proposes a new $50 billion “fix-it-first” initiative for immediate transportation investments, including $40 billion to improve existing infrastructure assets most in need of repair, $10 billion to help spur states and local innovation in infrastructure development and leveraging state, local, tribal and private funds, and a $2 billion competitive grant program that targets investment in roads, railways and runways. This is the fourth time the Administration has made a similar proposal.

Rural Business Programs Consolidated; Water-Wastewater Grants Chopped

The president’s budget increases overall budget authority for USDA Rural Development by 10 percent to $2.28 billion above the FY13 level. This increase returns the agency to a funding level slightly higher than the pre-sequester FY12 enacted level. However, most of the increase went to Salaries and Expenses ($58 million or 10 percent) and Rental Assistance Grants ($177 million or 21 percent), while Water and Waste Disposal Grants ($93 million or 23 percent) and Single Family Housing Direct Loans ($40 million or 80 percent) were targeted for major cuts.

The deep cut in the Water and Waste Disposal Grants will make rural water projects cost-prohibitive for some rural communities, and the shift towards a reliance on direct loans is unsustainable in the long run as interest rates will eventually rise, which will dramatically decrease the water infrastructure loan financing available through USDA.

The most significant rural development policy shift is the proposal to consolidate six of the agency’s rural business programs into the Rural Business and Cooperative Grant Program, funded at $55 million. This shift would eliminate the Rural Business Opportunity Grants, Rural Business Enterprise Grants and Rural Microenterprise Investment Program, which are three programs that counties and their public and nonprofit partners use in their economic development efforts.

The new program will provide the benefit of one streamlined application, a focus on regional priorities and $20 million in additional overall funding. However, NACo is concerned about public sector grantees being lumped into a program that will now directly serve individual producers, cooperatives, nonprofits and rural businesses as well through the authorities of the Rural Cooperative Development Grants, Grants to Assist Minority Producers and the Rural Community Development Initiative.

The budget no longer includes the Regional Innovation Initiative proposal, which NACo supports, and instead promises to concentrate on regional priorities through the new consolidated business program. NACo opposes the proposal to eliminate the Water-Wastewater and Community Facilities Guaranteed Loan Programs, High Cost Energy Grants and Economic Impact Initiative Grants.

A Virginia Circuit Court judge has ruled that the financing mechanism of the Elizabeth River Crossings project in the southeastern part of the state is unconstitutional, calling into question the future of the multi-billion dollar public-private partnership and other Virginia P3s.

Judge James A. Cales Jr. ruled from Portsmouth in Meeks v. Virginia Department of Transportation that the Virginia General Assembly went beyond its state constitutional authority in granting VDOT a free hand to set toll rates supporting backing the debt of the $2.1 billion tunnel under construction beneath the Elizabeth River between Norfolk and Portsmouth. The project is supported by $664 billion of private activity bonds and a $422 million federal loan under the Transportation Infrastructure Finance Innovation Act.

The tunnel, scheduled for completion in 2017, is intended to help clear congestion in one of the commonwealth’s major population centers, but a group of citizens brought the lawsuit last year after the project’s agreement with VDOT specified that drivers would begin paying tolls in January to use an existing tunnel. That revenue is being covered by VDOT in the interim. While area residents celebrated the decision, state leaders expressed disappointment. Virginia has become a national leader for P3s under Gov. Bob McDonnell, with the ERC project as the crown jewel.

Last month, the project was honored as the 2012 North America Toll Road Deal of the Year by Project Finance Magazine.

The private company formed for the project, Elizabeth River Crossings, LLC, is to operate and maintain the tunnel for 58 years under the terms of its agreement with VDOT. The company will also take point on several other major transportation projects in the area. McDonnell vowed to contest the circuit court’s decision.

“I am disappointed with the ruling made by Circuit Judge James A. Cales Jr. in Portsmouth today regarding the tolling for the critically needed Elizabeth River Crossings project, including the Midtown Tunnel, the Downtown Tunnels and the Martin Luther King Boulevard among other improvements,” McDonnell said following the decision. “The existing tunnels were built with toll revenues and tolls are needed again to build a second Midtown Tunnel and make other essential improvements for the sake of safety and efficient travel. The commonwealth will seek a stay and appeal the judge’s ruling to the Virginia Supreme Court because we believe the state’s position is legally correct through the Virginia Constitution and state code.”

Brian Gottstein, a spokesman for Virginia attorney general Ken Cuccinelli, said the decision could have grave implications for tolled projects all over the commonwealth.

“The revenues raised through the tunnel tolls were user fees to be used solely for a single transportation project,” Gottstein said. “As such, we still believe the tolls cannot be considered a tax and that it is completely within VDOT’s authority to set reasonable tolls to pay for the construction, operation, and maintenance of the project. Certainly, we are disappointed with the court’s decision. We expect to appeal. If this ruling stands and becomes the law of Virginia, it would threaten the commonwealth’s ability to use public-private partnerships to construct major transportation projects. Many tolled projects could require legislative approval before proceeding, which would mean significantly increased costs and construction delays.”

Scott Zuchorski, who rates the project’s debt for Fitch Ratings, said it is not yet clear what the decision will mean for the project and its rating. Fitch and Standard & Poor’s have both rated the project’s debt BBB-minus, and the PAB deal came to market in April 2012 with yields ranging from 4.45% with a 4.25% coupon in 2022 to 5.5% priced at par in 2042. That was “slightly below expectations,” according to a Fitch report.

“At this point we’ll obviously continue to monitor it,” Zuchorski said, adding that under the concession agreement VDOT would shoulder the burden to pay the bondholders.

“We think VDOT would be on the hook to pay off the ERC debt,” Zuchorski said.

A panel of three judges would need to approve the appeal before it could go before the seven justices of the Virginia Supreme Court.

Kyle Glazier

The Bond Buyer

When Laurence Gottlieb pitches his private-equity fund to investors, he says they often ask the same question: “What is going to happen if you buy a nursing home and kick granny out on the street?”

His answer: “That’s not our business.”

Investing in distressed municipal debt is a rough-and-tumble game. Fundamental Advisors LP, where Mr. Gottlieb is chairman and chief executive, is one of the biggest and best-known investors in the business.

Fundamental has bought debt in senior-care facilities, college dorms and the sewer system of bankrupt Jefferson County, Ala. Last month, the firm finished raising a $450 million investment fund that includes money from pension funds and other big investors.

The 44-year-old Mr. Gottlieb, a former municipal proprietary trader at Citigroup Inc., says Fundamental eschews the “sharklike private-equity model” that buys up targets, siphons off cash and makes few improvements. To succeed, Mr. Gottlieb must often convince political officials that a deal will benefit the greater good, not just Fundamental’s bottom line. “We don’t pave paradise to put up a parking lot,” he says.

The strategy is being put to work in Memphis, Tenn., where Fundamental bought $58 million in municipal bonds on a downtown baseball stadium for about 42 cents on the dollar in late 2010.

More than a third of pest-management companies in the U.S. were called in by hospitals in 2012 to exterminate bedbugs, according to a new survey by the National Pest Management Association. MarketWatch’s Jim Jelter reports.

Park’s owner defaulted on the bonds when ticket, food and beer sales didn’t live up to expectations. After essentially taking financial control of the ballpark, Fundamental spent $2 million on an upgraded scoreboard, improved seating and other efforts to make the park more family friendly. Attendance rose.

The private-equity firm now is helping lead talks to sell the park and the team. One proposed deal would involve an investor group led by the St. Louis Cardinals buying the minor-league Memphis Redbirds from their nonprofit owner.

The other piece of the proposed deal could involve the city borrowing money to buy the stadium from the nonprofit group. The proceeds of the deal would be used to pay off Fundamental.

To pay for the new bonds, Memphis would collect sales taxes from the stadium and lease payments from the Cardinals.

Not everyone is sold on the idea. “I can’t support the city getting in further debt or issuing bonds to buy a stadium when we could issue debt to rebuild our roads,” said Harold Collins, a member of the Memphis City Council. Other city and team officials say residents have an interest in preserving the stadium because it is a vital part of downtown Memphis and generates jobs. Fundamental has assured city officials that the deal won’t result in additional costs for taxpayers.

If the deal goes through, the firm is targeting a return on its distressed-debt purchase in Memphis in the 15%-to-20% range that is typical of its private-equity deals.

Representatives from California and two other states introduced a bill in Congress on Thursday that would strip states and cities of their right to issue tax-exempt bonds unless they first disclosed the true cost of their pension plans and whether they could pay it.

The measure seeks to prevent more municipal bankruptcies like the one in Stockton, Calif., where the city has defaulted on hundreds of millions of dollars’ worth of municipal bonds but continues to pay hundreds of millions of dollars more in pension costs.

A debate is now raging in that bankruptcy over which of the two debts has legal priority. The question has far-reaching implications both for labor relations and the building of public works, and many experts expect the Supreme Court to have the final say.

Sponsors of the disclosure bill, all Republicans, said Stockton and other distressed cities would not be in such deep trouble — and their workers, residents and bondholders exposed to such painful losses — if they had been keeping accurate track of what they promised to their retirees all along.

Sponsors said they wanted to send a signal that no matter what else happened, the federal government would not bail out states, cities or other governments that promised more than they could deliver.

“The costs of public pension funds are driving an increasing number of states and municipalities toward insolvency,” said a sponsor of the bill, Representative Devin Nunes, a California Republican whose district includes Fresno and other inland cities that are still struggling to recover from the housing bust and the Great Recession.

Another sponsor, Darrell Issa, also a California Republican, said he thought that because pension costs were essentially hidden, state and local officials could “pander to both public employees and taxpayers” by racking up huge promises that local taxpayers would never agree to if they understood the cost.

“The key to addressing this problem is shining a light on the financial health of pension systems and making clear that federal taxpayers will not pick up the bill for reckless mismanagement,” said Mr. Issa, whose district includes prosperous communities in San Diego County, which has had pension trouble, and Orange County, which declared bankruptcy in 1994 after its aggressive investments soured.

Other sponsors were Paul Ryan of Wisconsin, chairman of the House Budget Committee, and Senator Richard Burr of North Carolina. He said he would introduce the Senate version of the bill in a few days.

The bill would not require governments to change the type of benefits they offered workers, or to invest their retirement money in any particular way. The federal government has little or no power to direct such decisions by states and cities because of state sovereignty provisions in the Constitution.

A similar bill was introduced in 2011, and while it picked up sponsors from both parties, it drew withering opposition from public employees’ unions, who viewed it as an attack on public workers. They argued the bill was a deliberate effort to make pensions look exorbitant, to stoke taxpayer anger and resentment, and heighten the pressure on states and cities to switch to 401(k) plans.

“The federal government does not need to intervene in this issue,” said Iris J. Lav of the Center on Budget and Policy Priorities, a policy research group based in Washington, at a hearing on the previous bill before the House Ways and Means Subcommittee on Oversight. “States should be able to gradually solve their underfunding problems with the steps they are already taking,” like requiring bigger contributions from both workers and governments.

In the new bill, the method for calculating pension costs has been changed so that it closely resembles the one that actuaries already use under certain circumstances. The big bellwether California state pension system, known as Calpers, already uses such a method to calculate a local government’s final bill when it drops out of the system, for example.

This time, the bill may also gain momentum from the changing circumstances — Stockton’s pension fight is out in the open, for instance, and certain other cities, like Detroit, are clearly struggling more than ever with retirement benefit costs. Federal regulators recently accused Illinois of securities fraud for issuing what they said was misleading information about its pension system.

Perhaps most important, in Washington the search is on for ways to reduce the federal deficit. The tax exemption for municipal bonds costs the Treasury more than $30 billion a year in forgone revenue, and fiscal experts say municipalities are at greater risk of losing it now than since the Great Depression. The Obama administration has repeatedly proposed capping it. So did Mitt Romney during the last presidential campaign.

The new bill would not use the tax exemption so much to narrow the federal deficit as to force municipalities into giving the world an unvarnished look at their pension plans. Until now, the accounting rules have permitted governments to factor in actuarial assumptions and smoothing techniques that greatly lowballed the benefits’ cost.

In some cases, local governments could even say their workers’ benefits were free. The Governmental Accounting Standards Board recently tightened the rules, but many economists say the revisions do not go far enough.

Moody’s Investors Service, for one, has said it will not use the numbers that states and cities disclose in rating municipal bond offerings without first adjusting them. On Wednesday, Moody’s said it had started making the adjustments, and had put Chicago, Cincinnati, Minneapolis, Portland, Ore., and 25 other local governments and school districts on review for possible downgrades as a result.

“The manner in which these obligations are reported varies widely, and we believe the liabilities are underreported from a balance sheet perspective,” said Timothy Blake, a managing director at the ratings firm.

City and state officials generally remain hostile to the idea of so-called fair value pension disclosures. But they also cherish their ability to raise money at low cost with tax-exempt bonds and would probably make the disclosures if that were the only way to keep the tax exemption.

A controversial proposal to get local government officials to condemn distressed mortgages – in the same way they might condemn a dangerous property – is slowly gaining traction in some California communities, several months after it appeared the idea had been killed.

After months of contentious debate, officials in San Bernardino County, in January killed the idea of seizing troubled home loans in a process known as eminent domain. They rejected the idea after fierce opposition from Wall Street trade associations and investors in mortgage-backed securities.

But since then, San Francisco-based Mortgage Resolution Partners (MRP) has signed advisory agreements with five California towns that permit the financier-backed group to begin negotiating a sharp reduction in the dollar value of distressed loans that are held in securities administered by banks and mortgage servicing firms.

MRP’s strategy is to either achieve a voluntary agreement with servicers and banks to reduce the principal owed on loans that are valued at prices higher than the homes are worth, or use the club of eminent domain to forcibly seize the loans and restructure them at a lower price.

MRP, which earns a $4,500 fee for every loan that is restructured, argues the threat of eminent domain gives municipalities, hard-hit by the housing crisis, an opportunity to help cash-strapped homeowners struggling to pay their mortgages.

But Wall Street trade groups like the Securities Industry and Financial Markets Association and the Association of Mortgage Investors argue that forcibly condemning home loans and rewriting them is a violation of contractual agreements between a bank and a borrower.

“This type of government intervention is only going to harm the housing market,” said Chris Katopis, executive director of the Association of Mortgage Investors, which represents a group of about two dozen, private bond investors. “This is not a fair and equitable solution.”

Chris Killian, a SIFMA managing director, said the MRP plan forces “investors to lock in a loss on a loan” by reducing the mortgage value, even if the borrower is still making payments.

MRP’s most recent advisory agreement was signed on April 2 with the city of Richmond, Calif., according to public records and MRPs marketing materials reviewed by Reuters. Other California communities that have signed similar agreements with Mortgage Resolution Partners are El Monte, La Puente, San Joaquin and Orange Cove.

The group is also negotiating with officials in North Las Vegas, Nevada a community of 227,000 people that was particularly hard hit by the housing bust. In North Las Vegas, MRP has identified at least 4,700 underwater home loans, mortgages that are for more than the homes are currently worth, that could qualify under its plan.

The revival of eminent domain as a strategy for restructuring distressed mortgages comes as the U.S. housing market is showing signs of revival. But according to CoreLogic there are still an estimated 10.4 million U.S. homeowners who are underwater on their mortgages.

“It’s not a panacea to deal with the broad issue of foreclosure, but it is another tool that could be potentially effective,” said Bill Lindsay, the manager for Richmond, California, a city of 105,000 people.

The loans MRP seeks to restructure are those packaged into securities sold by Wall Street banks before the financial crisis. These private label mortgage securities do not carry a government guarantee of principal repayment, which distinguishes them from mortgage debt issued by government-sponsored mortgage firms Fannie Mae or Freddie Mac.

Loans in private label bonds are not eligible for most federal government mortgage modification programs.

Last year, private label mortgage bonds returned 21 percent, making it one of the top performing assets for bond investors, according to Amherst Securities Group. The bonds rose in value in response to the Federal Reserve’s decision to buy $40 billion in government-guaranteed mortgage debt each month and an improvement in the performance of some of loans.

Traditionally, local governments have used eminent domain to condemn blighted properties or seize land for public works projects. Wall Street trade groups have warned communities that using eminent domain to seize mortgages could spark litigation and cause lenders to be wary about writing mortgages in certain towns.

MRP, in its marketing documents, has said it has investors willing to finance the cost of condemnation so the municipalities do not have to spend any money seizing mortgages. The group has not publicly identified its financial backers.

By Matthew Goldstein

Minneapolis-based Piper Jaffray announced Wednesday that it is buying Seattle-Northwest Securities Corporation in a deal worth around $21 million.

The acquisition is subject to approval by Seattle-Northwest’s shareholders, as well as regulatory approvals and customary closing conditions. It is expected to close in the second half of 2013.

Upon closing, the tangible book value of Seattle-Northwest is estimated to be $13 million.

“Joining forces with Piper Jaffray will allow us to build on Seattle-Northwest’s strength and reputation in the Pacific Northwest,” said Karl Leaverton, chief executive officer and president of Seattle-Northwest. “We believe there is a strong cultural fit between our firms, and our employees and clients will benefit from Piper Jaffray’s specialized products, deep inventory and strong capital base.”

Founded in 1970, Seattle-Northwest is a public finance firm in the Northwest region that specializes in underwriting municipal securities. Piper Jaffray said the two firms have minimal geographic business overlap, and the combination will strengthen its public finance leadership in serving the middle market.

“We have known and respected Seattle-Northwest for many years,” said Andrew Duff, chairman and chief executive officer of Piper Jaffray. “A key part of our firm’s strategy is investing in our public finance business, and this represents a significant step forward in developing a national franchise for our business.”

Piper Jaffray is an investment bank and asset management firm founded in 1895. The firm was the tenth ranked underwriter of long-term municipal bonds by volume in 2012, according to Thomson Reuters data. Last year, Piper Jaffray worked on 568 issues totaling $9.3 billion.

With the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, individuals providing certain types of advice to muni issuers became regulated as “municipal advisors.”

Although all of the rules have yet to be proposed or implemented, there are laws and regulations currently in existence with which municipal advisors, or MAs, must comply, including those relating to fiduciary duty and fair dealing.

Nevertheless, some market participants have stated on numerous occasions that muni advisors are still totally unregulated, and have urged that the regulation of MAs be implemented as quickly as possible.

While the National Association of Independent Public Finance Advisors disagrees with these participants’ statements that municipal advisors are wholly unregulated, NAIPFA does agree that the Securities and Exchange Commission’s MA rulemaking should be completed as soon as possible to allow for further development of Municipal Security Rulemaking Board rules.

Therefore, we were surprised to learn that the bill referred to as the Dold Amendment was reintroduced in the current congressional session by Rep. Steve Stivers, R-Ohio.

The bill has the support of a number of those market participants who have and will continue to advocate for the quick implementation of Municipal Advisor rules.

Yet, this position seems contradictory in light of the SEC’s statements indicating that if such a bill were to be enacted its rulemaking undertakings could be delayed by as much as two years.

NAIPFA believes that the Dodd-Frank Act got it right by clearly delineating the roles of certain municipal market participants, particularly the roles of municipal advisors and underwriters.

These roles had been blurred for too long as a result of underwriters having provided advice to issuers within the scope of their underwriting engagement that was identical to that which was provided by financial advisors (i.e. municipal advisors), with the only distinction being that underwriters lacked corresponding fiduciary duties for such services.

As a result, muni issuers began to rely on their underwriters to provide advice that was perceived to have been given with the issuer’s best interests in mind.

Notably, even previous to the passage of the Dodd-Frank Act, the Government Financial Officers Association officially recognized that financial advisors owed duties to their clients that underwriters did not.

As such, GFOA went so far as to recommend the engagement of financial advisors in its best practices guide for municipal issuers.

But unlike the Dodd-Frank Act, the Stivers bill will allow underwriters to continue their long-standing business practices to the detriment of municipal issuers as well as taxpayers and ratepayers. In this regard, the proposed bill contains two provisions that are of particular concern.

First, the Stivers bill requires an individual to receive compensation for certain types of advice in order to be considered a municipal advisor.

Nevertheless, advice without compensation is still advice. What’s more, this measure, if it is enacted, will likely result in the eradication of substantial portions of the issuer protections put in place by the MA provisions of the Dodd-Frank Act.

Individuals who otherwise would have sought to receive compensation for providing advice as an issuer’s MA will simply stop seeking compensation for their advisory services in order to avoid regulation, and will instead seek to mask their advisory activities by receiving compensation for non-advisory related services.

Our concern in this regard is not limited to merely underwriters, but also attorneys, engineers, nonprofit organizations and any other individual who wishes to avoid regulation as a municipal advisor.

Second, the Stivers bill allows broker-dealers to provide advice “in connection with” their role as underwriter. This provision will allow broker-dealers serving as underwriters to provide advice on virtually every aspect of the financing, including with respect to the structure, timing, terms and other similar matters related to municipal securities issuance (municipal advisory services), but without owing a corresponding fiduciary duty to the issuer.

The Stivers bill purports to be a clarification of the regulation of municipal advisors. But in light of the foregoing it seems that this effort by Rep. Stivers with the support of the underwriting community to define MAs – not by the services they provide, but by whether they receive compensation for them – will instead undermine the original intent of Dodd-Frank’s municipal advisor provisions.

We do believe, however, that broker-dealers should be allowed to discuss matters with issuers that are related to the transaction and that are within the scope of their underwriting role as a purchaser and distributor of securities.

Nevertheless, broker-dealers that provide muni advisory services, regardless of the title they utilize, do have a conflict of interest and should not be allowed to provide them without obtaining fiduciary duties and triggering the corresponding prohibition on underwriting the issuer’s securities, by simply not receiving compensation for such services.

While some market participants may reminisce about their pre-Dodd-Frank business practices, unfortunately it is some of those very practices that led to the enactment of Dodd-Frank’s municipal issuer protections. It is time to move forward.

The role of the municipal advisor and underwriter are distinct, and the definition corresponding to each must be clear. Issuers must be able to distinguish between those individuals whose role is to provide advice and those whose role is to purchase and distribute securities.

It is our fear that Dodd-Frank’s accomplishments in this regard will be undone by the enactment of the Stivers bill.

We believe that the SEC understands the concerns of market participants and that it is fully capable of addressing these concerns.

Conversely, the Stivers bill takes the wrong approach to addressing the markets’ concerns and will simply allow certain market participants to return to the business practices that contributed to the worst financial crisis since the Great Depression.

Therefore, the SEC must be allowed the opportunity to develop and release a rule clarifying the definition of muni advisor prior to any legislative action that will only further delay the rulemaking process and undermine Dodd-Frank’s municipal issuer protections.

Jeanine Rodgers Caruso is president of the

National Association of Independent Public Finance Advisors.

The National Federation of Municipal Analysts (“NFMA”) announced today that it has submitted an amicus curiae brief (the “Brief”) with the Superior Court of California, County of Sacramento (the “Court”) in support of the Complaint and Writ of Mandate of Syncora Guarantee Inc. and Syncora Capital Assurance Inc. (“Syncora”).

The NFMA rarely files amicus briefs, and almost never at the trial court stage. However, the NFMA Board felt strongly that an exception should be made in this case given that the matter before the Court has such far-reaching ramifications for the municipal bond market generally. The Brief alerts the Court to the significant negative ramifications to the municipal market that can result from the passage of any law authorizing the elimination of existing bondholder protections, as exemplified by sections 34182(d), 34174, 34177(d), 34183(a)(4) and 34188 of the California Health and Safety Code, which were recently added to the California Health and Safety Code by Assembly Bill x1 26 (“AB26”) and Assembly Bill 1484 (“AB1484” and together with AB26, the “RDA Legislation”).

The dispute before the Court involves a challenge by Syncora to the RDA Legislation. While the NFMA takes no position generally regarding the dissolution of California’s redevelopment authorities, the NFMA argues in its Brief that the RDA Legislation has caused significant and unwarranted marketplace uncertainties and complexities which have already rippled through the marketplace, including across the board rating downgrades, rating withdrawals and constrained liquidity and may, if not clarified by the Court, fundamentally change market expectations nationwide with respect to certain previously irrevocable protections, rights and privileges.

The NFMA asserts in its Brief that the RDA Legislation is a textbook example of the type of change in security that undermines credit analysis and weakens the confidence that investors have in their understanding of the marketplace. The RDA Legislation seeks to unwind not only redevelopment agencies, but the layers of protection granted to bondholders, including a pledge of tax revenues, debt service coverage through excess revenues, exercisable remedies, and continuing disclosure.

“The NFMA is deeply concerned by the troubling precedent set when any state retroactively seeks to restructure, redistribute, and recast existing bondholder protections and covenants and the NFMA believes that it is important for the Court to understand the far-reaching significance of such actions which negatively impact the foundation of municipal finance nationwide” said Jeff Burger, NFMA Chairman.

The full brief can be found at:

http://www.nfma.org/assets/documents/position.stmt/ip.amicus.brief.ca.rda.4.13.pdf

While Orrick Herrington & Sutcliffe LLP retained its longstanding number one spot among law firms, little else remained the same among rankings during the first quarter of 2013.

Squire Sanders jumped to the number two spot from fourth place during the first quarter last year, working on 51 issues that totaled $5 billion, according to Thomson Reuters data. The firm also took second place behind Orrick in the negotiated-only issue category. Squire Sanders worked on $4.4 billion of negotiated deals and $608 million of competitive deals.

Hawkins Delafield & Wood LLP saw a strong first quarter, climbing up in rankings across the board. The firm jumped five spots from the first quarter last year to take third place for all issues, working on 80 deals, totaling $3.7 billion. Hawkins jumped to fourth place from seventh among negotiated deals, seventh from 28th among competitive deals, and to first from second among underwriter’s counsel.

Fulbright & Jaworski LLP jumped one spot to fourth place, with 94 issues totaling $3.6 billion. The firm came in third among bond counsel for negotiated issues, and sixth among underwriter’s counsel.

No firm came close to Orrick Herrington, however, which worked on 79 issues worth $9.7 billion this year. About $8.8 billion of that total were negotiated deals, the largest amount in the category. The firm took third place among competitive issues with $956.6 million, fourth place among underwriter’s counsel with $2.5 billion, and first place among disclosure counsel with $5.3 billion.

“We’re very proud that so many public entities, and so many of them repeatedly, choose us as their bond counsel,” said Roger Davis, partner and chair of the public finance department. “We think that reflects the quality and responsiveness of our legal services.”

Orrick, which was founded in San Francisco in 1863, had a 12% market share for the quarter – nearly twice the amount of the 6.2% market share of runner-up Squire Sanders.

“We work across every type of bond issue and across a broad geographic span as well, so there’s quite a lot of diversity, and that contributes to the consistency of our ranking,” Davis said.

The largest jump to a spot among the top 10 came from McCarter & English LLP, which jumped from 47th place last year, to fifth place this year.

“McCarter & English has been active in the public finance space for more than 30 years and we have continued to expand our bond counsel, as well as our other counsel roles in the area of public finance,” said Barbara Kroncke, partner and practice group leader for the public finance group.

The Newark, N.J.-based law firm worked on eight issues totaling $3.1 billion during the first quarter, with a 3.8% market share. Last year, the firm worked on four issues totaling $372.1 million in the first quarter. McCarter & English also took fifth place among negotiated issues with a 4.1% market share totaling $2.6 billion.

“We have attracted a growing array of clients over the years,” Kroncke said. “We’re fortunate that some of those clients were active during the first quarter.”

McCarter & English worked on the second largest deal of the first quarter  – a $2.3 billion refunding deal for the New Jersey Economic Development Authority in January.

Among trustees, the Bank of New York Mellon retained its number one spot, participating in 160 issues totaling $16.6 billion for the first quarter. US Bank worked on 170 issues – slightly more than BNY Mellon – but had a lower par amount at $12.8 billion.

The bond insurance industry continued its steady decline as the total principal amount of bonds insured dropped to $2.1 billion during the first quarter from $3.3 billion during the fourth quarter of 2012, and $3.7 billion during the first quarter of 2012. Bond insurers were responsible for wrapping 2.6% of the overall municipal market during the quarter, compared to 4.6% during the beginning of last year.

Assured Guaranty Municipal Corp., which has been responsible for almost all of the new issues insured in the past few years, saw its market share decline to 54.9% from 99.4% during the fourth quarter of 2012, and from 100% during the first quarter of 2012.

Assured said that the low interest rate and tight credit spreads are the main factors limiting insured market penetration.

“We have seen some investors willing to give up the additional safety of insurance in an effort to pick up every basis point of yield,” said Robert Tucker, managing director of investor relations and corporate communications at Assured. “As interest rates increase and spreads widen, we expect to see an increase in the demand for insurance.”

Another factor affecting business during the first quarter was the “natural market dislocation that occurs leading up to and just after a rating action,” Tucker said. “We’ve observed that, following a rating action, the market needs time to adjust — it seems like that has now occurred.”

The bond insurer had been on review for downgrade from Moody’s Investors Service for much of 2012, finally receiving a multi-notch drop to A2 from Aa3 in January.

Still, Assured remained the market leader, working on 129 issues totaling $1.2 billion in principal amount. The company also issued 148 policies totaling $214 million of par in the secondary market, according to Assured.

Build America Mutual Assurance Company saw a major uptick in business during the first quarter, insuring a total of 131 issues, worth $856.7 million. That amounted to a 40.1% market share for the quarter.

After it launched in July 2012, BAM insured one deal during the third quarter of 2012. During the fourth quarter, it insured 3 deals, which totaled $18.7 million for a 0.6% market share.

“We were particularly gratified that our market share of insured new issues grew substantially over the quarter, from 20% in January to 53% in February and March, and we continue to see inquiry from a variety of newly licensed states where BAM is now qualified to do business,” said Seán McCarthy, co-founder of BAM.

In the letter-of-credit business, JP Morgan Chase was the top provider by principal amount, with two issues, totaling $189.1 million. Wells Fargo Bank and Citibank followed closely behind.

Among guarantors, the Texas Permanent School Fund was again ranked first, with 103 issues totaling $2.3 billion.

The Bond Buyer.

U.S. regulators are probing whether securities firms are circumventing rules implemented in the wake of the financial crisis to protect municipalities against potentially biased investment advice, according to people familiar with regulators’ efforts.

At issue is whether banks are attempting to skirt postcrisis rules, including those restricting firms that provide financial advice to municipalities from underwriting certain municipal-bond transactions. Lawmakers and regulators implemented the changes to avoid situations similar to those leading up to the crisis in which some municipalities were steered into risky and complex deals municipal officials didn’t fully understand.

The 2010 Dodd-Frank law stipulates banks hired as financial advisers act as fiduciaries, or in their clients’ best interests. Regulators have also restricted banks from underwriting a municipal-bond transaction if they were initially hired to advise on the deal. Yet the Securities and Exchange Commission is concerned banks may be mischaracterizing their role in order to preserve their ability to underwrite bonds, according to the people familiar with regulators’ efforts.

The SEC is investigating several municipal contracts entered into by banks, including Goldman Sachs Group Inc., Piper Jaffray Cos., Robert W. Baird & Co. and Stifel Financial Corp.  Spokesmen for Piper and Stifel declined to comment. A spokeswoman for Baird didn’t respond to requests for comment.

The SEC is scrutinizing a February contract between Goldman and a St. Louis stadium authority, according to the people familiar with regulators’ efforts. Worried about losing the St. Louis Rams, the city’s National Football League franchise, local officials hired Goldman to analyze a range of financing options to upgrade the Edward Jones Dome and keep the team in the 18-year-old stadium. The options include a bond deal to finance contractually required upgrades.

Goldman’s $20,000-a-month contract as “financial advisor” to the St. Louis Regional Convention and Sports Complex Authority says the bank isn’t providing “advice” – just information to senior officials at the authority. The bank says it may seek to underwrite the authority’s bonds should the agency issue debt in the future.

James Shrewsbury, chairman of the stadium authority, said the agency hired Goldman at the request of Missouri Gov. Jay Nixon, who can appoint five of the authority’s 11 members, including its chairman. Mr. Shrewsbury said the stadium authority is trying to get the best advice on how to keep the Rams in the dome. The team’s contract to play in the stadium expires in 2015. “Right now, they are not underwriting any bonds,” he said of Goldman.

A spokesman for Gov. Nixon wasn’t immediately available for comment on the contract.

A person familiar with the contract said the firm was hired on a broad assignment that is still in its early stages, and that there is currently no plan to sell municipal bonds for the stadium. Still, regulators are concerned the firm is calling itself an adviser and then disclaiming responsibility to act as a fiduciary, according to the two people familiar with regulators’ efforts. Regulators are also concerned, according to these people, that the firm would have a say in how to structure a bond deal while setting itself up to underwrite the bonds, which is the type of role-switching regulators have tried to quash.

Previously, banks serving as financial advisers could switch roles provided they obtained their client’s consent and after disclosing that conflicts may exist. Regulators began to crack down on “role switching” in the $4 trillion municipal-bond market in 2010 at the behest of former SEC Chairman Mary Schapiro, who described the practice as a “classic example of a conflict of interest.” Unlike financial advisers, who act in the best interests of their clients, underwriters enter into an “arm’s length” relationship when they underwrite municipal debt. Supporters of the ban warn many municipal borrowers aren’t sophisticated enough to understand the distinction. Ms. Schapiro pushed the Municipal Securities Rulemaking Board, which sets the role-switching rule, to tighten the measure.

John Cross, director of the SEC’s municipal-securities office, said in a statement that the agency is generally concerned about investment banks’ compliance with role-switching restrictions and that municipalities receive conflict-free advice. He declined to comment on a specific company or its services.

Regulators also are scrutinizing “general consulting services” agreements, in which brokerage firms seek to sidestep the role-switching restrictions by providing “general” financial advice that isn’t tied to a specific bond transaction. In one such agreement between Monroe County, Wis., and regional bank Robert W. Baird, the firm said it will provide advice based on the county’s financing needs but warns it isn’t working in the capacity of a financial adviser or underwriter. Still, the firm leaves the door open to being hired in those roles in the future.

U.S. Conference of Mayors (USCM) announced last fall its new USCM Retirement Programs (Program) with Great-West Financial®. This new program brings, for the first time, widespread fee savings and transparency to cities and municipal entities of all sizes in the 457(b) deferred compensation market, coupled with a best- in-class plan design.

Because of this overhaul, the Program was nominated for Plan Sponsor Magazine’s prestigious Plan Sponsor of the Year Award. The Program came in as a finalist in the Public Defined Contribution category. As Conference CEO and Executive Director Tom Cochran explained, “We knew this Program would cause a ripple effect through the marketplace, and we are honored that Plan Sponsor has recognized this effort just 5 months into the Program.”

While other 457(b) programs have begun to follow the Program’s example by dropping fees and adding new resources to help municipalities meet their fiduciary duties, the Program acts as a benchmark for current best practices.

These best practices include:

• No Administrative Fees for Plans With $500,000 or More in Total Assets – An employee paying administrative fees
• of 0.65% to 0.95% pays an extra $50,000 to $70,000 over a 30-year savings period1.
• Fee Transparency – It is critically important for administrators and participants to understand exactly how their fees relate to the service and support they receive. Great-West Financial is ranked 2nd among the industry’s top 20 record keepers/administrators on fee transparency, according to DALBAR’s November 2012 Perspective on Fee Transparency whitepaper.
• Performance – The Program offers a rich lineup of investment options with the performance potential to improve employees’ retirement readiness. The variety of innovative solutions will allow employees to create diversified portfolios for potentially better performance. The Conference monitors the Program to ensure it remains by all accounts “best in class.”
• Education – Employee education is a high priority and offers a multi-channel, behavior-based approach to education that fits the needs of a wide range of employees with different learning styles.
• Fiduciary Support – The Program offers plan sponsor training about fiduciary matters and legislative updates both in person and by Web. The Program also includes the offering of plan documents, investment policy statements, outsourcing services, and a new fiduciary warranty provided by Great-West Financial.
• Service – The Program is committed to streamlining the workload of the city or municipality, including the sharing of plan administration, retirement plan best practices, and support in addressing fiduciary responsibilities at no cost.

A reduction of Stockton’s obligations to the California Employees’ Retirement System debts in the city’s bankruptcy reorganization would have major ramifications for bondholders as well as California municipalities, Moody’s Investors Service said in a report Wednesday.

Such an outcome if far from certain, but would set an important precedent, Moody’s said.

San Bernardino, Calif., in bankruptcy proceedings, has hired Orange County-based Urban Futures on a contract basis in lieu of hiring a finance director and filling other vacant finance department positions.

The number and scope of investment projects will decrease for state and local governments if a federal limit is placed on tax-exemption for municipal bonds, the National League of Cities warned in a survey released Thursday.

The U.S. Securities and Exchange Commission will force state and local government bond underwriters to disclose more information about donations to election campaigns supporting new debt sales.

Banks will be required to report the timing of their contributions to such campaigns, any work done on behalf of the effort and whether they won underwriting work on resulting bond issues passed by voters. On March 28, the SEC approved the mandates, proposed by the Municipal Securities Rulemaking Board last year.

http://www.bloomberg.com/news/2013-04-01/sec-backs-rule-to-force-bank-disclosures-on-muni-bond-campaigns.html

When reviewing a new client’s portfolio, I am often told that my recommendations need to include keeping the client’s municipal-bond manager, as they are earning over 4% tax-free. By comparison, the Vanguard Intermediate-Term Tax-Exempt Fund’s Admiral shares are earning only 1.64%.

To the client, it appears the manager is earning his fee by tripling the return, but appearances can be deceiving.

The illusion that one is earning this return can be illustrated by taking a look at one particular bond held by one of my clients: a California State Public Lease Revenue bond paying a handsome 4.5% coupon. It matures in just under four years, and the manager recently bought the bond at $112, or a 12% premium to the par value. The statement showed the bond yielding 4%, which is calculated by taking the $4.50 annual payment per $100 par and dividing by the $112 purchase price.

Still not too shabby.

Unfortunately, for those buying the bond at a premium, bonds mature at par. This means the investor gets back only $100 for every $112 invested. Simply put, the investor is losing $12 over the remaining four-year life of this muni, or roughly $3.00 per year – 2.7% of the initial investment.  So now the 4% yield is reduced to 1.3% after taking into account what is known as the “amortization” of the premium.

We’re not done yet. The manager charges this investor 1% annually for holding this and every other bond, reducing the 1.3% to a measly 0.3% annualized return. That’s what this investor will net by holding this bond until maturity.

Suddenly, the 1.64% yield of the low-cost diversified muni-bond fund is looking pretty good compared to the 0.3% this investor is netting after buying the bond at a hefty premium and paying a manager 1%.

The numbers in this example are a bit overly simplified to illustrate the point. The more-precise numbers are actually a bit worse for this investor. It’s also important to note that this illusion is just as prevalent and valid for taxable bonds as well.

That’s why I like low-cost diversified bond funds. Investors end up with a higher actual yield, much more diversification and higher liquidity as well. You just have to give up the illusion.

California on Tuesday had little trouble selling $380 million in municipal bonds backed by revenue from tobacco companies, even as litigation deepens over a payment dispute related to the companies’ lost market share.

Taking advantage of low interest rates, the Golden State Tobacco Securitization Corp. will use proceeds from the sale to refinance a portion of about $3.1 billion of tobacco bonds issued in 2005. On Tuesday, a 2030 bond was initially offered with a yield of 3.78%, but California lowered it to 3.70% later in the day, reflecting good demand from investors. Bond prices move inversely to yields.

The bonds will be backed by payments from tobacco companies, including Philip Morris USA Inc., Reynolds American Inc. RAI +1.15% and Lorillard Tobacco Co., LO +0.86% to the Golden State under a 1998 settlement agreement. That agreement resolved health-related claims by 46 states against the tobacco companies, and payments are based on annual cigarette shipments in the U.S. Many other states have also sold bonds backed by the tobacco payments.

Tobacco bonds, however, have run into some trouble in recent years. Cigarette consumption declined faster than expected in the wake of the recession, and last summer, Moody’s Investors Service MCO +1.09% said it expected about three-quarters of the tobacco bonds it rates to default should consumption continue to decline 3% to 4% annually. New tobacco bond sales recently have built in a bigger buffer, with larger annual declines needed before the bonds default.

Still, with extra risk comes extra yield, and that has attracted some investors to tobacco bonds at a time of low interest rates. The S&P Municipal Bond Tobacco Index has returned 2.15% so far this year, compared with the broader S&P Municipal Bond Index, which has returned only 0.61%.

California’s bond deal Tuesday is considered more secure than other tobacco bonds because it also carries an “appropriation pledge” from the state, meaning California promises to put money in its budget to pay the bonds back if tobacco revenue isn’t enough. The tobacco bond deal was rated A2 by Moody’s, single-A-minus by Standard & Poor’s Ratings Services and triple-B-plus by Fitch Ratings.

As a result, the price of the California tobacco deal is more closely tied to California state bond prices in general. State bonds have generally increased in value relative to the rest of the market after voters approved tax increases in November; though the bonds took a hit last month when the state brought a $2.5 billion deal to market.

Initial pricing Tuesday had the California tobacco bonds offering about 40 basis points, or hundredths of a percentage point, in extra yield compared with regular California state bonds. Michael Schroeder, chief investment officer at Wasmer Schroeder & Co., said that seemed fair. Typically, he said he would expect California tobacco bonds with the appropriation pledge to trade with between 25 to 50 basis points of extra yield over state bonds.

“We’ll probably focus on it for our California portfolios,” said Mr. Schroeder, whose firm oversees $3.5 billion in municipal bonds, adding that it is cheap enough to consider for non-California accounts as well.

Bill Black, who helps manage the $7.2 billion Invesco High Yield Municipal Fund, said the fund would likely skip the California deal because yields were too low. But he said the fund added some tobacco debt to its portfolio last year, noting that a December agreement between some states and the tobacco companies over a disputed portion of the payments is generally positive for the bonds. The dispute centered on a provision in the original agreement that allowed the tobacco companies to reduce their payments if they lost market share and certain other conditions were met.

Under the accord reached in December, the 17 states and two territories signing on will get 54% of their share of the money in dispute. At least one state, however, has moved to derail the agreement: Colorado filed a motion in state court to vacate the settlement, according to bond documents.

“What’s fun about tobacco bonds is it’s a never-ending story,” said Mr. Black, adding that he expected the settlement will ultimately go into effect. “You’re always looking for the next thing to try and figure out what’s going on.”

California’s tobacco deal follows a $170 million tobacco-refinancing issue from South Dakota’s Educational Enhancement Funding Corp. earlier this year. Louisiana is also looking into refinancing more than $800 million in outstanding tobacco debt.

The federal government, through laws and regulations, sometimes imposes requirements—known as federal mandates—on state, local, and tribal governments and entities in the private sector in order to achieve national goals. In 1995, lawmakers enacted the Unfunded Mandates Reform Act (UMRA) in part to ensure that, during the legislative process, the Congress receives information about the potential effects of mandates as it considers proposed legislation. To that end, UMRA requires CBO, at certain points in the legislative process, to assess the cost of mandates that would apply to state, local, and tribal governments or to the private sector. This report, which is part of an annual series that began in 1997, summarizes CBO’s activities in 2012 under UMRA.

How Is a Mandate Defined in UMRA?

UMRA defines a mandate as any provision in legislation that, when enacted, would do one of the following:

• Impose an enforceable duty on state, local, or tribal governments or on private-sector entities;
• Reduce or eliminate funding authorized to cover the costs of complying with existing mandates;
• Increase the stringency of conditions that apply to the provision of funds to state, local, or tribal governments through certain large mandatory programs or make cuts in federal funding for those mandatory programs if the affected governments lack the flexibility to alter the programs.
• Duties that arise from conditions of federal assistance or that are tied to participating in voluntary federal programs generally are not considered mandates as defined in UMRA.

What Does UMRA Require of CBO?

The law requires CBO to prepare mandate statements for bills and joint resolutions that are approved by authorizing committees; when requested, the agency also reviews proposals at other stages in the legislative process for intergovernmental and private-sector mandates. As a part of its review of legislation, CBO must determine whether the aggregate direct costs of the mandates would be greater than the statutory thresholds established in UMRA and identify any funding that the bill would provide to cover those costs. In 2012, the thresholds, which are adjusted annually for inflation, were $73 million for intergovernmental mandates and $146 million for private-sector mandates.

How Many Bills Reviewed by CBO in 2012 Contained Mandates?

CBO found that most of the legislation the Congress considered in 2012 contained no mandates as defined in UMRA. Of the 428 bills CBO reviewed in 2012, 68 (16 percent) contained intergovernmental mandates and 80 (19 percent) contained private-sector mandates. Most of the mandates that CBO identified in 2012 would not have imposed costs that exceeded those thresholds. Only two bills (fewer than 1 percent) included intergovernmental mandates with costs above the threshold, and 14 bills (3 percent) contained private-sector mandates that would have imposed costs exceeding the annual threshold.

Occasionally, CBO cannot determine whether the cost of the mandates in a bill would exceed the annual cost thresholds. The reason in most cases is uncertainty about the scope of a mandate—the number of people or entities affected, the extent of the requirements they would face, or both. Such uncertainty generally arises because of insufficient information about the contents of regulations that a bill might require. Legislation might give a federal agency broad discretion in issuing regulations, and without information about the scope of the regulations to be issued, CBO cannot estimate with any confidence the cost of the bill’s requirements at such an early stage. In 2012, CBO could not determine the annual costs of the intergovernmental mandates in six bills (about 1 percent) or the annual costs of the private-sector mandates in 18 bills (4 percent).

How Many Public Laws Enacted in 2012 Contain Mandates?

In addition to examining bills during the legislative process, CBO reviews public laws enacted each year for intergovernmental and private-sector mandates. This report assesses the 202 public laws that were passed by the 112th Congress (which ended on January 3, 2013) and were signed into law by the President in 2012 or early 2013. (For simplicity, the text of this report refers to those public laws as “enacted in 2012.”) Of those 202 public laws, 16 (8 percent) contain intergovernmental mandates and 23 (11 percent) contain private-sector mandates.

Public laws generally contain fewer intergovernmental mandates than private-sector mandates. In the 17 years since the enactment of UMRA, CBO has identified 13 laws with intergovernmental mandates that have costs estimated to exceed the statutory threshold. The last such law was enacted in 2010; none of the public laws enacted in 2012 contain intergovernmental mandates with costs estimated to exceed the statutory threshold. (One law contains an intergovernmental mandate with costs that CBO cannot estimate.) Since 1996, CBO has identified private-sector mandates with costs estimated to exceed the threshold in 89 public laws, including 7 laws enacted in 2012. Those 7 laws contain 12 private-sector mandates that impose government fees or regulate pipeline safety, transportation, pharmaceuticals, or telecommunications.

As indicated in the tables, the number of bills and other legislative proposals that contain mandates and the number of individual mandates that appear in proposed legislation generally differ. Because the House and the Senate may consider the same or similar mandates in more than one piece of legislation, the number of bills that contain mandates can be greater than the number of individual mandates considered by the Congress in any given year. Conversely, because one bill may contain several mandates, the number of mandates identified can be greater than the number bills reviewed.

http://www.cbo.gov/sites/default/files/cbofiles/attachments/44032_UMRA.pdf

Shifting the burden of national fiscal challenges to states and cities by placing a cap on or eliminating tax exemption of municipal bonds would be “inappropriate and shortsighted” and such a change would negatively affect the federal budget outlook, according to an April 2 letter to President Obama signed by 14 senators.

The National League of Cities in an April report announced the results of a survey finding that 61 percent of polled city officials said they would limit the number of projects undertaken if a federal limit is placed on the tax exemption of municipal bonds, while 54 percent said they would reduce the scope of projects.

The White House on Friday proposed a new “Rebuild America Partnership” program that would allow direct-pay American Fast Forward bonds to be used for any project that can currently be financed with tax-exempt private activity bonds.

Wall Street is taking America’s biggest pension fund to court this week, for a long-awaited battle over who takes the losses when a city goes bust — workers and retirees, municipal bondholders, or both.

Stockton, Calif., declared Chapter 9 bankruptcy last year after suffering one of the country’s sharpest riches-to-rags swings when the mortgage bubble burst. Struggling to stay afloat, Stockton has slashed tens of millions of dollars’ worth of city services — firefighters, senior centers, library programs for at-risk children — and said it would cut its municipal bond repayments to a degree never seen before in a municipal bankruptcy.

But it has drawn the line at slowing down its current workers’ pension accrual, or cutting the benefits its retirees now receive.

Mutual funds that hold the threatened bonds, and the insurers that guarantee them, have cried foul, citing the principle that in bankruptcy, similar classes of creditors must be treated the same way. Their objections have prompted the federal bankruptcy judge handling Stockton’s case, Christopher M. Klein, to schedule a four-day trial this week, starting Monday.

The immediate question before the judge is whether Stockton qualifies for Chapter 9 at all; unlike companies, cities must meet certain criteria before they can get federal court protection from creditors.

But there is a looming, larger question that has pension funds around the country nervous: Will a victory by bondholders in Stockton pave the way for cuts in its workers’ pensions and its payments to Calpers, which, in turn, could lead to the demise of other public pension plans?

President Barack Obama renewed his push for investing in roads, bridges and other infrastructure upgrades Friday, traveling to Florida to make the case for tax incentives and other efforts aimed at attracting private dollars to public works projects.

Calling it the “Rebuild America Partnership,” the president laid out a plan that he said would leverage private and public capital for infrastructure projects and generate jobs.

http://online.wsj.com/article/SB10001424127887323501004578390851308236448.html

H.R. 789, the Build America Bonds Act of 2013, introduced by House Ways and Means Committee member Richard E. Neal, D-Mass., would modify and permanently extend Build America Bonds.

Barclays is warning that if a Build America Bond subsidy payment is reduced under sequestration and this triggers an extraordinary redemption provision, the issuer may be able to call those BABs anytime, even years later when market changes make the call affordable.