Comments on: US muni bond tax exemption is accident of history

By: JP007

JP007 — Sat, 02 Jul 2011 20:21:16 +0000

“Large institutional investors tend to steer clear of munis because they’re after yield, not tax breaks.”
Does this belie the malfeasance of “large institutional investors” not looking out for net returns after taxes? Probably since most of their small and large clients reach for yield, aka the sticker price, rather than total cost of ownership.
Being right for the wrong reasons does not convince me here.

By: Jim_Walker

Jim_Walker — Sat, 02 Jul 2011 10:57:12 +0000

Hi Agnes

Mike Stanton, as always, makes a good point… “first do no harm”.

-Big changes to the muni market would rattle all investors since prices would go on a rollar coaster ride causing massive fund redemptions which would in turn reset similarly priced muni bonds across the board. The bonds of 50,000 issuers would be underwater.

-Taxable BABs did a bring in more foreign buyers who in some cases scooped up picked close to 20% of the offering. But dont BABs get the same thin disclosure that tax exempts get?

-As for small issues, its interesting that in Europe most small issues are done with the help of Banks stepping in to do all of the issue.

Jim Walker
http://www.Bondview.com

By: Acetracy

Acetracy — Fri, 01 Jul 2011 21:07:47 +0000

Your premise that making munis taxable would bring in more investors is absolutely ludicrous and wrong. First off, there is no problem finding investors, even in today’s stressed credit environment, for tax free munis. NONE.

For retail investors it has always been a scramble to get any bonds since institutions gobble them up so quickly. Ask any muni investor and they will verify.

The reason for tax exemption on muni bonds is that it lowers the cost of funding local governments. If you eliminate the tax exemption, you will again shift the burden of funding government away from the rich (who usually own munis) and back to the poor and middle class citizens through higher local taxes – most of which are very, very regressive (sales tax for one).

Your analysis reeks of conservative think tank jargon, with really no substance. It’s the same crap we hear about how high speed trading, hedge funds, prop trading desks and other speculators are providing LIQUIDITY to the markets. Actually it is just the opposite as soon as margin calls go out….

Go back and do your homework and analyze the effect higher interest rates on muni bonds would have on local cities, counties, and states. Instead of paying 3% for 15 years, they would end up paying nearly twice that amount – plus they would have to compete with other taxable bonds, so likely even have to pay higher and higher rates.

By: MikeStanton1891

MikeStanton1891 — Fri, 01 Jul 2011 19:42:24 +0000

I think I know how Morgan Stanley got that number, and it’s not a wholly unreasonable take, but let me state it a different way: BABs typically traded 100 bps or more above tax-exempts (but the cost to issuers was offset by the Federal subsidy). That means public sector borrowers’ interest costs would be 20%+ higher in a strictly-taxable world. That’s a pretty severe penalty, and would lead to fewer public projects getting financed.

There’s also another way to approach efficiency. One of the strengths of the historic, market-access-on-demand model in the muni market is that it allows public sector issuers to keep their working capital balances and costs low. Those gains could well be fully offset by improved pricing in a more liquid taxable market, but it has not been proven.

Finally, I wonder what the hurdle is for declaring the market “often dysfunctional.” Is volatility really any higher than in the corporate bond markets? New-issue disruptions certainly haven’t come close to approaching the three-year-old “Closed” sign on hanging the door of most structured-finance markets.

Munis have to aim for perfection, because investors purchase them specifically to occupy a “riskless asset” position in their portfolios. The market’s current disclosure practices and secondary market liquidity, they fall short of that lofty goal. But historically, particularly thanks with their extremely low default rates, they’ve come much closer than most of their peer asset classes. Reform discussions have to begin with “first, do no harm.”

– Mike Stanton, Publisher
The Bond Buyer