Muniland’s public officials are clueless, not corrupt

December 29, 2011

Matt Taibbi’s latest piece for Rolling Stone, “How Banks Cheat Taxpayers,” blasts a common municipal bond market practice in which a state or municipality selects an underwriter for an offering without soliciting competitive bids for the project. These are called “negotiated bond offerings” in muniland parlance, and Taibbi likens them to a legalized form of bribery:

By “negotiated underwriting,” what Bloomberg means is, “local governments just hand the bid over to the bank that tosses enough combined hard and soft money at the right politicians.”

I really hope that Taibbi’s is making a hyperbolic statement to draw attention to his main premise that new bond offerings should done on a competitive basis, with which I agree entirely. But he implies that all state and local politicians are standing around with their hands out and are actively being bribed by Wall Street banks. If our country is that corrupt, we are in for a lot of trouble.

In contrast to Taibbi’s view I think most public officials are overwhelmed by the complexity of the municipal bond markets, which are hard to understand, and rely on a “trusted” investment banker to guide them through the minefields. A great report from Claire McCaskill, who served as the Missouri State Auditor in 2005 and now represents the state in the U.S. Senate, contained the following:

Some issuers [local governments] used questionable reasons in choosing negotiated sales. In addition, officials contacted believed they achieved low interest rates on negotiated sales because underwriters offered rates below the national bond index. However, due to Missouri’s high credit rating, the majority of general obligation bonds issued in the state achieve rates below the national index.

The Missouri report says very politely that public officials are clueless. We’ve heard plenty of  stories over the last few years of public officials being misled about the benefits of doing certain types of transactions. Wall Street can be very good at disguising the underlying structure of deals as opposed to their outward appearance.

There are scads of academic studies conducted over the last 40 years showing that bidding out bond offerings saves money. Several of those peg the savings at 20 basis points, or 0.20 percent of the cost of the bond offering. Using Bloomberg’s estimate that 80 percent of the market is done via negogiated deals, I would guess that state and local governments paid approximately $600 million in additional fees this year. Doing some very rough calculations, I’d say they paid securities firms $2.6 billion overall for underwriting services this year. And, of course, securities dealers make more by trading these bonds and managing them for client accounts.

There is no magic formula to fix this problem, but every state legislature must address this issue. From the Missouri Auditors report again:

Missouri law does not require public school districts and municipalities to conduct competitive general obligation bond sales.  However, six of eight surrounding states have laws which restrict the method of sale for general obligation bonds sold at the local level. A legislative revision to state law is needed to address the trend of issuing negotiated general obligation bonds in the state.

Matt Taibbi, I’m with you on eliminating “negotiated” municipal bond deals. There are much better things to do in muniland than pay hundreds of millions to Wall Street for bond offerings. But let’s give public officials a little more credit and help them understand how to do better for those they serve.

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