Congress should protect municipalities from bad advice

July 25, 2012

Municipal advisers, those muniland professionals who are hired by public officials to evaluate their needs for financing and guide them through the underwriting process, don’t receive enough attention. Generally, they are paid by a government entity but also receive fees from the banks who underwrite the deals. Dodd-Frank set out to restrain potential conflicts in this space by requiring municipal advisers to register as such and imposing a fiduciary duty on their activities.

Now, however, some members of the House of Representatives are trying to roll back the portion of Dodd-Frank that would impose this fiduciary duty. A first-term congressman from Illinois, Robert J. Dold, whose prior professional experience was operating a pest-control business, has proposed legislation to strip the fiduciary duty requirement from Dodd-Frank. His bill currently has 35 co-sponsors.

Typically, municipal officials have little to no experience in financial markets. A financial adviser is on hand to untangle the complexities of different financing structures, guaranteed investment contracts (GICs) and derivatives. For public entities to get a fair deal, it’s critical that they get conflict-free advice from their financial advisers. The big Wall Street banks have for years sold highly complex and expensive products to poorly informed governments. See, for instance, these episodes from 2008:

Using derivatives, JPMorgan pitched a host of deals whose names alone are indecipherable. For Philadelphia International Airport, the bank sold something called a “path-dependent knock-out swaption.”

JPMorgan also sold interest-rate swap options, which are also known as swaptions, to school districts. When JPMorgan exercises those options, municipalities must issue floating-rate bonds and enter into interest-rate swaps with the bank.

Last fall I ran into Deven Sharma, the former president of credit rating agency Standard & Poor’s, on Sixth Avenue in New York. He asked what part of the fixed-income business I was working in now. When I told him it was the municipal market, he shook his head and said: “Oh, the complex part of the business.” He’s right: Muniland is the most difficult part of the bond business to understand, and issuers, the least informed parties in the transactions, need advisers with the fewest conflicts of interest possible. Representative Dold’s effort to strip the fiduciary duty from municipal advisers would weaken protections for cities and towns at a time when Congress should be working to strengthen them.


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