Why is the US Treasury awarding a no-bid contract for municipal research?

May 13, 2013

A rather surprising notice appeared on the Federal Business Opportunities website:

The Bureau of the Public Debt, on behalf of the Office of the Comptroller of the Currency (OCC) intends to award an order to Municipal Market Advisors for Municipal Bond Research. Municipal Market Advisors is the sole provider of the Municipal Bond Research.

Did the BPD bid this award out in an open process? Well, no not exactly, in fact not at all:

No solicitation package will be issued. This notice of intent to sole source is not a request for competitive quotations; however, the Government will consider responses received no later than 2:00 PM ET on May 17, 2013.

So no other input is wanted by the BPD and if you have something to say you have seven full days to make a peep. And what will this research be used for?

The Dodd Frank Act required OCC to change our investment regulations to remove any reference or reliance on credit ratings, and to establish an alternative standard of creditworthiness. So, going forward, the industry and our examiners will be spending more time assessing the risk of municipal bond portfolios and individual bond offerings in order to ensure compliance with our new investment grade standard. Almost all banks invest in municipal debt and generally rely heavily on the investment grade it rating from one of the credit rating agencies.

So federal regulators, who can no longer use credit ratings for evaluations of the municipal bond holdings of the commercial banks that they regulate, just gave a no bid contract to MMA, a relatively small firm with four principals. In essence the OCC will be substituting the opinions of MMA for those of the credit ratings agencies. Federally chartered banks held $363 billion of municipal securities as of 4th quarter 2012 according to the Federal Reserve (page 78, line 13).

The federal bank regulator will essentially be substituting the work of credit rating agencies, which issue over 1 million individual municipal ratings, with “research” from a small private shop. Is this wise? I think restricting themselves to such limited information is short-sighted given that muniland has over 80,000 issuers with $3.7 trillion of municipal debt outstanding. High quality credit analysis for even the debt of 50 states requires a shop bigger than MMA. Let alone all the other issuers.

But there is a matter about this deal that concerns me even more than relying on a very narrow view for credit analysis. It relates to the way that MMA sets benchmark yields for municipal securities. To determine their benchmark yields, MMA basically calls up 38 dealers and asks them to quote their “mid-market yield (a “mid market” yield represents the mid-point between the “bid” and “offered” side of the market). “This is essentially how Libor was set until it was discovered that it was rigged. It’s the opposite of using real market transactions to determine a market’s yield, and sounds like it could be easily gamed like Libor was rigged. Who would oversee the setting of this benchmark yield that bank regulators would use as reference for how banks are marking their securities holdings? The SEC, MSRB and market participants are desperately working to create more market integrity and transparency. Why is the OCC moving in the opposite direction?

Global regulators working together through the International Organization of Securities Commissions (“IOSCO”), recently published a consultation on financial benchmark development and administration. Here is a primary principle about benchmark creation:

Data Sufficiency: The data used to construct the Benchmark should be based on prices, rates, indices or values primarily under observable transactions entered into between parties at arm’s length. Non-transactional data such as bids and offers or the Administrator using its discretion to adjust the factors that may impact the quality of the data may be relied on only as an adjunct or supplement to transactional data.

Of course all the folks at MMA are nice, informed market professionals. But this process of hiring independent municipal research is ridiculous. No bid contracts have no place in our new, more transparent, post Dodd-Frank regulatory framework. The municipal bond market is facing its toughest challenges since the Great Depression and this BPD/OCC process needs more public input and openness.

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