The Treasury wades into muniland

April 21, 2014

The U.S. Treasury Department has organized a new office to monitor the municipal bond market, along with state and local finances and public pensions. Reuters reports:

The U.S. Treasury Department is forming a unit on state and local finance to coordinate its responses to developments in the country’s $3.7 trillion municipal bond market, a Treasury spokesperson said on Thursday.

According to the spokesperson, J.P. Morgan’s Managing Director for Public Finance Northeast Region and Housing Groups Kent Hiteshew will become director of the new unit in May.

Alongside liaising with state and municipal officials, the unit will monitor developments in the bond market and work on policies on public pensions. The unit, the establishment of which was first reported by the Wall Street Journal, will also develop policies for other pressing issues that emerge.

Treasury’s choice to lead the muni group, Kent Hiteshew, was a Bear Stearns banker who joined J.P. Morgan after Bear’s collapse in 2008. Although undoubtedly an able investment banker, Hiteshew is undoubtedly immersed in Wall Street’s priorities and ways of thinking.

For example, J.P. Morgan participated in the underwriting syndicate for the new Puerto Rico general obligation bond issued March 11, 2014. The offering had 15 pages of disclaimers warning investors that the Commonwealth may have to restructure its debts. Undeterred, the underwriting syndicate went on to distribute the largest-ever junk-rated municipal bond deal. The underwriters warned investors that the deal could blow up, but they brought the bonds anyway. Hopefully the Treasury Department and Hiteshew will not focus on protecting those underwriters and dealers from any fallout from a potential restructuring of Puerto Rico’s debt.

The excellent talk in the video above is given by David Unkovic, a bond attorney and former receiver of Harrisburg. Unkovic discusses how regulators focus too heavily on protecting the buy-side (especially large mutual funds) and the massive financial institutions operating in the municipal market through their investment banking arms instead of protecting state and local issuers and citizens. Hiteshew and his Treasury colleagues should pay close attention to Unkovic, who succeeded in involving and protecting taxpayers in a stressed situation In Harrisburg.

Unkovic’s focus on making citizens and taxpayers the priority in a workout of stressed debt differs from the direction taken by the U.S. Treasury and Federal Reserve in the 2008 financial crisis. According to documents obtained by Bloomberg through a court ruling, from 2008 through 2009 the U.S. Treasury and Federal Reserve loaned the six biggest U.S. banks $160 billion in TARP funds and as much as $460 billion of Fed loans.

The U.S. Treasury did not actively oversee the largest banks, many of which were also the nation’s largest mortgage servicers, through its Home Affordable Modification Program (HAMP), according to a 2012 investigation by ProPublica:

By now, HAMP’s disappointing performance is well known. The program was launched with President Obama’s promise to help three to four million homeowners avoid foreclosure. Three and a half years later, the program is only approaching 1.1 million modifications. It’s spent just $4 billion of its original $50 billion budget.

A recent study found a big reason for the program’s failure was that, despite all its rules, it didn’t change the behavior of the biggest banks. The banks did a poor job of modifying loans before HAMP was launched and weren’t much better after.

Watching increased fiscal distress in Puerto Rico and other pockets of muniland, I think there has been plenty of warning to market participants of the risk of owning the debt of weak issuers. Almost one year ago, SEC Commissioner Dan Gallagher warned of the possibility of an “Armageddon” for retail investors in muniland. He eschewed the passivity that had long hung over the municipal bond market. Muniland took a hard tumble soon thereafter on warnings of possible interest rate increases from then Fed Chairman Ben Bernanke.

As muniland struggles, bankrupt cities and towns (and Puerto Rico) need the protection of the federal government more than bondholders and financial firms. Congress empowered the Treasury Department, through its chairmanship of the Financial Stability Oversight Council (FSOC), to maintain stability in financial markets. But that mandate must be equally balanced with that of the SEC and Municipal Securities Rulemaking Board to protect state and local issuers and investors. Of course, it is also the purpose of the federal government to protect its citizens rather than the largest financial institutions.

I welcome the U.S. Treasury’s oversight of muniland if it keeps taxpayers and local and state governments as the priority. The nation’s most powerful financial institutions do not need more protection.

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Whom do the “bankrupt cities and towns (and Puerto Rico)” need protection from? Shouldn’t we expect that the professionals managing the debt of governments have the ability to know when they’re getting their constituents into trouble?

There’s no way to regulate for mismanagement and irresponsibility among governmental entities. The vast majority of muni issuers are doing just fine. Doesn’t that prove that distress and mismanagement are the exception, not the rule?

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