Wall Street drives a truck through mile-wide hole in the rules

The Wall Street Journal and my fellow Reuters blogger Felix Salmon have both addressed the issue of the Bank of New York Mellon giving off-market or false prices on foreign-exchange trades to one of their clients, namely California pension fund Calpers.

Morally the actions of BONY, if true, are reprehensible. But are they illegal?  Felix describes the specific problem:

BNY Mellon’s clients put in FX orders, the bank executed those orders and reported back a price. Only it lied to its clients about the price it was getting, padding its own profits while so doing. This is doubly evil: not only did the bank lie, but it lied while serving as a fiduciary to its clients, with an affirmative duty to give them “best execution.”

Point one: OTC markets are barely regulated

Foreign-exchange trades are conducted “over the counter” (OTC). OTC is basically two parties coming together in some manner and the opposite of an “exchange market” where a multitude of buyers and sellers come together for regulated dealing. For example, exchanges require market-makers to provide certain levels of liquidity, trade reporting and standards of fair dealing.

OTC markets lack these requirements, and regulators have yet to address many of these issues. There are lots of opportunities for custodians or dealers to provide “off-market” or inflated trade prices to clients because trade reporting is not public. Can we blame dealers for driving the truck through a mile-wide hole in the rules?

Muni sweeps: “Intergovernmental downloading”

“Intergovernmental downloading”

Lisa Lambert of Reuters writes about a report issued by Fitch Ratings. From the Fitch report:

As has been the case in past times of financial strain, states are rethinking the size, cost, and role of their governments as they develop solutions to budgetary shortfalls. In many cases, this process has resulted in decreased local government funding. The extent to which local governments will feel the impact of these actions varies based on how dependent they are on state funding.

As such, Fitch Ratings believes school districts and counties will experience the greatest funding reductions. This report addresses the relationship between state and local government issuer ratings and discusses some of the main ways in which state actions can affect local government finances.

Muni sweeps: Happy “Bike to Work” day

House Committee launches ‘YourWitness’ program

From YouTube:

The [House] Financial Services Committee has launched a new program, Your Witness, which allows Americans to submit questions they want to ask a witness during a hearing. During an Oversight and Investigations Subcommittee hearing on the Stanford Financial Ponzi scheme, Rep. Randy Neugebauer asks the first question of Julie Preuitt.

From the House Financial Services Committee website:

@RandyNeugebauer asks question at a hearing using #YourWitness, our new program that allows Americans to get involved

California goes after it’s “wall of debt”

From the Bond Buyer:

[Governor] Brown released a revised budget Monday that dramatically reduces planned bond issuance as part of an effort to curb overall borrowing by the state that he termed the “wall of debt.”

Solve the real problems

Unfunded municipal pension liabilities are getting all the attention now, but it’s the burden of Medicaid and health-care expenses that are really crushing state and county budgets. In California, for example, the state will make a $2.4 billion pension contribution to Calpers and spend approximately $16 billion on Medicaid. The federal government kicks in an additional $25 billion.

I first understood this when I listened to the governors of Vermont and Wisconsin testify to the House Oversight Committee on April 14.  Governor Peter Shumlin of Vermont explained his approach to bringing his state budget into balance:

This crisis is the result of the greatest recession in history. I didn’t start with changes to collective bargaining and pensions. Our first problem is that health care costs have doubled. Our second cost driver is that corrections have doubled in 10 years.

Muni sweeps: Investing in shared infrastructure

Investing in shared infrastructure

My favorite article this week is by William Alden of the Huffington Post. He brings out an element of the municipal bond market that I’ve long believed could be the future of muniland: the propensity of people to invest in projects and entities that they have a first-hand experience or a connection to.

War bonds, issued to pay for World War I and II, are a case in which investors moved their savings to particular investment products for emotional, social or patriotic reasons.

Alden highlights a new retail bond program I hadn’t heard of yet (emphasis mine):

Muni sweeps: Rocking the digital city

Rocking the digital city

The New York City Mayor’s Office has published the “Road Map for the Digital City.” It’s an exciting vision of a city government connecting to and empowering its citizens.

From the executive summary:

New York City government engages over 25 million people a year through more than 200 digital channels including, mobile applications, and social media.

As a pioneer in Open Government, New York City government has unlocked thousands of public records, enabling technologists to build tools that help New Yorkers everyday, from finding parking spaces to listening to audio tours of Central Park.

Borrowing from the future to fund today

This august gentleman is William Gibbs McAdoo, the Secretary of the Treasury in 1917 when Congress passed the Second Liberty Bond Act and set the first statutory limit on the public debt of the United States. Now the current Secretary of the Treasury, Timothy Geithner, is struggling with the Congress to raise the debt limit for the 11th time since 2001.

A debt limit applies to debt that is authorized but not yet issued. Debt limits are imposed for personal credit cards, home equity lines of credit, commercial loan covenants and the debt of public entities.

Here is data for the public debt of the state of California as of April 1, 2011:

Muni sweeps: Market turning points

A muniland expert alerted me that we passed a significant benchmark late last week. The benchmark, which market experts say is a key indicator, is the ratio between the yield for 10-year AAA municipal bonds and the yield for the 10-year U.S. Treasury note.  It hit a 12-month low of 82.35 last Thursday night.

Daniel Berger, Senior Market Strategist at Thomson Reuters MMD, tells me “the light primary market issuance in 2011 has not kept pace with bond redemptions. Muni buyers could be in a larger predicament and reach for muni bonds in June when redemptions jump to $27 billion if monthly average issuance continues to be less than $16 billion.”

Daniel is saying that there will be more money from bond redemptions chasing fewer newly-issued bonds. Prices will likely rise and yields will go down. This could cause a bigger market rally.

Muni sweeps: Education reform for Illinois

Happy Friday all!

Illinois passes landmark education reform

The Chicago Sun-Times reports that the Illinois state legislature has passed a substantial education reform bill. The legislation severely restrains the power of the teachers’ unions:

The measure continues to allow unions to strike in Chicago and the suburbs, but it imposes a requirement that school boards and unions take longer to negotiate and publicly disclose their bargaining positions before a strike can be launched.

In Chicago, no strikes could occur until as long as 120 days after the dispute goes to a special panel — and then, only if the Chicago Teachers Union has given a 10-day notice of a strike and has 75 percent of its bargaining unit members in agreement. Currently, a strike only requires a simple majority of everyone who votes.

Muni sweeps: “People learn deterrence”

Professor John Coffee of Columbia Law School, who is considered one of the foremost legal scholars in the securities area, discusses the effect of the conviction of Galleon Group co-founder Raj Rajaratnam on insider trading:

“People learn deterrence from actual vivid examples of people going to prison.  And that is what it takes in every generation to overcome the tremendous temptation to make tens of millions of dollars.”

What about the municipal market? Are there instances where dealers are receiving inside information and trading on it ahead of others?

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