MuniLand

Dodd-Frank appears in muniland

Already the long reach of Dodd-Frank into muniland is having an effect. Al.com tells the story (emphasis mine):

The Wall Street investment bank leading Jefferson County’s pitch to exit Chapter 9 municipal bankruptcy could be violating securities law if it serves as an underwriter in the deal, a lawsuit brought by Jefferson County sewer ratepayers says.

Under the Dodd-Frank Wall Street Reform and Consumer Protection Act, an investment bank may not act as both a financial advisor to a municipal issuer and as an underwriter when that debt goes to market. Serving in both roles could create a conflict of interest for the bank, and the practice was outlawed in 2011.

That appears to have been what’s happening as part of Jefferson County’s plan to exit bankruptcy.

Dodd-Frank is the first substantive law for muniland since 1975. One of the law’s most important provisions is that it added “municipal adviser” as a new category subject to regulation and disciplinary authority. Dodd-Frank outlawed the practice of an underwriter serving as a municipal adviser and then switching hats to underwrite the same deal.

Why SEC adviser rules are desperately needed

Stockton, California is in the early stages of their bankruptcy and a local grand jury polled current city council members about their understanding of public finance. Does the latest round of public servants have any knowledge municipal finance? No, sadly the San Joaquin County Grand Jury discovered that there was little understanding of the city finances that the council oversees and that they could easily repeat prior mistakes. Local ABC affiliate, News10, reports (emphasis mine):

It has been widely reported how Stockton mismanaged its finances into bankruptcy court.  The grand jury also questions the current council and council members’ ability to manage important financial issues.

“The Grand Jury’s concern is the limited grasp of municipal finances.  While a few [council members]) indicated they had taken college-level courses in finance, or attended workshops, none indicated they were proficient in the matter,” read the report.

Municipal issuers: Know your friends

Having spent almost a year on Capitol Hill when the Dodd-Frank financial reform bill was being debated and drafted, my antenna goes up when an industry trade group praises something done by Congress. It’s usually a sign that the trade group was successful at getting their points of view adopted into law. I’m much happier when trade groups are screaming and kicking about provisions of the law, such as the new rules for derivatives trading and reporting.

This week the Bond Buyer ran an op-ed from Michael Decker, managing director of the securities industry and financial markets association (SIFMA),that praises recent legislation by the House Financial Services Committee. The new legislation amends the Dodd-Frank definition of “municipal advisors” by narrowing who the law would cover and specifically removes securities dealers from that designation. Municipal advisors are professionals paid to advise cities and other municipal issuers on the best ways to structure new bond offerings and manage the debt they have outstanding.

Thankfully the legislation leaves in place a “fiduciary” responsibility for municipal advisors, which requires that they act in the best interests of their clients, the municipal bond issuers (ie cities, states, sewer and water authorities). A “fiduciary” obligation is the strictest form of relationship between two parties.

Glass-Steagall 2.0

Would resuscitating a Depression-era banking law strengthen the financial system that we have today? There are many, including me, who believe a reinstatement of Glass-Steagall would help separate the risks of high-velocity, high-volume securities speculation from the pedestrian activity of holding retail deposits. Often forgotten in the discussion of Glass-Steagall is the law’s primary accomplishment: the creation of deposit insurance through the FDIC, which promptly ended the recurring curse of mass withdrawal of retail deposits during financial crises. My grandparents lost all their savings in the banking crisis of 1933. In the wake of Glass-Steagall, the idea that their bank deposits were insured must have seemed like a miracle to them. This act established confidence in the banking system among everyday savers.

Yesterday, DealBook’s Andrew Ross Sorkin took up the issue of Glass-Steagall in a piece focusing on Massachusetts Senate candidate Elizabeth Warren. Sorkin argues that the dismantling of Glass-Steagall was not the cause of the financial crisis. Furthermore, he says that Warren’s proposal to reinstate Glass-Steagall is misguided and would not have prevented the global meltdown of 2008.

I don’t want to speak for Warren, a Harvard Law School professor, but I think what she is pointing to is the need for an updated version of the law, a Glass-Steagall 2.0. Sorkin’s description of why Glass-Steagall would have done little to avert the financial crisis of 2008 parrots the argument made by Wall Street’s elite. See this Bloomberg piece from December 2009, for instance:

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