MuniLand

Who is the “muppet” now?

The media is filled with reports and reviews of a book by former Goldman Sachs employee Greg Smith, which disparages his former employer. Smith alleges that traders on his London equity derivatives desk treated their clients harshly and would glibly refer to them as “muppets.” They secretly despised their clients as they ripped them off, according to Smith, especially the “muppet” clients that were mainly pension funds and non-profits. The Guardian reports (emphasis mine):

Getting an unsophisticated client was the golden prize,” he told the [60 Minutes] programme. “The quickest way to make money on Wall Street is to take the most sophisticated product and try to sell it to the least sophisticated client.

“What Wall Street will do is they will approach one of these philanthropies or endowments or teachers’ retirement pension funds in Alabama or Virginia or Oregon and they’ll say to them: ‘We have this great product that is going to serve your needs’. And it looks very alluring to these investors, but what they don’t realise is that upfront they are immediately paying the bank $2m (£1.2m) or $3m because of their lack of sophistication.”

How fast can you say “muniland muppet”? There happens to be a big derivatives controversy brewing in in the “City of Brotherly Love,” right now. Some background from the Philadelphia Inquirer:

Urged on by private-sector financial advisers, approved by bond lawyers, the city took advantage of a 2003 state law approved by then-Democratic Gov. Ed Rendell and Republican legislative leaders to “swap” interest-rate risk on the next several years’ borrowings with clients of JPMorgan, Goldman Sachs, Wells Fargo, and other big Wall Street banks…

Pay to play beyond Goldman Sachs

The SEC caught a big fish in muniland that was clearly breaking the “pay-to-play” rules. Pay-to-play is when municipal bond underwriters give contributions to politicians to win underwriting business. Reuters has the story:

Goldman Sachs Group Inc will pay more than $14 million to settle federal and state charges after it violated “pay-to-play” rules, in a case involving campaign contributions to former Massachusetts gubernatorial candidate Timothy Cahill.

Neil Morrison, a former vice president in Goldman’s Boston office, worked extensively on Cahill’s 2010 campaign while also soliciting underwriting business from the Massachusetts treasurer’s office, the Securities and Exchange Commission said. Cahill at the time was Massachusetts state treasurer.

What Goldman’s muniland charm offensive doesn’t tell you

When I did a Google search earlier yesterday for “Louisville Arena Authority bonds,” which were recently downgraded to junk by Moody’s, I saw this paid ad from Goldman Sachs alongside the results: Goldman Sachs: Louisville www.goldmansachs.com/Louisville How Goldman Sachs helped Louisville build a home for college basketball

 

 

 

 

It’s part of a series of ads touting the investment bank’s underwriting of the $349 million bond deal from 2008 that financed the construction of a new basketball arena at the University of Louisville. The ad says:

Let Europe kill municipal CDS

The solution to Greece’s debt crisis that Europe’s leaders announced on Thursday has market participants and commentators howling. It includes a provision that changes long-established rules for credit-default swaps mid-game. Mike Dolan, Reuters’ Investment Strategy Editor in Europe, said this:

For all the ifs and buts about the latest euro rescue agreement, one of its most profound market legacies may be to sound the death knell for sovereign credit default swaps — at least those covering richer developed economies.

I’d suggest that death knell just rang for U.S. municipal credit-default swaps (CDS), too. They’ve recently been on their last legs amid collapsing volumes, but actions in Europe just might have delivered the deathblow.

Untimely data will cost muniland potential investors

If municipal bonds lose their tax-exempt status, as some in the corridors of power in Washington are suggesting, municipalities will increasingly be competing with corporations for investors. As this competition intensifies, municipalities with poor accounting and disclosure practices could find it difficult attracting capital.

Let’s say you’re an investor looking to buy the bonds of either Goldman Sachs or New York City and to help guide your decision, you seek out their most recent financial statements. As a public company, Goldman Sachs is subject to the SEC’s disclosure regulations which mandate the filing of audited annual financial statements 60 days after the end of the year. If Goldman does not file within the 60 day window then the SEC has the authority to restrict certain simplified securities offerings and the New York Stock Exchange, which lists their securities, can take action too.

Contrast that with the Municipal Securities Rulemaking Board, New York’s regulator, which encourages municipalities to make public their audited statements, which are called CAFRs or Comprehensive Annual Financial Report within 120 days of the end of their fiscal year. Unlike the SEC, the MSRB has no authority to discipline issuers who file late, other than suggesting the municipality issue a notification of late filing.

The global spiderweb of debt

If you are not familiar with the municipal bond market, you may think that muniland is nothing more than states, municipalities and school districts offering plain bonds that mature on a set date and offer a fixed interest rate. That is the textbook description.

Actually the municipal bond market is a murky tangle of odd bond structures, variable-rate debt, multiple layers of issuers and bank guarantors. The lack of standardization of bond structures and relationships is one of the main reasons that the asset class has never migrated to the internet for retail investors.

Often the odd bond structures can create much more exposure to the tides of global affairs than plain vanilla bonds. The biggest example now is the Belgian-French bank Dexia, which is a big guarantor of U.S. muni bonds.The WSJ reported in an excellent article that investors are selling off muni bonds that Dexia insures:

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