If the Oracle of Omaha is right, the financial guaranty of municipal bonds is a pretty good line of business.
We've all observed the current plight in public finance credit markets, resulting from guarantees by major bond insurers of subprime mortgage and related collateralized debt obligation redits. This has caused many market players to explore new vehicles for enhancing municipal credits.
The business of providing surety for the payment of municipal debt, and market liquidity for state and local issuers, can be a sound one. Owing in large measure to the municipal credit-rating system chronicled on the front page in last Monday's New York Times, it can be good for the public sector and taxpayers. Owing to the creditworthiness of the public sector, it also can be good for investors.
There is a group of institutional investors that could constructively play the role of a well-compensated EMS driver for the safe-and-sound. It's a group that could effectively capture for the public any ensuing surplus from the recent credit disasters: the nation's public pension funds, with trillions of dollars in assets to be invested.
One of the many unintended consequences of the tax code is that public pension funds do not invest in highly rated municipals. This is not because those investments (usually in public infrastructure) are unsound as investments. It's because public pension funds are already tax-exempt organizations, with no demand for lower-than-market, tax-exempt interest. (Each of us has, elsewhere, proposed a way of fixing this problem in the tax code, which has left the financing of American infrastructure limited to an anachronistically domestic credit market, consisting mostly of bond funds, in an otherwise global financial economy.) Indeed, highly rated municipals could be responsive to the fiduciary obligations owed to pension beneficiaries. They would be far more attractive than the local economic development investments often urged on public pension funds.
Even without purchasing tax-exempt securities directly, however, public pension funds could do what pension funds all over the world do - support infrastructure development in their own jurisdictions. They would do this by becoming stakeholders in a new vehicle set up to guarantee municipals, and only municipals, the way the traditional bond insurers used to do, when they were all steady triple-A businesses.
This would be good for state and local governments, for it could avoid the sort of unanticipated credit chaos we've seen this year. But it would also be good for the public pension funds, for it could provide them, as stakeholders in the new vehicle, with a reliable source of long-term investment income from the returns generated by that vehicle's insurance fees and portfolio earnings. Also, stability in public finance credit markets would reduce unpredictable claims on governmental budgets - that is to say, on taxpayers - the main source of contributions to public pension funds. Similarly, earnings here would accrue to taxpayers.
There should also be collateral benefits. A small number of populous states issue the lion's share of the nation's tax-exempt bonds, and this would provide built-in diversity for a consortium of pension funds that guarantee obligations from those same states. Often, officials responsible for public pension funds are also responsible for budgets and finances in their own jurisdictions; and such a vehicle could provide practical, mutually reinforcing incentives both for prudent fiscal practices and for transparent municipal disclosure. Also, the consortium could agree to insure only municipals, and this would avoid the sort of riskier ventures that spawned the current difficulties.
Putting something like this together will require a fair amount of enterprise savvy, both in the business world, which this new group would seek to enter, and in the world of public pension funds, usually managed by careful, risk-averse trustees, acting for the exclusive benefit of pension-plan participants. Often, crisis-managers understandably tend to focus on the urgent rather than on the important. By contrast, some real enterprise savvy here could turn out to be good and good for us, on this urgent but nonetheless important matter.
Gene Harper is a partner of Squire, Sanders & Dempsey LLP in New York City. Ned Regan, a Baruch College professor at the City University of New York, is the former New York State comptroller and in that role was sole trustee of the state pension fund. The views expressed here are their own.
