WASHINGTON - The Securities Industry and Financial Markets Association is urging the Obama administration and key Democratic lawmakers to address liquidity problems in the municipal and auction-rate securities markets by developing a federally supported insurer or reinsurer and a facility to provide letters of credit or standby bond purchase agreements.
In identical letters sent to House Financial Services Committee chairman Barney Frank, D-Mass., and Senate Banking Committee chairman Christopher Dodd, D-Conn., SIFMA said the federal government should also consider: developing a commercial paper purchase facility to buy muni debt, similar to the Federal Reserve's Commercial Paper Funding Facility, which is currently closed to tax-exempt paper; authorizing $200 billion to start new state revolving fund programs for municipal financings; modifying restrictions on pension fund investments in in-state tax-exempt bond funds; and appointing a contact at Treasury to monitor the economic functioning of the muni market.
In addition, they ask the federal government to find a way, through a conduit, to finance the purchase of outstanding Federal Family Education Loan Program loans to thaw the frozen market for student loan bonds.
The letters, which were dated Tuesday but not released until yesterday, also appealed for help for regional broker-dealers, calling for fast-tracking applications for them to become bank holding companies, so they may access the Fed discount window, and providing net capital relief so that they and small firms do not have to take large capital charges on the auction-rate securities they hold in inventory.
Historically, municipal ARS and auction-rate preferred securities provided an attractive cost of financing for state and local governments, student loan financing authorities, and closed-end mutual funds, said the letters, which were signed by T. Timothy Ryan Jr., SIFMA president and chief executive officer.
ARS were considered highly-rated investments, but as the credit crisis spread into other markets, particularly the monoline insurers, demand for ARS halted, resulting in failed auctions and leaving investors unable to sell their holdings of the securities.
"Today, most ARS auctions continue to fail and many thousands of investors are holding securities which offer no liquidity and cannot be sold," the group said.
SIFMA called for Treasury to use funds under the Troubled Asset Relief Program to purchase ARS. It also said the government should: develop a federal liquidity facility to write standby letters of credit for ARPS; allow ARPS to be used as collateral for the Fed's discount window; and create develop a temporary federal guarantee program for ARPS.
In its letters, SIFMA warned that the lack of liquidity in the muni market, and in the ARS market in particular, has made it difficult for state and local issuers to meet their financing needs. It has threatened the viability of small regional broker-dealer firms and left individual investors holding onto illiquid securities, the securities group said.
"The municipal bond market is experiencing a significantly low level of liquidity," the group said. "State and local issuers are facing a critical need for reliable long-term credit enhancement, making it difficult to bring issues to the market."
"We wish to work with you to stabilize these critical markets at this difficult time in our economy," SIFMA told the lawmakers.
Though many of the proposals outlined in the letter have been bandied about by various market participants for several weeks, SIFMA said that it was writing Frank to keep him informed about its ongoing conversations with various federal policy makers in the Obama administration as well as the Federal Reserve.
"We're just making sure that the committees are aware of the proposals that we're trying to make the executive branch aware of," said Scott DeFife, SIFMA's senior managing director of government affairs.
"This is a new administration with new officials in the executive branch, so we are making sure they know about the issues and specific ideas that have been considered previously, as well as some new ideas to address the continuing problems in the marketplace," he said.
SIFMA said that the muni market is experiencing a "serious dislocation between supply and demand," with municipalities unable to find investors even for full faith and credit general obligation bonds.
To emphasize the "unprecedented conditions" in the muni market, SIFMA noted that triple-A rated 10-year tax-exempt paper is yielding as much as 143% of 10-year Treasury bonds, compared to historical yields for tax-exempt paper, which are slightly lower than Treasury yields. The shift comes as investors have sought shelter in Treasury bonds, dramatically lowering their yields.
Meanwhile, the lack of liquidity facilities for short-term money market fund eligible debt has forced cities and states to replace their variable-rate securities with more expensive, long-term fixed-rate debt, SIFMA said.
"This change in the supply of municipal bonds drives up rates on long-term munis, hurting municipal bond issuers and raising costs for taxpayers," the group told the lawmakers. "In other cases, municipal issues have simply been unable to find buyers in the short- and long-term markets for their debt issues."
SIFMA cited examples of issuers that have recently faced difficulties in the muni market, including the Port Authority of New York and New Jersey, which failed to receive any bids on its $300 million auction of taxable three-year notes in December, and the Michigan Municipal Bond Authority, which abandoned plans to issue $200 million of revenue bonds to help fund the state's clean water revolving fund, instead opting to issue $150 million of short-term notes. This will represent the first time in the program's 10-year history that the state issues notes instead of bonds, SIFMA said.
SIFMA's letters come as Frank and Obama officials appear to be coordinating closely on a plan to provide some form of federal backstop or liquidity facility for the municipal market, though no formal announcement has yet been made by the administration. Neither White House nor Treasury officials were available for comment.
But Frank has been outspoken in calling for federal assistance to the municipal marketplace, saying this week that he plans to push for a federally backed insurance program that he hopes will lure investors back to the muni market.
The details of the proposal will be worked out in the coming months, House sources have said.
SIFMA embraced the proposal in its letters, calling for the government to develop a federally supported monoline insurer or reinsurer.