It is critical for all of the muni market groups, particularly issuers, to band together now to lobby Congress to preserve tax-exemption, while the tax committees are writing policy papers on tax reform issues in preparation for next year, a long-time muni bond lobbyist told market participants meeting in Miami on Friday.
Micah Green, a partner at Patton Boggs who who had a front-row seat during the Tax Reform Act of 1986, told those attending the fourth National Municipal Bond Summit in Miami that “lesson number one [from 1986] is that issuers have to be directly, actively and visibly involved.”
“Issuers and the financial community have to join arms and combine voice and image and resources to get their voice out loudly and clearly,” said Green, who worked at the Public Securities Association at that time. “The best voice to have in advocating policies is the voice you create collectively. The time to see people is right now before they are taking pen to paper on those policy positions.”
Green made the remarks when asked by panel moderator Mike Nicholas, CEO of Bond Dealers of America, a sponsor of the conference, what lessons from the debate on the Tax Reform Act of 1986 can be applied to the forthcoming debate over tax reform.
Green told those at the conference that the muni market community is wrong to presume lawmakers who are former state and local officials will defend the muni market because there will be many groups seeking support from them for many competing issues.
Muni market participants will have to find a lawmaker who will act as a leader and take “ownership” of tax-exempt issues, Green said. They need a “lead defender” of tax-exemption who will speak up during the debates.
The tax panel members debated whether the perception of losing tax-exemption might be worse than actually losing it. “Yes, I think the perception is probably worse than the reality,” said Mark Price, principal with Trident Municipal Research. Losing tax-exemption would bring clarity to the market because “sometimes it obfuscates exactly what the value of the credit is,” he said.
“It’s a challenge for smaller issuers,” Price said. “But I would say there is also an opportunity there. If there is anything we’ve learned in financial services, it’s give us an environment and we will work our way through.”
Pass also noted that the Build America Bonds program served as an alternative to tax-exemption and received a positive reaction from the market. He had said earlier in the session, “I think Congress now knows that they can have a taxable municipal bond option that works. I’m not saying that BABs are coming back.”
The key issue, he said, is whether “the government wants to subsidize the issuer or does it want to subsidize retail or institutional investors.
The BAB program, established under the American Recovery and Reinvestment Act in 2009, expired at the end of 2010. BABs are taxable, but the Treasury Department makes subsidy payments to issuers at rates equal to 35% of their interest costs.
But Green argued that tax-exempt bonds will always be needed to help smaller issuers access the capital markets.
“Where you stand depends on where you sit,” Green said, noting that BABs were popular with large investors who frequently issue bonds and have no trouble accessing the capital markets.
“I do worry about the absence of tax-exemption, which has provided this decentralized marketplace so that more issuers, thousands of issuers, can have access to the capital markets,” Green said.
Tax-exemption could be “absolutely critical” to small- and medium-size issuers, he added.
But James Pass, managing director, municipal portfolio manager at Guggenheim Partners, said his firm’s portfolios include a combination of small- and medium-size issuers that took advantage of BABs.
“They weren’t the first out of the chute,” but once the market became comfortable with BABs, the small- and medium-size issuers began participating, he said.
Green, who represents Assured Guaranty Corp, said that even with BABs, there is still going to be a need for credit enhancement.
“Frankly the BAB program had a mistake in it,” he said. “They didn’t factor in the ability to do credit enhancement and they handled it wrong in Treasury’s interpretation of the statute.”
The law “should have been written to allow an insurance premium to be treated as interest in factoring the subsidy,” he said. “You’d actually reduce the cost of the subsidy and increase the cost of savings to the issuer.”
Green also pointed out that while, with tax-exempt bonds, state and local issuers and voters generally are free to decide how many bonds they want to issue and the volume of those bonds determines the amount of tax-exempt interest paid, BABs permit the Treasury to see clearly what bonds cost because the department is making the subsidy payments.
“BABs was a way to not only broaden the market for tax-exempt bonds, it was also a way to being that concept of limiting ,” Green said, comparing them to bonds issued under volume caps.
Pass contended that if President Obama is reelected in the November election, BABs will likely return at a 28% subsidy rate.
Nicholas asked if the market would still be interested in BABs with that subsidy rate.
“Congress or the administration in their wildest dreams could not have designed a better product for an institutional investor — it was a new credit, ratings were stronger, diversification for internal portfolios and duration, so whether the subsidy is 35% or 28%,” you’ll have natural buyers, Pass said.
Nicholas asked the panel whether tax reform would be a partisan process.
Green said that if one of the main goals for tax reform is economic growth, then that would be positive for municipal bonds because they are a key tool for economic growth.
However, he warned, “If it a becomes battle of class warfare and deficit reduction is introduced into the process, I think all bets are off because it’s hard for that not to get partisan.”
Nicholas questioned how it would be possible to keep deficit reduction out of tax-reform process.
Green said deficit reduction must be on a separate path than tax reform.
