The two items in The Bond Buyer in recent months considered a widely reported phenomenon. "Adverse selection" by a number of monoline insurers in guaranteeing collateralized debt obligations of subprime mortgage CDOs has destabilized the tax-exempt bond market, despite the distinction between structured finance and traditional municipal finance.
On June 6, there was a detailed front-page article about monoline insurance in the municipal bond market: "MBIA, Ambac Lowered: S&P Drops Both to AA, Sees Inflexibility." Previously, on March 10, a commentary by myself and Ned Regan addressed a related topic in the article: "Surety for Munis: Good, and Good for Pension Funds."
The Bond Buyer's own reporting, supplemented by extended coverage in the financial media generally, has focused attention on how the market might produce appropriate institutional arrangements providing the stability, the information economies, and the profits once provided by a monoline "oligopoly."
The nation's public pension funds, with some $3 trillion in assets, have been identified by many as an excellent source of capital for those purposes. Because they are already tax-exempt organizations, they do not invest in tax-exempt municipals. But they could invest in a new municipal bond insurer, as they have invested in some of the troubled monolines. Why not now? How?
In The Bond Buyer and elsewhere, capitalists in private equity firms have been reported to be investigating just those questions.
In the world of private equity investing and fundraising, there are some pretty tried-and-true approaches. The problem is that they are probably not going to succeed here, particularly if "succeeding" means creating a long-term stable institution that will stick to insuring municipal bonds at a steady profit, but instead will be sheltered from the slings and arrows of outrageous quarterly-earnings-report competition, "adverse selection" in insurance, and not to put too fine a point on it greed.
The chief investment officer of any major public pension fund could explain to you the ABCs of private-equity funding the promoter's expected returns (2% and 20%), the requisite exit strategies, the importunate of eventual access to public equity markets, etc. But the ABCs are probably not likely to resonate here, if the chief information officers and fund trustees have long-term interests in mind, especially the long-term interest of fund beneficiaries and fund contributors.
Aside from combined efforts concerning public-interest issues like corporate governance, public pension funds have little or no track record for acting cooperatively with one another. In making investments, each fund has its own trustees, its own CIO, its own advisers and gatekeepers, its own guidelines, etc. All act for the exclusive benefit of fund beneficiaries, and they purchase equity or debt instruments with acceptable risk-reward ratios. Many, of course, invested in monoline bond insurers.
If public pension funds were, however, to own their own municipal bond insurer i.e., wholly-own it they could, if past is prologue, be able to meet appropriate risk-reward criteria. They could also accomplish a number of objectives that would serve their beneficiaries, as described in the March 10 commentary. So maybe they should cooperate with one another here, perhaps in a manner similar to their important work on corporate governance.
That would present an investment challenge altogether different from buying publicly traded stock, or participating in a private equity venture, or even succumbing to an ETI proposal. It's a challenge that appears to require an altogether different approach just to get the ball rolling.
To be effective, the new company would need to be independent and profitable, with profits accruing only to the pension fund investors.
This would require a strong and savvy board, capable of forging a shareholder agreement among the pension fund, which would be the charter for a long-term institution.
The board would have to be capable of acting in the new company's best interests, both to shield it from struggles among different jurisdictions about the "right" sort of guarantee, and to shield CIOs and trustees from political pressures to make the "wrong" sort of guarantee.
It would require a board to be above the fray, capable of supervising the formulation of a credible business plan, directing and managing the affairs of the company, ensuring that the right people are hired to run it, and knowing how to compensate those people.
In short, it would require a board not limited to Wall Street or Main Street, but rather senior statesmen, so to speak, from State Street.
But individuals like that need to be given a nudge to step forward for the common good.
Maybe one or more members of the National Association of State Treasurers or the Government Finance Officers Association, or even Rep. Barney Frank, D-Mass., could use their respective bully pulpits. Perhaps a few CIOs or fund trustees could, too.
Those public sector figures could encourage the formation of a private sector steering Committee to Renew Basic Infrastructure, whose No. 1 job would be to explore the possibility of, and serve as a focal point for, public pension fund investment that would be aimed at stabilizing and enhancing the current municipal bond market.
Each of us surely has in mind a list of five such individuals. Perhaps they could get the ball rolling for something of lasting value.
Eugene W. Harper Jr., a member of the New York bar, is a partner of Squire, Sanders & Dempsey LLP. The views expressed here are his own.
