For more than a year, municipal market participants have looked to Washington for policy changes to help restore state and local governments' access to affordable capital. With the passage of the stimulus package earlier this month, the cavalry finally arrived.

And now the battle begins. The fact that the stimulus provisions impacting bonds expire at the end of 2010 means the next two years will be a crucible for the marketplace. Issuers will have access to a wider array of financing tools than ever before, and how they use them has the potential to re-shape the practice of municipal finance for decades. Congress and the White House will be watching to see how their new programs perform - and whether the municipal market can regain its legs (and historic yield advantage over Treasuries).

In the traditional tax-exempt bond market, issuers and market professionals will take advantage of the expansion of the bank deductibility rules and a handful of other changes that should improve investor demand - and make sure that translates to lower yields.

But they are also gearing up to test radical new alternatives to traditional tax-exempt financing - including tax-credit bonds and the "taxable bond option" - that could divert supply, and perhaps eventually supplant the tax-exempt bond market as the primary source of capital for municipalities.

The historic nature of this period was not lost on any of the almost 250 market leaders who attended the first National Municipal Bond Summit that The Bond Buyer sponsored with the Regional Bond Dealers Association earlier this month. (For those of you who couldn't join us, the sessions will soon be available as podcasts.)

Even as they discussed practical issues about whether taxable bond sales will require different structures and whether tax-credit bonds will find a market in the current "income-constrained" economy, they learned that more changes could be ahead. Rep. Gerald Connolly, D-Va., who's already emerged as a leader on public finance issues in only his first term in office, invited the audience to share their recommendations for additional changes via a dedicated e-mail address:

And there are plenty of ideas out there - many elegantly simple, like municipal bond veteran Jim Lebenthal's call to extend the state revolving fund structure to sectors beyond water and wastewater financing. Traditional tax-exempt investors in the room said underwriters and issuers need to get back to basics: taking more time to explain deals and working harder to actually sell investors on the credit.

As the market races to adjust to and embrace these changes, it does need to keep sight of a broader goal: Improving the analytical tools available to issuers who need to weigh the costs they'll face when raising capital through either traditional channels or the new structures.

Assessing the risk-adjusted costs of different financing techniques has never been more critical. Just ask an issuer who sold insured auction-rate securities in conjunction with interest-rate swaps, then watched risks they thought they had successfully hedged re-emerge to devour the savings they thought they'd locked in.

On that front, the market's greatest historic asset becomes a liability. The flexibility that allows issuers to tightly match their debt payments to their cash flows, and to access the markets only when the capital can be put to work quickly, also makes it difficult to evaluate the true all-in cost of different financing alternatives.

And that liability becomes exponentially greater as issuers weigh the cost of traditional tax-exempt financing against the new structures, like the taxable bond option. Even after deciding to sell taxable debt, issuers will have to navigate a myriad of choices that could cost them money, like whether to seek a lower interest rate by consolidating numerous serial maturities into a single bullet maturity, or whether to give up the municipal market's traditional 10-year par call option. Both of those moves should entitle the issuers to lower rates, but it will take serious analysis to determine whether the savings offset the additional carrying cost.

Making sure every financing team performs those analyses, and making sure the math is reliable, will be crucial in the coming year: It's easy for market professionals to convince themselves that "what's good for the municipal bond market is good for states and local governments."

Congress didn't reject that out of hand, but by creating the new financing channels, it definitely sent word that it's open to municipal bond alternatives. And that's no idle threat - in this environment, the federal government has already stepped in to become the primary source of capital for home mortgages and student loans. Adding municipal finance to the mix would not be a huge leap.

The game is on and the stakes are high. Let's make sure the scorekeeping is honest.

Michael Stanton is publisher of The Bond Buyer and managing director of SourceMedia's Capital Markets Publications Group. He can be reached at Michael Stanton and also welcomes public comments at The Bond Blogger,


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