Two professors are proposing that states and localities create a national nonprofit institution that would provide issuers with independent advice on bond financings, help them disclose standardized information, and take other steps to improve liquidity in the muni market.
They described the new institution, which would be called CommonMuni, in a discussion paper released Friday.
The paper, "Lowering Borrowing Costs for States and Municipalities Through CommonMuni," was written by Andrew Ang, a finance professor at Columbia Business School, and Richard Green, a financial economics professor at Carnegie Mellon University, and was released by the Brookings Institution Friday.
The paper targets two problems in the municipal bond market: an illiquid secondary market and inconsistent, opaque information on issuers and their financial wellbeing.
These problems, absent in other bond and asset markets, can be eased with old-fashioned voluntary cooperation, the authors argue.
When issuers join forces and streamline their disclosure policies and securities, they will benefit from the natural economies of scale that will reduce borrowing costs, they said.
The authors started their work following the creation of the Municipal Securities Rulemaking Board's online EMMA system, which started in July 2009.
While parsing the data on EMMA, the authors found illiquidity in the secondary market that they said increases costs for issuers and investors alike. The authors found municipal securities are almost twice as expensive to trade today than during the 1920s, when some were listed on the New York Stock Exchange. The cost of this illiquidity adds about $30 billion a year for market participants, they said in the paper.
"It's horrendous," Ang said in an interview Friday. "It's very hard to come up with any other example of a financial security which is more costly to trade today" than it was 80 years ago, he said.
The authors believe CommonMuni can be created with just $25 million. They claim the resulting savings would be in the "tens of billions" of dollars.
The muni institution would be modeled on the nonprofit organization Commonfund, a coalition of college endowments started in 1971.
CommonMuni would provide issuers with financial advisory services. Participants would agree to best practices for disclosure and would explore how to streamline securities so that they trade more easily.
The authors said this voluntary participation has worked well for issuers who participate in municipal bond banks and similar state institutions that issue debt on behalf of smaller issuers.
Nonprofit institutions could be created at the state level, but the economies of scale would work best at the national level, they said.
The authors make recommendations that could rattle the way the muni market currently does business.
They would discourage serial bond issues and advanced refundings, transactions they claim contribute to illiquidity in the muni market. Such transactions are the enemy of homogeneity and "are not amenable to liquidity," Ang said.
The report also calls for a repeal of the Tower Amendment. The amendment, which was added in 1975 to the Securities Exchange Act of 1934, prohibits the Securities and Exchange Commission and MSRB from conducting pre-offering reviews of issuers' muni securities issues.
"CommonMuni would advocate for the repeal of the Tower Amendment," the authors said in the paper.
The two professors also believe the Governmental Accounting Standards Board, which establishes accounting and reporting requirements for state and local governments, does not go far enough.
GASB standards are voluntary but state and local governments must comply with them to get unqualified opinions from auditors on their financial statements.
Only 38 states require issuers to use GASB standards, the professors said. States like Kansas, New Jersey and Washington set their own standards, they noted.
"You want to present your liabilities in the most transparent way as possible," Ang said. "Transparency is a really good thing."