Subprime Crisis Provides Impetus to FHLB Legislation Push

Advocates of legislation to allow the 12 Federal Home Loan Banks to provide credit enhancement to small tax-exempt bond issuers contend it has the best chance of passage in years because of the tumult municipal bond insurers are facing due to the subprime mortgage crisis.

While big financial guarantors historically have shied away from backing smaller borrowers, the financial losses they have suffered due to the subprime crisis has made them even less able to insure small issuers, they said.

“Given the turmoil in the private bond insurance market, it is more important than ever that [the banks] be allowed to provide this service to municipalities,” said Rep. Sander Levin, D-Mich., the sponsor of legislation in the House said yesterday. “Our cities are on the front lines of the current economic slowdown and this legislation will help relieve some of the pressure on their already strained budgets.”

The turmoil escalated Friday when Fitch Ratings lowered the insurer financial strength rating on Ambac Assurance Corp. to AA from AAA. In addition, Moody’s Investors Service last week put its ratings on both Ambac and MBIA Insurance Corp. on watch for possible downgrade and Standard & Poor’s put Ambac on negative watch.

Advocates of the legislation, which now has 40 co-sponsors in the House and 10 in the Senate, concede that it is unlikely Congress will pass it as a stand-alone measure, but are hoping that it will clear the House and Senate as part of a stimulus package federal lawmakers are expected to craft in the coming weeks.

“It could be very attractive as something that’s part of the stimulus package,” said Charles A. Samuels, an attorney here at Mintz Levin Cohn Ferris Glovsky and Popeo PC, who has worked to organize a coalition of state and local groups to support it.

Still, Levin said lawmakers are still looking for the “appropriate legislative vehicle” for the proposal.

As introduced into both chambers, the legislation would change the federal tax code and allow any of the 8,100 member lenders of the FHLB system to issue letters of credit, which could be used to insure small tax-exempt industrial development bond deals or transactions involving small nonprofit health care facilities, colleges, or universities, according to supporters. It would put the FHLB system on the same level as Fannie Mae and Freddie Mac, two other government-sponsored enterprises that are permitted to issue letters of credit in support of tax-exempt bonds, they said.

Sixteen national organizations support the proposal, among them the National Association of Counties and the National League of Cities, as well as an additional 75 state agencies and conduit issuers.

Meanwhile, the debt committee of the Government Finance Officers Association, the largest issuers group, is going to consider a policy statement supporting the bill at its winter meeting here this week, said Susan Gaffney, GFOA’s federal liaison director. Members of the committee believe the proposal is important for small and midsize communities, she said.

If the GFOA’s debt committee approves the statement this week, the group’s executive board would vote on it in the spring, after which the group’s membership would have to approve it at their annual meeting in June.

“A lot of my borrowers are unrated and could benefit tremendously from access to these letters of credit,” said Robert Donovan, executive director of the Rhode Island Health and Educational Building Corp. “Small, in-state banks may not have been an active player in the bond market before, but if they’re able to access the federal home loan banks’ [triple-A] credit rating, it gives them an alternative to seek some enhancement for smaller deals.”

Donovan said the deals would be snatched up by money market funds and mutual funds and, in some circumstances, perhaps even retail investors.

The push to amend the federal tax code to allow bonds to be credit-enhanced by the banks comes after the Internal Revenue Service began auditing deals in which the banks had issued what it dubbed “illegal federal guarantees” on the bonds. Currently, only housing bonds can be backed by a federal guarantee and still retain their tax-exempt status.

Though the FHLB system does not have an estimate of the volume of bonds that could be enhanced by the banks, the Congressional Budget Office has estimated that $6 million would be diverted from federal coffers if the banks were allowed to provide letters of credit for tax-exempt deals.

Still, the argument that several localities have been historically shut out of capital markets has been rejected by the insurance industry, which argues that the market is already well-served by efficient private firms.

The Association of Financial Guaranty Insurers, an industry group, has said that the legislation would reduce the fiscal discipline that capital markets currently impose on issuers and would significantly limit the tax revenue currently paid to the federal, state and local governments. In addition, the group claims, the legislation would create a double government tax subsidy: the bonds would retain their tax-exempt status and would also be backed by a GSE.

Bob Mackin, AFGI’s executive director, said yesterday that his group’s position against the bill remains unchanged.

“It’s bad tax policy,” he said.

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