ALERT: HFSC Hearing on "Legislative Proposals to Improve the Efficiency and Oversight of Municipal Finance"

May 22, 2009

On May 21, 2009, the House Financial Services Committee held a hearing entitled “Legislative Proposals to Improve the Efficiency and Oversight of Municipal Finance.” The following is a brief summary. [1]

Prior to the hearing, the Chairman distributed drafts of four pieces of legislation:

(1) The Municipal Bond Fairness Act, which seeks to ensure a consistent rating system is applied to municipal and corporate bonds;

(2) The Municipal Bond Insurance Enhancement Act, which creates an Office of Public Finance in the Treasury Department to provide reinsurance coverage for insured losses of qualified municipal bond insurers;

(3) The Municipal Bond Liquidity Enhancement Act, which provides the Federal Reserve with the necessary authority to create a lending facility for the purchase of certain variable rate demand obligations and short-term bonds issued by a municipal issuer; and

(4) The Municipal Advisers Regulation Act, which would permit the SEC to regulate municipal financial advisors.

Panel 1:

Ms. Martha Mahan Haines, Chief, Office of Municipal Securities, U.S. Securities and Exchange Commission

• The SEC is concerned about conduct of some municipal financial advisors, including “pay to play” practices, undisclosed conflicts of interest, advice rendered by financial advisors without adequate training or qualifications, and failure to place the duty of loyalty to their clients ahead of their own interests. SEC’s current statutory authority limits their ability to address these concerns adequately. An expansion of authority under the Municipal Advisers Regulation Act would provide tools to address these problems, including the clarification of the specific duty of care that a financial advisor owes to its client.
• The SEC staff stands ready to provide technical assistance to the committee on the Municipal Bond Fairness Act.

Mr. Bill Apgar, Senior Advisor to the Secretary, Department of Housing and Urban Development

• The lack of liquidity and other constraints within the municipal bond markets have severely hindered the ability of state and local Housing Finance Agencies to achieve their mission of facilitating the availability of affordable mortgages and rental housing and could undermine the housing and economic recovery.
  
  
• While the Administration is not yet able to take a position on the proposed legislation, taking appropriate steps to improve the functioning of the municipal bond market can be an important component of our overall response to the current housing crisis.

Mr. David W Wilcox, Deputy Director, Division of Research & Statistics, Board of Governors of the Federal Reserve System

• If Congress chooses to address strains in the municipal bond market, the most productive actions would be ones that address the weakened fiscal condition of the issuing municipalities, the diminished financial strength and capacity of the financial guarantors, and the reduced availability and higher costs of liquidity backstops and credit enhancement from banks and other financial institutions.
  
  
• Congress may wish to bear in mind as it considers future action is the degree to which government involvement in this market is appropriate in the long term. If Congress determines that other financial structures will likely be more robust under adverse market conditions, then it may choose to tailor any government intervention in the municipal bond market relatively narrowly, aiming, for example, to encourage market participants to seek private-sector solutions, if possible, and to facilitate the government’s exit from the market.

The Honorable Thomas C. Leppert, Mayor of Dallas, Texas on behalf of the U.S. Conference of Mayors

• Credit rating legislation will better ensure equality in the rating system and will spur increased investment in municipal bonds. Ensuring that rating agencies use uniform and accurate credit ratings for all securities will lower borrowing costs and make it easier for new investors to participate in the municipal securities market. The Conference of Mayors fully supports this legislation.
  
  
• The Municipal Bond Insurance Enhancement Act would help increase the capacity of municipal bond insurers to insure new risks and thereby make it easier for issuers, particularly small issuers, to borrow in the capital markets.
  
  
• The liquidity legislation to create a federal liquidity facility for outstanding variable rate demand notes would greatly help this sector of the market. It would fill the vacuum created by the absence of private sector providers and provide the Treasury Department authority to purchase these notes so that issuers do not have to continue to pay enormous amounts every time these products must be remarketed, saving local governments a tremendous amount of money.

Mr. Ben Watkins, Director of State of Florida Division of Bond Finance, State Board of Administration, Florida

• It is essential for investors to have an apples-to-apples comparison on credit quality for municipal and corporate securities. The GFOA supports this legislation as it will help many governments, especially smaller, lower rated governments sell debt at more affordable rates and save taxpayers money.
  
  
• There would be value in assistance to obtaining affordable bond insurance for the municipal bond market. Supporting some form of municipal bond insurance would help address the problems governments currently face with market access and will lower the cost of borrowing.
  
  
• The liquidity legislation would greatly help governments with outstanding variable rate obligations that need to be restructured, and also would aid in the restructuring auction rate securities. GFOA and many municipal market participants believe that the Federal Reserve and the Treasury currently have the power to assist this market and state and local governments; however, the Act’s specific call to create programs for these instruments is tremendously beneficial.

Questions & Answers

Chairman Frank (D-MA): Interested in a suggested state and local government-owned municipal bond insurer. Stressed that relief must be brought to municipal governments through the bond markets, as this is a much relied upon source of financing for infrastructure and governmental services.

Rep. Bachus (R-AL): Asked the Mr. Wilcox, Federal Reserve, about its concerns related to reinsurance. His concerns were: (1) the Federal Reserve’s need to preserve independence and being able to protect its creditworthiness as a central bank; (2) the need for the programs to have clear exit strategies so as to control bank reserves in the future and (3) the need to protect the Federal Reserve’s balance sheet from the risk of losses He also asked Ms. Haines, SEC, how quickly a financial advisor registration/examination process could be created. She said that it could be done “promptly” once given authority.

Rep. Posey (R-FL) asked why municipal bonds are now a part of the economic crisis and why the government should get involved.

Ms. Haines, SEC, responded that there is a need to protect investors.

Mr. Watkins, Florida Bond Finance, responded that states and local governments currently cannot borrow money for infrastructure projects.

Mayor Leppert responded that we need a going-forward policy to provide short-term financing.

In response to a question from Rep. Putnam (R-FL), Mayor Leppert said that the length of the any municipal bond market government enhancement must be market-driven and not for a specific period of time.

Rep. Capuano (D-MA) commented that corporate and municipal bonds should be rated based on the economics of the security and the ability for the issuer to pay. He also said that the relief provided by the bills is for 2010 or 2011 and that relief needs to be more immediate.

Rep. Scott (D-GA) stressed the importance of the legislation and that the lack of funding was posing problems on projects in his district, including the financing of a new terminal at the Atlanta airport. He stressed that without assistance, there could be thousands of jobs at risk.

Rep. Campbell (R-CA) asked the Federal Reserve about the moral hazard of interfering with market principles.

Rep. Green (D-TX) asked the SEC about “pay to play” and Ms. Haines replied that the proposed legislation would give the SEC the needed authority to address “pay to play” with civil remedies.

Rep. Perlmutter (D-CO) asked the Federal Reserve to explain why it had decided to give assistance to Bear Stearns and AIG under the authority granted by Section 13(3) of the Federal Reserve Act but not for Lehman Brothers or the municipal bond market. Mr. Wilcox replied that in making such a determination, the Federal Reserve first determines whether a problem requires a fix, and then whether the Federal Reserve is the proper entity to provide assistance. He said that the Federal Reserve gets its direction from Congress and the authority it is granted. In addition, the historical and factual circumstances will dictate the action taken. If an entity has received TARP funds could change the outcome. In the end, the Federal Reserve’s determination will be based upon whether a particular entity’s viability poses a threat to the stability of the financial market.

Panel 2:

Mr. Michael J. Marz, Vice Chairman, First Southwest Company on behalf of the Regional Bond Dealers Association

• The RBDA supports the four draft bills. The legislation would offer the municipal market targeted and temporary assistance for those sectors still acutely affected by the credit crisis and would provide federal accountability for all financial professionals by addressing long-standing holes in the regulation of the market. The bills to address the variable rate municipal bond market and to establish a regulatory system for municipal financial advisors are especially important in the current market environment.

Ms. Laura Levenstein, Senior Managing Director, Moody’s Investors Service

• Moody’s investors and issuers have indicated for many years that they wanted ratings to draw finer distinctions among municipal bonds, which generally have had a lower credit risk when compared to corporate or structured finance obligations. It is for this reason that there is not necessarily ratings comparability between municipal and non-municipal bonds.

Mr. Keith Curry, PFM Group, Managing Director

• There is no demonstrated need for registration and regulation to protect investors. Every publicized instance of abuse of investors or municipal issuers in the last decade has involved broker firms which already were registered with the Commission.

Mr. Alan B. Ispass, PE, BCEE, Vice President and Global Director of Utility Management Solutions, CH2M Hill

• Utilities have had significant declines in revenues due to foreclosures and reductions in commercial and industrial water use while there are an estimated $600 billion of investment needed in our nation’s water and wastewater infrastructure. Accessibility to the bond market is now a problem for many utilities. Reinsurance program provides a mechanism for allowing many municipal borrowers with less than top credit ratings to move forward with their capital programs.

Mr. Sean W. McCarthy, President and Chief Operating Officer, Financial Security Assurance, Inc.

• A focused, short-term program providing reinsurance for insured losses of qualified municipal bond insurers would result in more affordable financing to state and local governments needed to provide basic municipal services. A temporary liquidity facility would also lessen the burden on municipal issuers.

Mr. Bernard Beal, Chief Executive Officer, MR Beal & Company on behalf of The Securities Industry and Financial Markets Association (SIFMA)

• Lower-rated state and local government issuers face a critical need for reliable liquidity facilities and long-term credit enhancement, and the lack thereof is making it difficult for them to bring transactions to market. Such a delays important infrastructure projects SIFMA supports the proposed pieces of legislation. They offer constructive solutions to assist state and local issuers gain access to capital markets and address important regulatory, ratings matters and market access issues.

Ms. Mary Jo Ochson, CFA, Senior Vice President, Chief Investment Officer for the Tax-Exempt Money Market and Municipal Bond Investment Groups and Senior Portfolio Manager, The Federated Funds

• Liquidity legislation would assist (1) current and any future VRDO issuers struggling with the “bank bonds” problem, and (2) issuers that may be unable to have market access to sell cash management notes. We agree with the approach of letting issuers of cash management notes first come to market, and then if they are not able to sell their notes, invoking the support facility.

Mr. Mike Allen, Chief Financial Officer, Winona Health on behalf of Healthcare Financial Management Association

• Access to an efficient tax exempt bond market is very important to the hospital industry and by extension to achieving the nation’s healthcare goals. Eighty-five percent of all hospitals are not-for-profit. Facilitating access to stable and inexpensive sources of capital funding will reduce the cost of healthcare ensuring access to hospital care for all patients. Further, without reliable funding, it will be difficult for providers to implement electronic health records and take other steps needed to facilitate health system reform.

Mr. Sean Egan, Managing Director, Egan-Jones Ratings Co.

• While the rating agency legislation is directly within its market niche, all of these proposals are directly related to the performance or, more precisely, the lack of credible performance by S&P, Moody’s and Fitch in the execution of their core mission to produce accurate and timely credit ratings.

Questions & Answers

Chairman Frank (D-MA) asked Ms. Levenstein, Moody’s, to explain how there can be lower rated municipal bonds with a better credit risk than higher rated corporate bonds. He then asked Ms. Ochson to explain a factual assertion in her testimony about municipal bond defaults in the 1970s.

Congressman Sherman (D-CA) said that the legislation needs to assist 501(c)(3) entities in addition to state and local governments. Chairman Frank replied that they will.

Rep. Ellison (D-MN) asked about the reinsurance legislation. Mr. McCarthy replied that the reinsurance program will be only for municipal bond insurers and not for asset-backed securities. In addition, he added that other municipal bond insurers faced current difficulties because they were involved in asset-backed securities and collateralized debt obligations and that FSA was succeeding because it was focused on the municipal bond market.