Muni bills might help liquefy ARS market

Fiduciary duty for municipal advisers is also being debated

Jun 7, 2009 @ 12:01 am

By Dan Jamieson

The House Financial Services Committee is considering a package of legislation to tighten regulation of the municipal bond market.

One bill, which would empower the Federal Reserve to act as the ultimate liquidity provider for variable-rate muni debt, might help mop up some of the estimated $200 billion of outstanding auction rate securities.

The legislation, called the Municipal Market Liquidity Enhancement Act, would be “one potential way to get at part of the [ARS] problem,” said Michael Decker, co-chief executive of the Regional Bond Dealers Association in Washington.

The draft legislation would provide a government backstop for new issues of variable-rate-demand notes if the proceeds were used for, among other things, the refinancing of auction rate securities.

Such notes have been widely used by issuers to cut financing costs. And many of the deals have been married with controversial interest rate swaps.

The liquidity backstop for variable-rate-demand notes historically has been provided by banks. The backstop is essentially a put feature that guarantees liquidity for holders.

With the credit crisis, though, some banks have withdrawn from the liquidity-providing business or don't have a high enough credit rating to provide the service, leaving the variable-rate-demand-note market in disarray, observers said. Holders have little liquidity, and new buyers are staying away.

That has left muni issuers stuck paying high rates without the ability to refinance.

The association estimates that about $400 billion in variable-rate-demand notes remains outstanding.

With the Fed acting as the ultimate liquidity provider, a “significant number of ARS issuers [could] convert to other variable-rate debt,” Mr. Decker said.

“The purpose [of a government-backed liquidity facility] would be to give buyers confidence,” said Michael Bradshaw, a partner at Kutak Rock LLP, a Washington-based law firm that works with muni issuers.

Some Republican critics of the bill, which is sponsored by Financial Services Committee Chairman Barney Frank, D-Mass., have expressed concern about putting taxpayers on the hook for muni debt.

At hearings last month, a Fed official said the central bank would be reluctant to backstop muni debt without an exit strategy. But the concern was dismissed by Mr. Frank, who pointed to the $183 billion of taxpayer funds sunk into New York-based American International Group Inc. with little in the way of planning.

“It's unlikely the Fed would end up owning many [muni] bonds at all” under the bill because the variable-rate-demand note market suffers from liquidity fears, not concerns over credit quality, Mr. Decker said.

Once the Fed steps in, liquidity concerns will dissipate, he said.

“And if [the Fed charged] a fee, it would make money on the program,” Mr. Decker added.

Also being considered is legislation to designate the Securities and Exchange Commission as the regulator of financial advisers who work with municipalities. The proposal would also impose a fiduciary duty on them. The bill, known as the Municipal Advisers Regulation Act, doesn't define “fiduciary.” But in what might be a preview of a similar debate affecting retail stockbrokers, industry interests such as the Regional Bond Dealers Association and the Securities Industry and Financial Markets Association of New York and Washington are pushing for a national fiduciary standard.

The bill, sponsored by Rep. Steve Driehaus, D-Ohio, directs the SEC to “prescribe means reasonably designed to prevent [behavior that is] not consistent with a municipal financial adviser's fiduciary duty to its clients.”

Although some state laws impose fiduciary duties on advisers, “the standard of care required of financial advisers is not always clear,” Martha Haines, head of the SEC's Office of Municipal Securities, said during testimony last month.

“I don't think [the Municipal Advisers Regulation Act] would impact us,” said Steven Apfelbacher, president of the Montgomery, Ill.-based National Association of Independent Public Finance Advisors and president of Ehlers & Associates Inc. in Roseville, Minn.

NAIPFA members, who don't engage in underwriting activity, already act as fiduciaries, he said.

“All those who provide advice [to issuers] should be regulated,” said Mr. Apfelbacher, adding that the proposed legislation isn't clear as to how investment bankers might be covered.

NAIPFA supports having the SEC, rather than a self-regulatory organization, oversee muni advisers.

Also being considered by the Financial Services Committee are the Municipal Bond Insurance Enhancement Act, which would establish a temporary government re-insurance program for private muni bond insurers, and the Municipal Bond Fairness Act, which would require credit-rating agencies to rate muni bonds similarly to corporate debt.

Observers said that the Municipal Advisers Regulation Act enjoys broad support. The outlook for the other legislation is unclear.

No companion bills have been introduced in the Senate.

E-mail Dan Jamieson at


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