Navigating a changing financial landscape
Updated: Feb 9, 2018
Over the last several decades, growth of the financial sector has vastly outstripped that of other sectors of the economy. In 1980, all financial assets in the U.S. amounted to four times all the real goods and services produced in the economy. By 2007, this financial wealth outnumbered real wealth by ten to one. The amount of outstanding state and local government debt in the U.S. has grown over the past twenty years at twice the rate of growth in the nation’s personal income.
The municipal market has also undergone significant structural change brought about by the consolidation of the financial intermediaries who underwrite municipal bonds and the manner in which they distribute these bonds to investors. Specific changes that public agencies have had to adapt to include:
The use of complex financial products, usually as alternatives to fixed-rate long-term borrowing, has grown substantially and continues to grow. Issuers, especially smaller, less sophisticated agencies, need to make decisions about products in the context of their unique service mission and risk tolerance.
The collapse of the municipal bond insurance industry. Many issuers that held these types of securities struggled to understand the scope of their risk because they lacked complete knowledge of their debt portfolio. More importantly, issuers, who are required to disclose to investors a downgrade of an insurer or security provider were hampered by incomplete knowledge and procedures, exposing them to potential violations of securities law.
Changes in short-term rate products. The disappearance of two main types of short-term products, variable rate demand bonds with bank liquidity support and auction rate securities, results in a slew of creative products that issuers are increasingly using. These include direct bank loans, LIBOR and SIFMA-indexed notes, and convertible commercial paper. While these products may help issuers avoid bank-related risks, they contain their own risks.
Swap agreements and interest rate hedges. Issuers failed to recognize the risk posed by the potential loss of refunding opportunities, the time and cost of restructuring, counterparty risks (e.g., issuers were required to make payments to Lehman Bros. on swaps that terminated because of their bankruptcy), standard and non-standard triggers or collateral posting, and the risks to an issuer’s liquidity therein.
Competitive vs. negotiated sales and new technology. Tools such as online ordering, which adds transparency to the retail investor segment and upgrades to the Electronic Municipal Market Access (“EMMA”) platform trade reporting capabilities, have expanded the information that issuers have about their bond sales, both during and post-issuance and eased some issuer’s aversion to negotiated sales. Supported by technology, issuers can benefit from exposure to these new sales processes, the role of different investor groups, and what it truly means to reach a broad investor base.
Despite these changes that have altered many critical components of the municipal market, and thus the ways in which public agencies borrow money for capital projects, the public agencies that are responsible for 75% of the infrastructure in the United States are still largely left managing these complex financial dynamics with spreadsheets and filing cabinets.
In order to effectively address the infrastructure needs of the United States, it is imperative that public agencies across the United States have modern tools that allow them to engage with the markets more efficiently, effectively, and transparently.