“We now have three-quarters of public infrastructure financed on the state and local levels, and that’s a huge shift and very unique in the world. The municipal market exists because that is the way the financing of our infrastructure has worked out. I think we actually have a great market.”
Marcy Edwards, June 4, 2015 The Remaking of the Municipal Market
While enforcement could prosecute malfeasance, it remained an indirect instrument of regulation. The MSRB gained more concrete regulatory powers with the enactment of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act. There was more on municipal market regulation in this massive response to the Great Recession than in any federal statute since 1975, particularly in provisions requiring the MSRB to protect issuers and giving it authority to regulate municipal advisors. Dodd-Frank’s immediate effect was to reconstitute the MSRB to make it more responsive to the public. Board membership was increased from 15 to 21, with unregulated members such as issuers and investors outnumbering regulated broker-dealer, bank and advisor members.
It was the empowering of the MSRB to regulate municipal advisors that was seen as “a significant turning point in the history of the MSRB. We previously only had the responsibility to regulate dealer activity, and under Dodd-Frank, we now have the responsibility to create a regulatory framework for municipal advisors.” 34 Concern about the role of advisors grew out of episodes such as the Orange County default in which self-serving advice from investment bankers, consultants and financial advisors helped orchestrate the financial damage. The MSRB spent months drafting Rules G-42 and G-44 covering, respectively, the core standards for, and the supervisory and compliance obligations of, municipal advisors. In between came Rule G-43, which established duties and conduct of “broker’s brokers,” who served as market makers in an industry without an exchange. While the latter two are slated to take effect, Rule G-42 remains in draft, having gone through two rounds of comment.
Dodd-Frank also sought to extend SEC oversight of the municipal market. While the Office of Municipal Securities had functioned independently during SEC Chairman Levitt’s tenure, it later was incorporated into the Division of Trading and Markets. Following the Dodd-Frank requirement that it be restored to independent status, the Office worked on municipal advisors issues and contributed to the 2012 SEC Study of the Municipal Markets initiated by SEC Chair Elisse Walter.
Another innovation with roots in the Great Recession, as part of the Obama Administration’s recovery program, was the issuance of Build America Bonds (BABs), taxable municipal securities that provided special tax credits or subsidies. There were “neither fish nor fowl” questions about BABs and some suspected they were a ploy to roll back the tax exemption. As part of its ongoing educational initiatives, the MSRB systematically delineated how municipal rules applied to BABs and conveyed that information to both issuers and purchasers. Emblematic of the changing market is the fact that, in the first six months of the BAB market, some $35 billion worth were issued, on par with the value of the entire municipal market in 1975.
Although the 2008 financial crisis accelerated change in municipal securities regulation, continuity remained the dominant theme in the market overall. In one respect at least, the industry has made a striking return to the past. With the Great Recession having crippled the bond insurance industry, issuers and broker-dealers have returned to old methods of promoting bonds, making old-fashioned ratings agency presentations and investor road trips. Trading activity remains exceptionally light compared to the stock market, with most occurring within weeks of issue after which, in industry parlance, “all bonds go to heaven.” Price discovery, therefore, will remain a challenge, making the MSRB’s latest initiative, a best execution rule, difficult to implement if no less necessary.
Despite the fact that the municipal market remains comparatively less scandal-prone than its equities counterpart, perhaps the best known old story is the one of sensational defaults. If Harrisburg, Pennsylvania, Stockton, California, and Jefferson County, Alabama were somewhat overlooked in the lingering turbulence of the financial crisis, everyone noticed when Detroit filed for Chapter 9 in July 2013, the new largest municipal bankruptcy ever. Failures like this spurred the SEC to launch its 2014 Municipalities Continuing Disclosure Cooperation Initiative, designed to compel issuers and broker-dealers to take new disclosure rules more seriously. The resulting workouts also underscored concerns about the disclosure of unfunded pension liabilities, the subject of recent SEC enforcement actions in both Illinois and Kansas.
But the public showed little of the interest in Detroit that it did in New York four decades before, and even less alarm with the much larger default of Puerto Rican municipal issuers. Veteran participants in the municipal market seem even less concerned. Regular recourse to EMMA demonstrates that the vast majority of the state and municipality issuers have healthy balance sheets. That, perhaps, is the oldest news in the new municipal market. Unlike corporations, which fully participate in capitalism’s “creative destruction,” cities and states do not go out of business.
