Antitrust Probe of Municipal Bond Market

The first antitrust probe of the municipal bond market began in November, and except for one article from Bloomberg, it has been entirely ignored.

According to the Bloomberg article, the Justice Department's Antitrust Division is looking for evidence of bid rigging, that is, collusion between banks and brokers to fix prices on guaranteed investment contracts (GICs). GICs are arrangements by which local governments temporarily invest money from bond proceeds in instruments that pay more interest than the local governments are paying on the bonds.

The Antitrust Division suspects that banks arrange to submit "courtesy losing bids" so that the winning bidder pays less interest on the GIC than it otherwise would. There might also be a problem with other financial products purchased by local governments, such as derivatives.

The result is that local governments get less money from their GICs and, therefore, pay lower taxes on them. In other words, municipal taxpayers have to make up for lower returns, and the IRS gets less. The only winners are banks and brokers. And, perhaps, the candidates they support.

Banks and bond brokers are not allowed to do business with local governments if they have, directly or indirectly, given campaign contributions to their officials. But since there are no disclosure requirements, their lobbyists and consultants apparently can, although it's not legal. (See Municipal Securities Rulemaking Board (MSRB) Rules G37 and G38)

In addition to banks and brokers, investigators are looking into firms that advise local government regarding GIC bids and derivatives.

Another problem mentioned in the Bloomberg article is the failure of local governments to use competitive bidding for bond sales. Thirty years ago, 74% of bond sales were competitively bid; today, the number's gone down to 20%. Instead, local governments depend on brokers. Local governments are required to do competitive bidding on GICs, which is why collusion is the only way out of fair dealing.

The result of a failure to bid out bond sales is a lack of transparency in the bond process. As Patrick Born, Minneapolis's CFO, is quoted as saying, "when you don't have transparency you can have abuses."

Carol Lew, president of the National Association of Bond Lawyers, suggests that local governments consider whether GICs are the best investment for them.

Let's hope this investigation (which is an extension of a still ongoing investigation into municipal finance in Philadelphia) gets a lot of coverage, as Kit Taylor of the MSRB predicted at a COGEL session in early December. And let's hope that local governments reconsider the way they handle bonds, GICs, and other financial instruments, as well as their relationships with banks, brokers, and financial advisers.

Spread the word around.