MUNICIPAL BOND FINANCING ISSUES Municipal bonds are issued by

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MUNICIPAL BOND FINANCING ISSUES Municipal bonds are issued by Powered By Docstoc
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MUNICIPAL BOND FINANCING ISSUES Municipal bonds are issued by states, cities, and counties, or their agencies to raise funds for capital improvement projects and the maintenance of city services. The subprime mortgage crisis has imposed serious disruptions in the municipal bond market that have affected the ability of local governments to finance infrastructure and meet other capital financing needs. While a number of provisions were included in the American Recovery and Reinvestment Act of 2009 (ARRA) to provide incentives for banks and other corporation to purchase municipal bonds, one critical and outstanding issue that must be remedied is the provision of municipal bond insurance. While the historic risk involved in municipal bond investment is negligible (the municipal default rate is about 20 times lower than investment grade securities in the corporate sector), local governments that issue municipal bonds often choose to purchase bond insurance to enhance the security of the bond to bond purchasers and because of the exceptional ratings of bond insurers lower their borrowing costs. For example, a bond that is insured will have a higher credit rating than a non-insured bond. The higher credit rating (AAA for example) enables local governments to pay a lower interest rate on the bonds when they are sold. While the purchase of bond insurance by local governments has been a routine practice to lower the cost of borrowing and fund critical local projects, this practice has been severely impacted by the subprime mortgage crisis. Nearly all of the bond insurance companies that local governments relied on to provide highly rated insurance are the same institutions that also guaranteed the payments on securities backed by subprime loans. As a result those insurance companies have seen a downgrading of their investment rating or have ceased business operations entirely. Thus, the benefits of insurers' bond insurance are lost and the cost of borrowing for local governments utilizing bond financing increases. Further, with few highly rated insurance providers available, local governments, who are already facing severe budget constraints and fewer investors in the marketplace, must now assume increased borrowing costs. Seeking Solutions In the midst of this crisis and absence of bond insurance providers, local governments are working to develop creative solutions to enable jurisdictions to continue to finance important local projects and maintain vital services to residents. • One solution is to urge the U.S. Department of Treasury to act as a temporary guarantor of municipal bonds exercising authority granted to Treasury under the Emergency Economic Stabilization Act of 2008 (P.L. 110-343). Another solution gaining momentum among the national local government organizations is the creation of a mutual guarantor for municipal bonds. The proposed entity could insure new, fixed-rate securities covering general obligation bonds and revenue bonds issued by cities, counties and school districts and revenue bonds sold to finance essential governmental services such as water and sewer facilities. Such a voluntary, national mutual insurance


company owned and operated by local governments would have many advantages. It would be mission-driven rather than profit-motivated with the objective of minimizing borrowing costs paid by its members. Federal capital support would be needed to establish such a guarantor. • Another solution identified, though it comes with significant limitations and costs, is to provide bond security in place of highly rated bond insurance is a letter of credit (LOC). Under this arrangement, a bank providing a LOC lends its own credit rating to the bond issuer. However there is only one bank (Union Bank of California) that will extend a LOC and they will only provide such a letter to cities and counties with a Moody's Investment Grade rating of 1 (MIG-1) or better. This means that a number of local governments—in many instances those with the greatest need for bond financing assistance—will not be extended support. In addition, costs will be higher for those cities and counties that are able to participate, as the cost of obtaining a LOC versus securing bond insurance is higher.