League of Cities Wants U.S. Money to Start Bond Insurer

Published September 1, 2009

The National League of Cities has asked the U.S. Treasury for a $5 billion interest-free loan to capitalize a new municipal bond insurer it plans to create.

With $5 billion in capital, Issuers Mutual Bond Assurance Co. would be the nation’s biggest municipal bond insurer. The next-largest companies include MBIA Inc. (capital base of $3.8 billion) and Assured Guaranty Inc. (capital base of $1.1 billion).

“Fifteen shareholder-owned municipal bond insurers have failed because of the intense pressure to produce 15 percent to 25 percent annual returns for their shareholders,” stated the preliminary business plan the group submitted to Treasury in May.

Bond insurance enables states and localities to use an insurer’s higher credit rating in exchange for payment of a one-time premium up front. It guarantees timely payment of principal and interest.

Rising Costs

During 2008 the insurers did less business as they sustained losses and write-downs. The spreads between top-rated and lower-rated debt widened, making it more expensive for issuers who otherwise would have used insurance to sell bonds.

“The flight to quality in all financial markets that ensued from the general economic decline made it either impossible or prohibitively expensive for small issuers with A or BBB credits to access the market,” the league said in its business plan.

“This is a bad idea for a couple of different reasons,” said Ryan Ellis, director of public policy at Americans for Tax Reform in Washington, DC. “The private sector already does this. They took a hit with everything that happened in the last year. But that doesn’t mean the government should get into it. If the hot dog business goes down, that doesn’t mean the government should get into the hot dog business.”

Various municipalities and several states, most notably California, are having difficulty making promised bond payouts and are saddled with other debt as well, but setting up an entity like the Issuers Mutual Bond Assurance Co. would just delay the problem, not fix it, Ellis says.

Passing Bad Debt

“What Congress is trying to do is to make it easier for state and local governments to pass along their bad debt on to everyone else,” Ellis explained. “Since there’s a private sector [market] already [insuring against] this, I don’t see how it’s a good idea for cities [and states] to avoid the consequences of decisions that they’ve made.”

Ellis said an economic downturn is no reason for the government to step into the business.

“Just because the domestic auto industry has taken a hit, it doesn’t mean that it’s a good idea for the government to step in,” Ellis said. “If a business goes down, someone else [from the private sector] will come in and service the need. There will always be someone willing to take your money. It may not be the same companies that were there 18 years ago. You may not get the interest rate that you want or expected [on the bonds], but welcome to the real world.”

Government Involvement Unnecessary

Though the idea of a municipal insurer might have some merit, federal government involvement isn’t needed, agrees Peter Coffin, who manages $9 billion in municipal bonds at Boston, Massachusetts-based Breckenridge Capital Advisors Inc.

“There’s a better way to do these things,” Coffin said. “If they want to have some type of cooperative structure, with the local governments aligned in some way to pledge support to create a bond insurer, then that makes sense.”

Coffin said bringing in a private insurer with experience with insuring bonds, unlike municipal governments, would be another way to improve such a venture, provided federal taxpayer money isn’t spent on it.

Ellis acknowledged some municipalities and other government entities are in financial trouble due to poor financial decisions made by previous administrations. Even so, he said, “To socialize [the financial difficulties] just kicks the can down the road to another administration. If you ran [for office] on [a call for] fixing the mess in the state capitol [or city government], you can’t complain when you come in there and it’s a mess. That’s what you ran on.”

Phil Britt ([email protected]) writes from South Holland, Illinois.