Borrowing Costs

Recently, a lot of attention has been placed upon the borrowing costs of municipalities. Congressman Barney Frank has held hearings and has threatened the rating agencies, attempting to cajole them into rating municipal bonds on the same plane as corporate bonds.

At the same time, California State Treasurer Bill Lockyer has stated a campaign to have that state start its own insurance program to insure municipal bonds issued by California municipalities. His analysis suggests that municipal borrowing costs could be reduced if the state operated its own insurance program.

It is very easy to fall into the trap of more government oversight and government sponsored enterprises will benefit the taxpayer. But the facts make one question whether these efforts are really sound.

According to data published by the Federal Reserve, from 1977 until 1986, the yield of the Bond Buyer index averaged 76% of the yield of "AAA" Corporate bonds. The range was 64% to 92%.

After the tax reform act of 1986 reduced marginal tax rates, the average from 1987 until June of 1993 was 79% with a high of 90% and a low of 72%.

In June of 1993, the Internal Revenue Service issued its "Final" Arbitrage Regulations. Even that did not materially change the spreads. From June of 1993 until the end of 2003, municipal yields averaged 77% of "AAA" corporate with a maximum of 88% and a minimum of 70%.

Since 2003, the average spread has been 81% with a maximum of 91% and a minimum of 76%. It does seem that the level has risen but not markedly so.

Proposals to "fix" the municipal market have been around for decades. Fortunately, most of them have not been put in place. And I seriously question whether more government programs will materially affect the municipal borrower's cost of funds. The "AAA" corporate and the Bond Buyer yield spreads have been among the most stable and consistent over the last 40 years.

Be careful not to fix something that is not broken.