Looking Past Libor
The Municipal Securities Rulemaking Board is hoping to help arm issuers with more information before they borrow money.
$6 billion. That's how much state and local governments have lost to date, thanks to the rigging of "Libor," the London interbank offered rate. Interest rates for floating bonds and swaps are pegged to Libor, which is set by polling London bankers. State and local governments relied on that poll-based rate as their benchmark when they invested in such complex financial instruments as interest-rate swaps, or bets on the direction of interest rates. This $6 billion loss comes on top of the $4 billion that muni borrowers have already paid big banks to close out derivatives trades that went bad, partly because of Libor manipulation.
But the now-infamous Libor isn't the only index state and local governments use as they go about the business of investing and borrowing money. Municipal bond issuers, for example, also rely on indices that benchmark the tax-exempt interest rate they pay investors for bonds. But how reliable are these indices and how do they work? J.R. Rieger, a vice president at Standard & Poor's (S&P), answered these questions in a recent interview.
What's the role of indices in the muni bond market?
There are a lot of different benchmarks in the municipal bond market. Some are for investors to track performance, and then there are indices for a base rate for auction and variable-rate bonds. Those are the ones muni issuers should be aware of. When there's a variable-rate issue, there's typically an index chosen to use to set a base rate for what the periodic interest rate should be. The two primary indices used come from SIFMA [Securities Industry and Financial Markets Association] and S&P. Libor, to my knowledge, is not used as a base rate for muni bonds.
How does the S&P index determine its base rate?
We use observable market inputs. We track actual bonds or the coupon being paid on those bonds and average them based on straightforward math. This is a rules-based index and it's transparent. The methodology is published on the Web and anyone can look at the values and other information institutions use. Muni issuers can find the data easily on S&P's website.
How is it like or unlike the Libor process?
You can't compare it to Libor. We identify real bonds by characteristics and put them into an index. We average the rates to produce our base rates. We do not use a polling process -- that's very important. We publish everything. Everyone knows how the index is run and what the results are.
Help for Issuers
As big a problem as Libor has been and continues to be for state and local governments, the concerns about the future stability and integrity of the municipal bond market now revolve around establishing further protections for investors. The Securities and Exchange Commission (SEC) and the Municipal Securities Rulemaking Board (MSRB) have taken and will be taking additional steps to provide those investors with more material to keep them from making a grievous error or being taken advantage of, including requiring better financial disclosure by issuers.
But what about the issuer? Arguably, the Harrisburg, Pa., and Jefferson County, Ala., debacles can be traced in part to poor, misleading or incomplete advice given state and local officials. That is, officials were lured into using sophisticated financial vehicles that were difficult to understand, particularly when it came to the risk of those vehicles. It would be a stretch to say MSRB is now riding to the rescue of bond issuers. But the board is making efforts to help them by providing additional basic information about what happens when they borrow money. The online toolkit for state and local governments, which was launched last year, was expanded this fall. It now includes an overview of the roles and responsibilities of the many financial professionals involved in municipal bond transactions, a tool for tracking trading activity of municipal bonds in the secondary market and information on key market regulations, among other resources.
According to MSRB, the centerpiece of the expanded toolkit is the EMMA (Electronic Municipal Market Access) Trade Monitor. It allows state and local governments to export trade data from the EMMA website to a desktop application for analysis of secondary market bond trading activity. State and local governments can use the downloaded data to analyze the prices, yield and amount of secondary market trade activity of municipal bonds in support of, among other things, evaluating pricing for their new issues. There's also help in understanding municipal market indices, yield curves and muni benchmark data.
The toolkit may help with the basics, but it still doesn't address the trickier issue: How to help state and local officials who are tempted to cut borrowing costs by using risky and ultra-sophisticated financing tools -- tools they may not fully understand and that only a small percentage of Wall Street bankers comprehend.
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