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Policy Proposals

Lowering borrowing costs for states and municipalities through CommonMuni

February 25, 2011

 

The Problem

Municipal bonds are a critical generator of local infrastructure financing, but evidence suggests that the municipal bond market is inefficient, with borrowers and investors paying billions each year in unnecessary fees, transaction costs, and interest expenses. Moreover, it is difficult for bondholders to sell at short notice at a price close to the bond’s intrinsic value, requiring that borrowers pay more in interest to compensate.

The Proposal

With the aim of lowering borrowing costs, creation of a nonprofit organization called CommonMuni would provide individualized, independent, high-quality advice at fair market rates to municipal borrowers, coordinate market participants to promote liquidity, and disseminate information about the municipal bond market. Greater information about the financial conditions of issuing states and municipalities would generate greater bond availability as well as consumer and issuer interest in the bond market.


Abstract

States and municipalities throughout the United States depend on the municipal bond market to raise funds for important investments in America’s schools, roads and highways, hospitals, utilities, and public buildings. Additionally, many individuals rely on municipal bonds as a dependable investment. Evidence suggests, however, that state and local governments that borrow money by issuing bonds and ordinary investors who buy those bonds may pay billions of dollars each year in unnecessary fees, transactions costs, and interest expense due to the lack of both transparency and liquidity in the municipal bond market. The liquidity cost alone represents approximately $30 billion per year on the current $2.9 trillion stock of outstanding bonds. This paper proposes the establishment of CommonMuni, a not-for-profit, independent advisory firm that would reduce borrowing costs for municipalities and increase returns for investors by overcoming the difficulty individual municipalities and investors have in coordinating their actions and sharing market knowledge. CommonMuni would provide individualized advice, gather and disseminate information on bond issuers and transaction prices to increase transparency, and coordinate market participants to enhance liquidity in the municipal bond market. Importantly, CommonMuni could be started for roughly $25 million, just a tiny fraction of the potential benefits.