Muni Bonds Pay-to-Play

President-elect Obama -- The municipal bond market still seems to be rigged in favor of those who "pay to play." It's been that way for 40 years. Why not clean up this part of the financial mess while you are cleaning up the rest? (If not now, when? If not you, who?).

The NY Times today has a prominent story on the "Nationwide Inquiry on Bids for Municipal Bonds" by Mary Williams Walsh. It starts:

The federal investigation that prompted Gov. Bill Richardson of New Mexico to withdraw his nomination as commerce secretary offers a rare glimpse into a long-simmering investigation of possible bid-rigging, tax evasion and other wrongdoing throughout the municipal bond business. Three federal agencies and a loose consortium of state attorneys general have for several years been gathering evidence of what appears to be collusion among the banks and other companies that have helped state and local governments take approximately $400 billion worth of municipal notes and bonds to market each year.

The original investigation related to the former Treasurer of New Mexico who resigned in October 2005 facing 21 federal counts of extortion. The NY Times story continues:

E-mail messages, taped phone conversations and other court documents suggest that companies did not engage in open competition for this lucrative business, but secretly divided it among themselves, imposing layers of excess cost on local governments, violating the federal rules for tax-exempt bonds and making questionable payments and campaign contributions to local officials who could steer them business. In some cases, they created exotic financial structures that blew up.

After the NYC fiscal crisis in 1975 and concerns about the municipal securities market, the Municipal Securities Rulemaking Board was created. In 1978, the Council on Municipal Performance produced, with the assistance of the law firm of Chadbourne Parke, a ten-volume study of the municipal markets, the Municipal Securities Regulation series. Referencing this study, a NY Times editorial called for greater regulation of the municipal bond market. Twenty years later, then-SEC Chairman Arthur Levitt said in a March 30, 1999 Speech:

Today, a new form of pressure exists on those who manage public funds. The pressure comes from the ever-escalating costs of political campaigns and the temptation to use control over public monies to raise funds to cover those costs. The pressure I'm talking about is "pay-to-play" - the selection of investment advisers to manage public funds based on their political contributions. I've been talking about pay-to-play since the very beginning of my tenure as SEC Chairman. Up until now, that discussion has focused on the municipal bond market. And, I'm proud to say that after a sustained period of cooperation between the private sector, self-regulatory organizations and the SEC, much has been done to address this insidious practice. Six years ago, the municipal securities business was rife with pay-to-play practices. Because of the importance of those markets, I placed banishing these practices at the forefront of our agenda, and in 1994, we approved the Municipal Securities Rulemaking Board's Rule G-37. It requires a two-year time out from doing business with a government client after a firm or its executives makes a contribution to an elected official. Some called the rule too strong a medicine. Well, when the patient is suffering and the fever is contagious, merely drinking a lot of liquids probably isn't the right or most effective solution. It's worth noting that a group of investment bankers were the first to confront the ethical implications of pay-to-play. They placed a voluntary ban on political contributions to officials with whom they did business. And just a few months ago, a group of financial advisors that help municipalities structure bond offerings met with me to announce a self-imposed ban on the same activity.

But Chairman Levitt followed up with a study of pay-to-play in the public pension area and he concluded:

Pay-to-play can be a powerful force in the selection of money managers of public pension plans. We found allegations of this activity in at least 17 states. Pay-to-play has affected both the largest of pension plans and the smallest of plans. The comptroller of a large state raised $1.8 million from pension fund contractors - many of whom are out-of-state. A former treasurer of a small state raised virtually all of his campaign contributions -- $73,000 -- from contractors for the state retirement system.

The SEC after Levitt doesn't seem to have dealt with the problem, as we read in today's NY Times that pay-to-play in the municipal bond market is "endemic", according to a retired IRS manager in charge of overseeing the market. This is not a victimless crime. There are undoubtedly beneficiaries of a lax regulatory environment. But taxpayers are paying for it.