Personal Finance: Muni Bonds Can Cost More to Trade Than Stocks

The Wall Street Journal via Dow Jones

Municipal-bond investors pay significantly more to buy and sell their securities than stock investors do, according to a new study by two Securities and Exchange Commission economists.

The study, presented yesterday by SEC Chief Economist Lawrence Harris at a conference in Ottawa, Canada, showed that individual investors trading tax-advantaged municipal bonds pay an "effective spread" of 2% of the securities' price.

That spread -- the difference between the price at which investors are buying and selling the same security -- is only about 1% for large municipal-bond trades and even lower for trades in the stock market, Mr. Harris argues.

"Municipal bonds are expensive" for individual investors to trade, according to the study, written by Mr. Harris and Michael Piwowar. Mr. Harris is on leave from his job as a finance professor at the University of Southern California, and Mr. Piwowar is on a temporary leave from Iowa State University.

The new findings come amid heightened scrutiny of the $1.9 trillion municipal-bond market. The SEC and National Association of Securities Dealers are investigating wide price swings and potentially large dealer markups in the bond market. And this week, the Municipal Securities Rulemaking Board is considering new rules to enhance transparency. About two-thirds of municipal bonds are owned by individuals directly or through municipal-bond mutual funds.

The study looked at a sample of 167,000 U.S. municipal bonds from November 1999 through October 2000. The study showed that it's relatively more expensive to trade bonds in smaller amounts than it is in larger amounts, the opposite of the relationship in the stock market.

The Bond Market Association said it welcomed the study, but found flaws in its results. "Since the study was conducted, a number of significant steps to increase transparency have been taken," the trade group for bond dealers said in a statement. The group suggested that the trading costs might have been lower if data had been collected more recently, because more muni-bond prices are being reported these days. The BMA also took issue with the comparison of bond and stock trading, arguing that the bond market is more complex and has far more issues that don't trade often.

The study traces the high cost of buying and selling municipal bonds to the increasing complexity of bond deals and the scarcity of real-time information available to investors. While stock investors are accustomed to seeing current prices, and government and corporate bond investors usually can find relatively current price data, municipal-bond investors rely on data from the previous day supplied by the MSRB.

If new rules are approved when the MSRB meets this week, public pricing information for most municipal bonds starting next year will be posted within 15 minutes of a trade. "We expect that ongoing regulatory initiatives to increase transparency in the municipal-bond market" will lead to improvements that will help individual investors, the study says.

"Large institutional traders generally have a good sense of the values of municipal bonds, whereas small traders do not," the authors wrote.