Joe Mysak is a columnist for Bloomberg News. The opinions expressed are his own.

Can the Muni Market Be Made Safe for Investors?: Joe Mysak

Feb. 13 (Bloomberg) -- If you are an individual investor in the municipal bond market, you pay too much in fees for your bonds.

You pay about double what the institutional investors do, about 2 percent of the value of the securities you buy.

That's because there's little price transparency in the municipal market, and also because municipal bonds are by their nature too complex for their own good. There are too many variables such as maturity, coupon, calls and credit enhancement.

This is the conclusion of a report on ``Municipal Bond Liquidity'' by Lawrence E. Harris, chief economist of the Securities and Exchange Commission, and Michael S. Piwowar, a visiting scholar in the SEC's Office of Economic Analysis, published this week.

The report was based on an analysis of 167,000 trades reported to the Municipal Securities Rulemaking Board from November 1999 through October of 2000.

``Unlike in the equity market where the unit costs of trading increases with trade size, we find that small trades are substantially more expensive than large trades,'' the report says. ``We attribute the difference primarily to the lack of transparency in these markets.''

Leap Forward
None of these are stunning revelations to anyone familiar with the municipal market. What's nice is that they are being made at all, and by the Securities and Exchange Commission.

The release of the study comes on the heels of a speech by Cynthia Glassman, an SEC commissioner, in which she urged municipal-market professionals to ``get to the end of the transparency timeline.''

The MSRB plans to release price information within 15 minutes of a trade beginning in January of 2005. The board began releasing information on the prices of certain bonds, on a one- day delay, in 1995.

That represented a great leap forward for the market. Before that, the market, that is, the secondary market for bonds that had already been sold, was opaque. It existed almost as a theoretical abstraction, unless you were familiar with a professional dealer's publication called the Blue List, which listed dealer inventory, and knew how to read it.

Now You See It
The new SEC study, at least as far as transparency goes, is almost irrelevant. The municipal market is now more transparent than it has ever been, and promises to become more so.

The real heart of the matter is, Now that you can see it, do you like what you see?

That's a little more problematic. Every day, you can trawl through the MSRB's summary of the previous day's trades and come up with examples of wide price disparities that leave you wondering, and not just on weird bonds, or distressed bonds, or unknown bonds, but on some well known, widely held bonds.

The most important paragraph of the new SEC report is this one: ``The impact of bond complexity -- attached calls, sinking funds, credit enhancement, etc. -- on liquidity is particularly notable. Buy-side traders incur significantly higher transaction costs when trading complex bonds than when trading otherwise simple bonds,'' the study says.

And then the clincher: ``These results suggest that issuers may be able to raise funds at lower cost by creating simpler bonds.''

Bankers, who have spent the better part of the past two decades selling issuers on more and more complex securities as the best way to bring down borrowing costs, will likely have other opinions.

Made Safe
What all this newfound scrutiny of and concern about the municipal bond market really boils down to is one question: Can the municipal bond market be made safe for individual investors? Or is it really, deep down, something that will always and forever be a market dominated by professionals?

Consider some bonds sold by the Port Authority of New York and New Jersey that traded recently. These are the consolidated revenue bonds the Port sells regularly, backed by the fees it collects at New York area airports and tunnels, among other things.

In other words, these are very solid bonds. As if that were not enough, these bonds are also insured, and so rated triple-A as to payment of principal and interest: the gold standard.

The bonds were sold in 1998, and carry a 4.25 percent coupon due in 2026. They were originally priced at 92.16 to yield 4.76 percent, and are callable at 101 in 2005, and at par in 2007.

What's the Price?
What's the price? On three days last week, the bonds were worth 92.5, 95, 95.5, 96, 96.5, and 98, depending on where you sat in the transaction and how many bonds you were buying or selling. This week, the bonds were worth 91.765, 92.856 and 96.5. Over the two weeks, the yields ranged from 4.38 percent to 4.79 percent.

That seems to be a pretty big gap for some very secure and generic securities.

Let's say I am the guy who sold $100,000 of his bonds at a price of 92.54, to yield 4.79 percent. Did I get a fair price?

In order to find out if I did, I'd have to compare my bonds with other securities of similar quality, maturity, coupon and block size. You know what? You find another 4.25 percent bond maturing in 2026. These bonds were originally priced at a significant discount, but most buyers are going to look at that coupon, and right now, insured revenue bonds maturing in 20 years yield 4.60 percent.

And remember, the Port Authority bonds are comparatively simple.

Last Updated: February 13, 2004 00:02 EST