Why The Volker Rule Is Good For Municipal Bonds Buyers

(February 2012) There have been a number of articles talking about the unintended consequences of the Volker Rule on the municipal bond market. Critics of the Volker rule say that the it will hurt the ability of municipalities to raise money through debt offerings or at the very least force them to pay a higher yield to do so.

Lets see why. When municipal bonds are original sold, they are often done so in what is called a negotiated sale. Banks and brokerage firms buy big chunks of the bond offering and then turn-around and sell the offering to their retail clients WITH A NICE MARK-UP. In theory (although, I am not sure how many times in practice), the brokerage firm or bank could lose money on the bonds when re-selling them to their clients. The Volker Rule limits this sort of activity; it is trying to curb the amount of risk-taking (exposure to the market) that a bank with client deposits take part in.

The actual law provides and exemption for about 60% of municipal bonds, but because of the exact language, agencies such as independent sewage and water authorities are not covered by the exemption.  In these cases, the underwriters of the bond would have to solicit bids from institutional and retail investors to take part in the primary offering for the bonds to be sold.

Here is my take:

The objections to this rule are by a bunch of sell-serving underwriters and brokerages that don’t want to give up a relatively low-risk, but highly profitable way of doing business.

False: Raising money will be more difficult for some municipal entities.

No. Demand for Municipal Bonds outstrips supply by something like 3 to 1. Yes,  brokerage firms and underwritters will have to change their internal practices, like letting retail investors know about primary bond offerings in advance and making it easy for them to participate. Yes, there may be a couple offerings that have problems, while processes are re-worked. However, this is a small technical problem – not a reason to stop the Volker Rule. The winners from this will be retail investors who are able buy bonds without paying a mark-up.

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