Demand for Municipal Bonds Sags
Confusion reigned throughout the municipal bond market for a second day Thursday in the aftermath of a Senate Republican proposal that interest on the securities, which are currently tax-exempt, be subject to the federal minimum tax.
Prices on some municipal bond issues recovered Thursday from their severe slump the previous day, but traders said that trading volume was a tiny fraction of customary levels.
“There was a flurry of trading early this morning, but since 9:30 or 10 a.m. the volume has slowed to a trickle,” said David Whitford, a senior bond trader for First Boston Corp.
“I’ve been in this room for a long time and I’ve never seen it so quiet,” said trader Dennis Boyle from the Merrill Lynch trading floor in lower Manhattan. Until the tax-exemption question is resolved, he said, “you can’t even be sure you’re offering the customer a tax-exempt product anymore.”
Trading Disrupted
Trading in the $600-billion market was disrupted Wednesday when Senate Finance Committee Chairman Bob Packwood (R-Ore.) proposed subjecting all tax-exempt interest to the federal alternative minimum tax. That 20% tax is generally imposed when a taxpayer uses tax shelters to reduce his or her income tax to below that rate; up to now, tax-exempt bond interest has not had to be counted as an applicable shelter.
A previous version of the plan would apply only to interest on municipal bonds acquired by a taxpayer after Jan. 1, 1987; the latest proposal covers all such interest.
Word of the change sent bond prices plunging Wednesday by three to five points, or $30 to $50 for every $1,000 in face value. Traders said that, as the market rebounded from those lows late Wednesday and early Thursday, trading picked up steam as institutional investors, skeptical about the seriousness of the Senate proposal, sought bargains. But once prices recovered early Thursday to “pre-Packwood levels,” as one trader put it, trading demand all but evaporated.
“No one wanted to sell what they owned at the lows,” said Thomas Sexton, deputy director of municipal trading at First Boston, “and no one wants to acquire a new position until the situation clears up.”
“It’s very difficult for our sales people to find purchasers,” added Neal Atterman, manager of municipal research at the investment firm of Kidder, Peabody & Co.
Active Player
One institutional investor that played the municipal market actively on Wednesday and Thursday was T. Rowe Price Inc., the sponsor of three tax-exempt bond mutual funds. Peter J. D. Gordon, manager of those funds, said he expected the market to gradually recover.
“What’s important is that the majority of participants, after having been shocked, can see there’s very little in this plan,” he said.
In Washington, Senate staff members indicated that word of the proposal had galvanized municipal officials, individual and institutional bondholders and lobbyists for other affected interests.
“Our phones are ringing off the hook,” said Ed Silverman, a legislative assistant to Sen. Christopher J. Dodd (D-Conn.), who fought a similar proposal in 1982. Dodd’s constituents include not only a large number of municipal issuers and bondholders but plenty of Wall Street executives living in Connecticut’s affluent southwest corner.
Ten of the committee’s 20 members criticized the proposal in a letter to Packwood as unlikely to raise significant new revenue and certain to harm localities in need of borrowed funds. The plan is “not warranted and should be immediately reversed,” the letter said. At least one more committee member, Sen. Russell B. Long (D-La.), did not sign the letter but is known to stand firmly against the tax.
Packwood agreed to bring the issue to the top of the committee’s agenda when it meets Monday morning, staff members said. But he indicated that he intended to fight for its survival. “I’m sure he’s going to vote for it,” said William Diefenderfer, GOP chief of staff of the Senate committee.
The market’s uncertainty disrupted the plans of at least two bond issuers to close their latest deals. The scheduled delivery to underwriters and investors Thursday of a $75-million offering by the State of Hawaii and a $307-million issue by the City of San Antonio were deferred, Hawaii’s to March 25 and San Antonio’s to March 31. The delay gives those issuers a chance to reconsider their borrowings if the committee fails to eliminate the proposal on Monday.
An estimated $4 billion more in such bonds awaits delivery and might be similarly deferred in the coming days, market participants said. Widespread cancellations or deferrals might even affect the market in government securities, since the U.S. Treasury sells a certain portion of its securities to municipalities investing the proceeds of tax-exempt bond issues.
Advised to Delay
“The Treasury has been allowing issuers to put off their (purchase) commitments,” said Ted Palatucci, manager of the national municipal bond group for Merrill Lynch & Co. “But that certainly has an impact on the Treasury’s cash flow and eventually impacts the government market” by forcing the Treasury to borrow more heavily.
Palatucci and other market professionals said they were advising municipal clients to avoid bringing new issues to market until the fate of the Packwood proposal is clear. On Merrill Lynch’s advice, the City of New York on Wednesday postponed the sale of $450 million in general obligation bonds.
“We’re hopeful that in a matter of days this issue will be resolved,” Palatucci said. “Barring that, it would be foolish for issuers to come to market. We tell them, no matter what happens, you’re going to be wrong--either you’re priced five or six points too cheap, in which case the investor gets a windfall, or too high, in which case the issuer gets a windfall and the investor gets hurt.”
