Jitters in the Bond Market
Homeowners stuck with 12% and 13% mortgages are rushing to re-finance at the current lower interest rates. This past week the Metropolitan Water District of Southern California decided to do the same thing--and got a rude shock.
MWD officials prepared to pay off $250 million of revenue and general-obligation bonds carrying interest rates of 8.5% and 9% and replace them with new bonds at rates of 7% or lower. The result would be a $30-million saving over the life of the bonds--a saving that could be passed on to municipalities and other local agencies in the form of lower water rates. But when MWD, along with many others, went out to sell the bonds this past week it could find no buyers. The municipal bond market had evaporated.
The market disappeared when bond brokers learned that Sen. Bob Packwood’s (R-Ore.) tax-reform proposal would apply the alternative minimum tax to interest income on all local and state bonds, including those already in investors’ portfolios. Further, Packwood’s measure was vague about timing.
The Finance Committee may have alleviated some of the fears when it later agreed to delay most tax changes until next year. Additionally, Chairman Dan Rostenkowski (D-Ill.) of the House Ways and Means Committee said that he would agree to put off any changes affecting municipal bonds until Sept. 1, 1986. But more action is needed, and quickly.
Government bonds have been a prime investment for the wealthy seeking to shelter their income. If a major rationale behind tax reform is to bring equity to the system, there is logic in making the very rich pay some tax on those investments. But the general public also has become active in the municipal bond market through investment trusts in recent years. Bond brokers fear that small investors may also be hit with the new tax.
Long-term, tax-exempt bonding has been a boon for state and local governments because the relatively low interest rates reduce the cost of financing public works such as buildings, highways and water projects. Subjecting the bonds to a minimum tax would decrease their allure and raise the cost of projects through higher interest rates.
Congress is far from fashioning a final tax-reform package. But some action is needed to soothe the jitters of the bond market and local and state government finance officials. Fairness would dictate that any tax be applied only on yet-to-be-issued bonds and not on those already purchased on the assumption that they would be tax exempt. Small investors, already paying a fair share of taxes, should be protected from the minimum tax.
The problem affects not only the Metropolitan Water District’s ability to refinance its existing bonds, but also all governmental entities that need money to go ahead with new projects. The Finance Committee should end the uncertainty when it meets today.
