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    Tuesday
    Apr052016

    Municipal Bond Market Faces New Pressure

    A new federal rule could make it more expensive for governments to issue debt in a financial crisis.
    BY  APRIL 5, 2016

    Selling government bonds could become more difficult during the next credit crunch, thanks to a new federal rule outlining the kind of liquid assets that banks must hold in case of an emergency.

    The rule, issued Friday, greatly limits the kinds of municipal bonds that qualify in a big bank’s investment portfolio as "highly liquid" -- in other words, assets that can be sold quickly for cash. The new regulation was issued by the U.S. Federal Reserve, and is a modification of its previous proposal with the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation.

    There's no immediate negative effect for government issuers. But if and when the next credit crunch hits, it could become more expensive for states and localities to issue debt. That's because if fewer bonds qualify as highly liquid, there would be less market demand for them. And lower demand would mean higher interest rates for governments.

    “As long as munis continue to have a good risk-adjusted return for banks, they’ll continue to invest," said Chris Mauro, who leads RBC Capital Markets’ municipal strategy team. “It’s really when you’re entering a liquidity crisis and banks are running up against their limit: Unfortunately they may liquidate some of their municipal [bonds] as a result. And they’ll use those proceeds to buy highly liquid assets.”

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