Some of the most-traded municipal bonds may still gain approval as easily sellable assets that banks can use to show they can weather a credit crunch.
The Federal Reserve and the Office of the Comptroller of the Currency adopted liquidity rules today that bar debt issued by states and municipalities from being listed as high-quality assets that could sustain a bank through a 30-day squeeze. The Federal Deposit Insurance Corp. is also set to vote. Yet regulators haven’t shut the door completely: Fed staff recommended developing a new proposal that would allow the most easily traded munis to be included.
Regulators said they were buffeted by arguments to include munis, ranging from the debt’s low default rate to its stability during the financial crisis. Issuers and analysts have said the rule could depress prices in the $3.7 trillion municipal market by giving banks less incentive to buy bonds that finance schools, roads and public works.
While no munis are currently deemed high-quality liquid assets, “staff recommends developing a new proposal for public comment that would allow the most liquid municipal securities to be included,” according to a memo from Daniel Tarullo, a member of the Fed’s board of governors.
In the past month, the most-traded fixed-rate munis were from California, New York City, the Puerto Rico Sales Tax Financing Corp. and the Port Authority of New York & New Jersey, data compiled by Bloomberg show. Debt from Minnesota, Texas, Connecticut, Maryland and Illinois also rank among the 15 issuers whose debt changed hands most frequently.
To head off the vulnerability seen during the credit crisis, the Fed, the OCC and the FDIC based their liquidity rule on an accord reached by the 27-nation Basel Committee on Banking Supervision. The FDIC is also set to vote on the measures today.
Banks have four months to reach an 80 percent liquidity level at the start of the year, and will have two more years to reach full compliance. Treasuries, foreign-government debt and corporate bonds are among assets that will satisfy the requirements.
Banks have added more than $200 billion to their muni holdings since the start of 2010, more than any other type of investor, according to Fed data.
If that demand were to weaken, state and local officials argue that interest rates on their debt would rise. Benchmark 10-year yields are close to the lowest since May 2013.
A letter yesterday signed by 31 state treasurers said they were “concerned and dismayed” about the prospect of munis being excluded from the menu of liquid assets because it would boost their borrowing costs.