Munis 101: Basic Self Defense

One bank executive calls it "a cross between an oriental bazaar and a Charlie Chaplin movie." Other market watchers just shake their heads and mutter about chaos. "It" is the system for trading municipal bonds--the Wall Street equivalent of a huge used-car lot.

Unlike the New York Stock Exchange, where 2,089 common stocks are listed, and NASDAQ, where about 4,900 issues trade, there is no central marketplace for trading the 1.5 million different municipal bond issues, only a fraction of which get regular coverage in the press.

While some newspapers list the most actively traded munis, most smaller, obscure issues get little notice, and the average investor cannot track prices daily--or even weekly. For the individual investor, "there is no data base, no listings, no computer programs," says James J. Cooner, senior vice-president in charge of tax-exempt securities for Bank of New York. Since brokers and dealers act as principals, buying and selling from their own inventory, Cooner compares the muni market to the collectibles market, where pricing is highly subjective. Individuals may take a beating when selling into the market, since the markup and costs passed along by a broker can be sky-high for trades of fewer than 100 bonds or less than $100,000 in face value. It's difficult to know what markup an investor is paying, since all costs are worked into the bid or offer price.

The muni market plays by its own rules. While many investors assume that one broker's bid or offering price on a bond will be much like another's, that's not how it works. John F. Martin of Key Biscayne, Fla., a longtime investor in munis, says he has seen a difference of as much as $45 to $50 per $1,000 on the same bond issue. "The ones bidding aggressively were specialists in that bond and knew they had customers that they could sell it to," says Martin. "The others figured they would just have to sell it to another bond house, and they had to be able to sell it cheaply enough." Says Robert B. Lamb, a professor of finance and management at New York University's Stern School of Business: "The unknowing investor just accepts the first price they're given." Savvy investors often ask their brokers to put a bond "out for bid." The broker then has a dealer canvass others for the best bid.

Pricing is most uniform for large issues, such as state and city bonds or bonds of major municipal authorities, simply because those markets are more liquid--there are more buyers and sellers. But with smaller issues, getting a sense for how liquid the market is can be tough. Looking at The Blue List, a compilation of dealers' offering prices, may a give clue. "If there are very few offerings on a bond, that tells you something" about trading volume, says John Markese, president of the American Association of Individual Investors.

A look at complaints to industry arbitration panels shows that the pitfalls for muni investors echo those in other markets. The three most common claims, according to Wilson White, author of The Municipal Bond Investment Advisor: Brokers misrepresented or omitted material facts about a bond; investors were sold a bond not suitable for them; and brokers churned the investors' accounts.

NOT IN KANSAS. Many arbitrations center around investors not being informed of a bond's call features. New York securities attorney Roger Deitz notes that in 1990, he paid $7,673 for $100,000 worth of 25-year zero-coupon Saline County (Kan.) single-family mortgage revenue bonds. The bonds offered a yield to maturity of 10.24% until the year 2015, making them perfect for the trust that Deitz was handling. "My objective was to lock in the current interest rate and have it compound for 25 years," he says. But in December, 1992, $50,000 of the principal amount of the bond was called.

Deitz, who represents customers in securities arbitration, knew that any call feature should be noted on the face of the confirmation slip from the brokerage house. But the face of his confirmation slip had no mention of a call feature. Eventually, after the brokerage firm said it couldn't be done, Deitz found a bond that would re-create much the same position that he was aiming for with the original bond. After Deitz handed over funds from the called bonds, along with the other bonds from the original investment, his brokerage firm agreed to kick in the extra money needed to replace his position with a similar bond.

For the uninitiated, buying and selling municipal bonds is often a daunting prospect. Pressure for greater price disclosure is rising, but not too much has happened yet. For individual investors, the secondary market is a classic case of buyer beware.

        -- Shop around for the best bid. Never accept the first price quoted. One way 
      to get a better price: Ask the broker to put a bond "out for bid." The broker 
      should have a dealer canvass others for the highest bid.
        -- Stick to large, nationally recognized name bonds. These will have the best 
      marketability and liquidity should you ever need to sell.
        -- Check a bond's liquidity. Ask whether it is actively traded and what the 
      volume is. The number of entries for a bond in The Blue List, which tracks 
      dealers' offerings, can yield clues.
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