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Aula 7: Política e Financiamento Municipal

Aula 7: Política e Financiamento Municipal. (Material apresentado durante o seminário: Nova Gestão Pública e Finanças New Public Management & Finance) Seminário Especial FGV-EAESP Jeffrey Leifer Kurt von Mettenheim 5–9 Junho 2006 Rua Itapeva 474 Sala 4002 13:00 – 16:00. Lecture Topics.

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Aula 7: Política e Financiamento Municipal

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  1. Aula 7: Política e Financiamento Municipal (Material apresentado durante o seminário: Nova Gestão Pública e FinançasNew Public Management & Finance) Seminário Especial FGV-EAESP Jeffrey Leifer Kurt von Mettenheim 5–9 Junho 2006 Rua Itapeva 474 Sala 4002 13:00 – 16:00

  2. Lecture Topics • Introduction: US Municipal Bond Market • Diagnosis 1: Achilles Heel of Brazilian Development = Local Government Finance • Diagnosis 2: Economic & Financial Reforms make Brazilian Municipal Bond Market viable • Diagnosis 3: Recommendations from Successful Muni Markets in Emerging Economies (& Calif. Model) • Proposal: BMBMwg (Brazilian Municipal Bond Market working group) 2nd Semester 2006  CVMM, Comissão de Valores Mobiliários Municipais

  3. 1) US Municipal Bond Market“Municipal bonds have been issued by US local government since 1812” Fahim, Mayraj. Infrastructure in the United States is generally financed through municipal bonds (all sub-national governments, agencies, quasi-public “special districts”). 1st paper: General obligation bond, i.e. backed by taxing power and revenues of issuer. “…without the ability of state and local governments to issue debt … today’s America, as we know it, would cease to exist.” 2005 Market Value = 2.0 Trillion US$ = 15% US GDP

  4. History of US “Muni” Bond Market 1902 = 2.1 billion or $27 per capita. 1927 = 14.9 billion or $125 per capita. Downturn From WWI  Great Depression  WWII 1945+ “Pent up demand” for infrastructure (urbanization…) 1960 = 66.0 billion If 1/3 per capita US mkt, 1981 = 361.0 billion Brazilian Municipal Bond 1998 = 1.3 trillion.Market = R$ 6.5 billion

  5. Types of US Municipal Bonds • General obligation bonds secured by pledge of government taxing power; • Revenue bonds secured by pledge of project revenues. • Hyrids… General Obligation Bonds = early bonds Current Market = Bonds with revenue stream of a particular entity (user fees and service charges) and Bonds issued by special districts. Before 1957 most revenue bonds = utility projects or local public housing projects. 1960 + = Revenue Bonds replace general obligation bonds

  6. Legal Framework Origin = financial ruin brought about by the unregulated and uninhibited issuance of municipal debt. 19th Century = 3 Depressions cause = over- issuance of Munis: 1837-43  1873-79  1893-99 Constitutional restrictions imposed on state and local government spending. Federal System  State Level Regulation 1940  1999 HIGHEST DEFAULT RATE = 1.1%

  7. Default History 1839  1969 = 6,195 defaults (4,770 1929-1935) 1940s = 79 municipal defaults 1950s = 112 1960s = 300 Transition from “Institutional Investors” to Credit and Risk Analysis & Individual Investors History = From “Boom & Bust” to stable market, Today = flight to quality...

  8. Bartley & Zorn. “The Evolution of the State and Local Government Municipal Debt Market over the Past Quarter Century.” Public Budgeting & Finance, December 2005 1986 Tax Reform Act • innovations in the market (changing economic and social conditions) • Increase in disclosure requirements • Credit enhancements & efficacy of municipal securities for US state and local governments.

  9. Innovations 1986 + Revenue Bonds & Custom Solutions > long-term, fixed-coupon general obligation (GO) bonds. Creative ways to avoid debt limits and procedural hurdles Lease financing (Certificates of Participation (COPs), Tax increment financing (TIF), Bond banks, Revolving loan funds. Issuers protect investors via letter of credit (LOC) Reset securities, or floating rate debt Interest rate exposure mitigated via swaps and derivatives. All above increase liability risks… Simpler instruments needed?

  10. TOPIC 2: Diagnosis: Achilles Heel of Brazilian Development = Local Government Finance Sequence of Fiscal, Monetary, Banking, and Financial Market reforms 1982 Dual Fiscal & Debt Crises 1994 Plano Real, 1999 Inflation Targeting, Fiscal Adjustment, Flexible FOREX • Financial Deepening without Local Government Finance • Repressed Demand = HUGE MARGINS  Easy Start • Desafio da Presidência da FGV (2003 SAP) How to grow Brazilian economy @ 8%

  11. Savings & Growth, 1948-2000(% private/public/foreign + GDP growth)

  12. Capital Formation & Growth 1948-2000(% Private, Public + GDP growth)

  13. Bond Markets = Achilles Heel of Brazilian Development(BIS report, The Development of Bond Markets in Emerging Economies)

  14. Achilles Heel... %GDP Finance

  15. Diagnosis 2: Economic & Financial Reforms make Brazilian Municipal Bond Market viable 1) World Class Transparency & Govt–Market Relations 2) Risk Analysis/IT/Finance: FGV-EAESP Tradition 3) Recentralization = Fiscal Mantra 1990s Decentralization = Financial Mantra of 2000s 4) Market Confidence  Municipal Finance * New Public Management = Transparency, Advocacy, Education & Training, Public & Private collaboration... * Old Public Management  Hi Cost of Capital, Slow Economic Growth, Social Exclusion...

  16. Macro-Forecasts & Viability of Brazilian Municipal Bond Market • BCB FOCUS (FGV Brazil Forecast) 3-5 Year Forecasts (Econ/Politics/Govt) Consensus: Macro-Fundamentals  Foreign & Domestic Debt Structure Improve... 2) 15-50 year forecasts a) US Govt National Intelligence Study b) Goldman Sachs BRIC´s Study c) Deutsche Bank Scenarios

  17. Long-Term: Brazil & Globalization US NIC Study: * NAFTA = north, South America new geopolitical zone * Global Firms must build emerging market presence / platforms Goldman Sachs “Dreaming with the BRICS” * BRIC GDP > G8 Countries in 2040 Deutsche Bank: 2020 projections * @ 2.8 % growth, not so soon…

  18. Diagnosis 3: Recommendations from Successful Muni Markets in Emerging Economies(& California Model Sale) • Preconditions: (Recommendations  Brazilian Situation & Viability) • Market Structure: (Recommendations  Brazilian Situation & Viability) Bahl, Roy & Sally Wallace. “Public Financing in Developing and Transition Countries” Public Budgeting & Finance. Jan 2005

  19. Pre-Conditions for Muni Market RecommendationBrazilSituation ------------------------------------------------------------------------------------- 1. Devolutionofsufficient ClearIntragovernmental revenues to encourage Budget Flows, butmyth? of payment. no repayment (00s vs 90s) ------------------------------------------------------------------------------------- 2. Devolutionofauthority Yes > % Budget = Mun. Govt. for budgeting. (orçamento participativo...) -------------------------------------------------------------------------------------- 3. Borrowingauthority NO to issue short- & long-termdebt. ------------------------------------------------------------------------------------- 4. Provisionofpublic uses  RepressedDemand ofborrowing. LowCapacity -------------------------------------------------------------------------------------- 5. Limitson sources  LRF: Fed. MinistryofFinance ofborrowedfunds. (Sec. Treasury & CAE Senate)

  20. Pre-Conditions for Muni Market RecommendationBrazil Situation ------------------------------------------------------------------------------------- 6. Requirement that debt  Must Design Frame: approximates economic life Cost/Benefit Analysis... asset or project. Revenue Stream ------------------------------------------------------------------------------------- 7. Transparent and reasonable  Transparent YES debt limits % total spending Reasonable NO (2%RLC) on past budget of future. ------------------------------------------------------------------------------------- 8. Provision for payment  Who? 1) Insurance co´s debt service arrears & default. 2) Govt., 3) Bond Bank ------------------------------------------------------------------------------------- 9. Budget law distinguishes  NO? Accounting culture: capital from recurrent expenditures. From “debt”  “capital”

  21. Market Structure RecommendationBrazil Prospects ------------------------------------------------------------------------------------- 1. Yields priced for risk.  Primary Market Launches... ------------------------------------------------------------------------------------- 2. Instruments placed in  Underwriter? Insurance Co´s Market with private parties Bond Bank as underwriters or lenders. Consortia ----------------------------------------------------------------------------------- 3. Risk assessed by institutions,  Must Adapt Credit Analysis banks, insurance, pension, to Municipal Finance/Budget securities firms. ------------------------------------------------------------------------------------- 4. Criteria for grants &  Policy Discretion for Gov´t. subsidized market loans clear & classified from low to high risk.

  22. Manage Market RecommendationBrazilProspects -------------------------------------------------------------------------------------- 1. Accounting systems that LowCapacity support local liability management. (asset management systems>). -------------------------------------------------------------------------------------- 2. Regular reports to compare  HiCapacity Budget planned-to-actualexpendituresandLoexperiencefinance track budget progress (debtschedule). -------------------------------------------------------------------------------------- 3. Projectsevaluatedindividuallyand LowCapacity according to economiccriteria. Local unitshaveprofessional capital programming, budget systems, and applycost/benefitand net presentvaluetechniques.

  23. Tips RecommendationBrazil Situation ------------------------------------------------------------------------------------- Uncertainty stunts market growth.  Hi Market Confidence -------------------------------------------------------------------------------------- Political commitment critical.  Legislative Alliances -------------------------------------------------------------------------------------- 1st focus = municipal borrowing  Outlawed in LRF framework (municipal credit markets) --------------------------------------------------------------------------------------- Example: Mexico via provisions for  Who? Fed Govt Collateral & Debt Security Insurance co´s Bond Bank/Consortia -------------------------------------------------------------------------------------- Remedies for nonrepayment  Adapt LRF/ Market Premium?

  24. Tips, cont. RecommendationBrazil Situation -------------------------------------------------------------------------------------- Central government guarantee  NO -------------------------------------------------------------------------------------- Devolution of authority to borrow  NO -------------------------------------------------------------------------------------- Tighter reporting requirements  Tight as Stand in on commitments and capital expenditures. Budget/Fical Law --------------------------------------------------------------------------------------- National governments and donor  BIG ADVANTAGE requirements can direct institutional savings into domestic investments. -------------------------------------------------------------------------------------- Can provide subsidies to certain  BIG ADVANTAGE actors and reduce them over time.

  25. Politics & Brazil Muni Market 2007 = New Federal and São Paulo State Governments  “Supercoalitions” after Mensalão Problem: Link Federal  State & Local Politics (partial) Solution: Municipal Bond Market : * Transform Zero-Sum Budget Disputes into Positive-Sum collaboration via access to capital markets * Executive-Legislative-Judiciary + market discipline * Risk Ratings to Reward 7 years fiscal adjustment < Cost of Capital + Deepen Financial System

  26. Diagnosis 3: Lessons from Emerging Market Experiences with Municipal Bond Markets Success: South Africa / Mexico / Poland (failure Indonesia) Proposed/Started: China / Philippines / Hungary Explanatory Variables: “Legal & Regulatory Borrowing Framework” “Allocation of Credit by Risk”

  27. California Model Sale County of Stanislaus 2004 Certificates of Participation, Series 2004 A & B $15,340,000 Series A COPs $27,455,000 Series B COPs. A= construction of Gallo Center for the Arts. B = 12th Street Parking Garage and Office Building, and acquisition and renovation of Salida Regional Library and Community Center.

  28. Security A = pledge Gallo Center for the Arts Security B = pledge of County assets, (former City Hall building, unencumbered portions of the downtown County jail, Parking Garage to be constructed, and Salida Library). Bond insurance = commitment from AMBAC, Assurance Corporation. AAA Moody´s = saved County $667,000 debt service compared to uninsured COPs ‘A3.’ Capitalize Interest of 1st 2 years, 20 term.

  29. Complex Pricing • multiple bond series, one (tax purposes) as 501(c)(3) bonds, 2% cost of issuance limit, • no underlying ratings for either series • lesser essential asset in the Performing Arts Center, • complicated private use tax issues and restrictions • a very difficult market for California paper.

  30. County saved $1.9m 26/3/04 vs two weeks later. Bond Buyer 20-Bond Index (avg. yield 20 GO bonds 20-year “A”)

  31. New Public Management and Finance • Decentralization, Democratization, Transparency, Accountability • Capitalization of Public Sector • Issuer-Driven Investor Outreach • Non-Transactional Services • Debt Affordability Analyses • Debt Policies • Municipal Finance Educational Workshops • Integrity and Accountability

  32. Principles of Prudent Municipal Debt Management Independent FA(No conflicts) Informed Decision Making Debt Affordability InvestorOutreach CompetitiveSale Due Diligence andEnhanced Disclosure

  33. 4) Proposal: Brazilian Municipal Bond Market working group Working Group  Creation of Muni Debt Authority(ies) ?= CVMM, Comissão de Valores Mobiliários Municipais (MBA, Municipal Bond Authority) Challenge: Write Strategic Plan for Municipal Bond Market (December 2006) Challenge: Attract Membership: Academic, Public, Private Sector Leaders

  34. Critical Juncture 1) Brazil = Successful Sequence of Economic Reforms, but loosing out on international capital movements & confidence among international investors. 2) Brazil = World Class IT / Risk / Accounting practices. * Private Sector Public Sector * New Public Management = Debt Capacity Analysis / Cost- Benefit / IT / Capital Planning / Cash Management /  New Public-Private dynamic... 3) Can Build Virtual Cycle via Positive Sum: * Lower Cost of Capital (Hi spreads  Hi marginal returns). * Increase Transparency / Accountability / Democratization * Reverse Brain Drain to Private Sector * Develop Bank Capacity & Market Differentiation 4) “Relational Financial Management” = Pre-Sale  Post-Sale, education / training  < cost of capital  new issues  education / training  < cost of capital... INVESTMENT GRADE...

  35. From Vision to Market BMBMwg Monthly Meetings, 2nd ½ 2006 Market Design, 2007 Primary Market Launches, 2007 & 2008 Secondary Market 2009+

  36. 2007 2008 2009-10a=investor b=federal c=local govtrelationsgovt. taskstasks

  37. BMBMwg: Tasks / Schedule June 5-9: Seminar  Today´s PPT = Test Baloon... June 24: List of Projects for “Pearl” launches, test market, build confidence, demonstration effect (47 São Paulo State Strategic Projects? Package Refinance existing?) August 31: Presentation & Discussion: Market Design September 30: Approve Draft Memorandum: Market Design October 28: Roundtable and Discussion: Veto/Amend Market Design November 25: Present Proposal to FGV Presidency, Public Opinion, Fed & State Finance Authorities 2007+

  38. Thank You * GVpesquisa, Prof. Peter Spink * FGV-EAESP CDAPG, Coordenador, Fernando Abrucio & Research Groups Transformação do Estado e Políticas Públicas (Prof´s Bresser- Pereira, Pacheco, Abrucio, Loureiro, Martes, B.Taschner) Finanças Públicas (Prof´s Arvate, Biderman, Avelino) * FGV-SP : EAESP EDSP EESP (professors, students, staff...) * Jeffrey Leifer; Financial Advocate of California Municipalities  Best Practices * Antonio Roberto Bono Olenscki, CDAPG & New Public Management  São Paulo State Government

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