Muni Bond Games and the IRS’ Lurking Arbitrage Vampires



For example, Oakland, Calif., cleverly figured out in 1985 that it could issue tax-exempt bonds to fund its underwater pension plan, the proceeds of which it in turn would invest in normal pension portfolio holdings like taxable stocks and corporate bonds with a higher long-term return. It was a strategy almost certain to make a profit over time, even with the ups and downs in the stock market, but it didn’t take long for the IRS to put an end to that ploy as an abuse of the tax exemption. Thereafter, the IRS ruled, such pension bonds must be taxable.

Likewise, the arbitrage police have played cops-and-robbers with clever public financiers who invest their cash during construction periods at interest rates higher than their tax-exempt cost of money. Using today’s interest rate levels, for example, a tax-exempt 20-year AAA-rated bond can be issued with coupons around three-and-a-half percent and the proceeds reinvested in Treasury bills and notes at 4 to 5 percent. In almost any year like this one, there’s a profit to be gleaned when borrowing tax-exempt and reinvesting at taxable rates.


There is also a new controversy brewing in a niche sector of the muni bond market, in which issuers of taxable bonds are finding an opportunity to refinance at lower tax-exempt rates. Investors are suing them. It’s premature to guess how this issue will be resolved in the courts, but worth watching.


As interest rates drift lower in tandem with hoped-for disinflation, muni bond professionals are starting to chat up the idea that soon we’ll see a wave of advance refundings, in which a municipality can refinance its debt at a lower interest rate. In corporate America, the finance team must usually wait until the issue’s maturity or call date before refinancing. In muni-land, however, there is a unique situation that is peculiar to the tax-exempt world: the opportunity to issue new bonds to replace the old ones at a lower interest rate before their scheduled call date — typically within 10 years after issuance — by setting up an escrow fund to pay off the original debt when it is callable.

It doesn’t take a math or market genius to figure out that this advance refunding strategy is susceptible to abuses. In theory and previously in practice, it could be repeated several times over the life of the original bonds: wash, rinse and repeat. So the IRS caught on to this and Congress put a limit — of one — on such deals. To accommodate this unique feature of the muni market, the Treasury Department even created a special class of its own securities, known as the State and Local Government Series (SLGS, or “slugs” in industry jargon), which bear interest rates equal to the new borrowing rate to preclude the arbitrage profit gambit.

The political challenge for municipal officials today is that underwriters and advisers are keen to promote these advance refundings as soon as they become feasible. Some will compete with each other to make the first pitch to win an engagement even if it’s not optimal longer term. The motto of some hucksters is “whoever gets to the decision-makers first, wins.” All they really want is the engagement fees; to them, a dollar earned today is worth more than a dollar tomorrow, so they get lathered up without necessarily showing their clients the potential to save even more if they wait a couple years for even lower rates. This year and next could be just such a time period, depending on when you think the next national recession will occur.

Mostly it will be the muni bonds sold in 2022 and early 2023, when interest rates were peaking (above 4 percent on AAA paper and maybe 5 percent for lower ratings), that the advance-refunding promoters will pitch. Just remember that the IRS rules now prohibit multiple advance refundings: It’s one bite of the apple, and there will be an opportunity cost for jumping the gun ahead of lower long-term interest rates in future years. Although short-term interest rates are expected to decline, it’s not so obvious that the longer end of the Treasury and muni bond yield curves will follow in this business cycle, at least until the next recession. Refundings are almost always timely in recessions, but can be premature in the middle of an interest rate cycle.

Author(s): Girard Miller

Publication Date: 13 Mar 2024

Publication Site: Governing

What do rising interest rates mean for government debt?




The higher the interest rates, the more costly the financing of a new project is over the long run, thus increasing pressure on the municipal budget.

The example below compares the cost of a 20-year, $10 million debt issuance at different rates. “Coupons” refer to the interest rate that bondholders get back on their investment. “PV” stands for “present value,” or the face value of the bonds when they’re issued.

Author(s): Martin Feinstein

Publication Date: 18 Aug 2023

Publication Site: Long Story Short, Liz Farmer’s Substack

SEC attempts to calm muni market over FDTA implementation



As the timeline for implementing the Financial Data Transparency Act grows shorter, the Securities and Exchange Commission is teaming up with other federal regulators in an attempt to allay fears about implementation.

“There’s no new disclosure requirements, standards or timelines, it’s just about structured data,” said Dave Sanchez, director of the SEC’s Office of Municipal Securities.

The comments came during a panel discussion produced by XBRL US on Thursday. The FDTA was passed last year as a remedy for providing more transparency to the financial markets by introducing machine-readable formats into the Municipal Securities Rulemaking Board’s EMMA system, which tracks the muni market.

The SEC is in charge of developing the standards for how the data will be submitted to the MSRB. The upcoming deadlines include publishing proposed rules by June 2024, which will kick off the public comment period. Determining the standards is set for December 2024, with specific rulemaking to be in place by 2026.

Author(s): Scott Sowers

Publication Date: 10 Nov 2023

Publication Site: Bond Buyer at Fidelity Fixed Income

If Puerto Rico bankruptcy ruling stands, it could devastate municipal borrowing



In the bankruptcy proceedings of the power utility, Swain sided with borrowers and concluded that special revenue bondholders do not hold a secured claim on current and future net revenues. As The Wall Street Journal explained in March, “A federal judge curbed Puerto Rico bondholders’ rights to the electric revenue generated by its public power utility.”

Furthermore, the ruling stated that the original legal obligation of the borrowers is not the face value of the debt, but rather what the borrower (in this case “PREPA”) can feasibly repay. This ruling raises concerns regarding its broader implications for the municipal bond market. 

Municipal bonds play a pivotal role in financing vital infrastructure projects across America. However, Swain’s decision poses a significant threat to the traditional free-market principles that underpin the structure and security of municipal bonds, particularly special revenue bonds.  

These bonds have provided investors with the assurance of repayment through revenue streams generated by specific projects or utilities. By eroding this sense of security, the ruling fundamentally alters the risk-reward dynamics of municipal bonds, disregarding the principles of free markets and limited-government intervention.  

Consequently, state and local governments may encounter elevated borrowing costs when issuing bonds for necessary public investments, hindering fiscal responsibility and the efficient allocation of resources. 

Author(s): Matthew Whitaker

Publication Date: 5 Sep 2023

Publication Site: Fox Business

The Municipal Bond Cases Revisited




The invocation of ultra vires to escape bond obligations is nothing new, though. In the second half of the nineteenth century, municipal debtors frequently welched on their debts. In the 1850s and 1860s, cities, towns, and counties across the Midwest and West issued bonds to finance the construction of railroads and other infrastructure. Many ultimately defaulted. Rather than simply announce that they couldn’t or wouldn’t pay, however, they often contended that they needn’t pay: for one or another reason, the relevant bonds had been issued ultra vires and so were no obligation of the municipality at all. Litigation in the federal courts was common. Several hundred repudiation disputes made their way to the Supreme Court in the forty years starting 1859.

With an eye to the modern cases, we set out to understand how the Court reckoned with repudiation. We read every one of the 196 cases in which the Justices opined on bond validity (i.e. the enforceability of a bond in the hands of innocent purchasers). In a recently published article, we correct received wisdom about the cases and remark on the logical structure of the Court’s reasoning.

To the extent the municipal bond cases are remembered, modern scholars usually think of them as exemplary instances of a political model of judging. The caricature has the Court siding with bondholders even when the law called on them to rule for the repudiating municipalities. The Justices—or a majority of them—are imagined as staunch political allies of the capitalist class, set against the institutions of state government and their regard for agricultural interests. We find that this picture is inconsistent with reality. In fact, the Court ruled for the repudiating municipality in a third of all the validity cases. As importantly, the Court’s decisions reflected a readily articulable formal logic, a logic the Justices seem, to our eyes, to have applied soundly.

Paper link:

Citation: Buccola, Allison and Buccola, Vincent S.J., The Municipal Bond Cases Revisited (September 25, 2020). 94 American Bankruptcy Law Journal 591 (2020), Available at SSRN:


Recent high-profile attempts to repudiate municipal bonds break from what had become a stable American norm of honoring public debt. In the nineteenth century, though, hundreds of cities, towns, and counties walked away from their bonds. The Supreme Court’s handling of repudiation in the so-called municipal bond cases conjured intense animus at the time. But the years as well as the archaic prose and sheer volume of the opinions have obscured the cases’ significance.

This article reconstructs the bond cases with an eye to modern disputes. It reports the results of our reading all 203 cases, decided 1859–1899, in which the Justices opined on bond validity. At a high level, our findings correct a stock narrative in the literature. The standard account paints the Court as a reliable champion of northeastern capitalists in what resembled regional or class politics more than law. That story does not withstand scrutiny, however. We find, for example, that the Court ruled for the repudiating municipality about a third of the time. Moreover, the decisions had a readily articulable logic at the heart of which lay a familiar law/fact distinction. Estoppel barred issuers in most instances from denying factual predicates of bond validity, but it did not prevent scrutiny of legal predicates. The Justices were willing to hold bonds void on even highly technical legal grounds.

Author(s): Allison Buccola (Independent) and Vince Buccola (Assistant Professor, The Wharton School)

Publication Date: 1 June 2021

Publication Site: Harvard Law School, Bankruptcy Roundtable