Municipal bonds have several features that appeal to a wide swath of investors, particularly their exemption from federal taxes. And if you live in the state that issues the bond, it's typically exempt from your state's tax as well.
Despite the wide popularity of muni bonds, reliable and transparent information about them has been generally lacking, leading unsuspecting buyers and sellers to often pay spreads of two to three percent or more when these bonds trade.
So, it comes as a big step in the right direction that the organization that regulates munis, the Municipal Securities Rule Making Board (MSRB), has recently launched a user-friendly tool that makes pricing information easily available to individual investors. Jennifer Galloway, the regulator's chief communications officer, recently told me about me the new Price Discovery Tool, which is part of the MSRB's Electronic Municipal Market Access (EMMA) service. Using any muni bond as your starting point, now you can:
- Find other bonds with similar characteristics.
- See side-by-side comparisons of bond prices and yields.
- View an easy-to-read graph of trade prices over time.
Galloway, along with Justin Pica, the MSRB's director of product management, gave me a tour (you can watch a demonstration video on EMMA). The bond they selected to illustrate was relatively actively traded. But many of the approximately 1.2 million outstanding muni bonds don't have a single trade for many months or more and are very hard to price. Thus, the tool finds bonds with similar features such as credit ratings, maturities and call features to give an investor an idea of a bond's current market value.
Think of it as akin to what Zillow does for real estate prices. Put in an address, and Zillow will show you some recent comparable sales. Zillow, however, will also provide a price estimate for your home, while the EMMA Price Discovery Tool won't do that for your bond. Galloway explained that the MSRB didn't want to show an estimated price because, as a regulator, it merely wants to provide "unbiased data." If you own your muni bonds though a brokerage company, it often uses private services to price the bond.
What I found most useful was the tool's great graphical information about trades. In the example I saw, the graph revealed a 6 percent spread on a single day. This means someone bought the bond for six percent higher than the seller sold, with brokers profiting. This 6 percent also happens to be about the same spread the real estate industry charges for selling a home. Galloway noted that the tool shows the investors involved in this transaction what happened and that they "might want to talk to their brokers" about it. She added: "Transparency is our goal."
My take is that although this tool is useful tool for looking at comparables, it's even more useful in looking at a bond's liquidity. If you're about to buy or sell a muni bond, you may want to let your broker know you'll be looking over his shoulder, and if the spread is close to a year's interest, he'll have some explaining to do.
The Price Discovery Tool is a good step toward making the muni bond market a tad more transparent. In my view, however, the MSRB still has more work to do. A good next move would be requiring dealers to report profits on each bond being sold or bought for an investor. Very few investors I've worked with are aware of these spreads and are somewhat outraged when I tell them.
Next, if transparency is the MSRB's goal, allowing brokerages to show the entire coupon payment as "income" is something that needs to change now. I call it the muni bond illusion. I asked Galloway the same question a client once asked me: "Why is this legal?" She responded that she could set me up with an interview with MSRB Executive Director Lynnette Kelly. If that happens, I'll fill you in.