WASHINGTON -- Congress could entice or even require the nation's nearly $4 trillion of pension funds to invest in tax-exempt municipal bonds to spur infrastructure development, but doing so would be costly and controversial, investment bankers told a congressional commission last week.
Their comments came as the Infrastructure Investment Commission, charged by Congress in last year's highway bill to make recommendations on expanding investment in infrastructure, launched a series of hearings focusing on such ideas as generating more pension fund interest in municipal bonds.
The commission's principal mission is to recommend how to attract pension fund investment in infrastructure, possibly through the creation of a new federally backed infrastructure security. But the commission's chairman, Daniel V. Flanagan, said it also is open to other proposals that were clearly preferred by investment bankers at the Thursday hearing.
The commission's idea of encouraging the estimated $3.8 trillion of public and private pension and retirement funds to invest in municipal bonds received a tepid response, at best, from the investment bankers.
The Public Securities Association, in testimony presented by Prudential Securities Inc. Executive Vice President Gerald P. McBride, pointed out that pension funds "generally do not invest in tax-exempt securities" because they are themselves tax-exempt.
"Short of taxing the investment income of pension funds, devising a scheme to encourage funds' participation in public infrastructure investment while ensuring that federal infrastructure dollars continue to be spent efficiently presents a serious policy challenge," the PSA testified.
In addition, with the widespread availability of tax-exempt financing for infrastructure, the creation of a "new taxable infrastructure financing instrument, while it might be popular with fund managers, would draw little attention from state and local borrowers," the PSA said.
Nevertheless, the PSA said Congress might consider refining a bill introduced earlier this year by Rep. Tom McMillen, D-Md., that proposes that the federal government pay qualified pension funds 43 cents for every dollar of tax-exempt interest the funds receive through infrastructure investment.
While that proposal would be costly, according to one bond dealer who asked not to be identified, the only alternative would be simply to require pension funds by law to invest in infrastructure bonds, regardless of their tax-exempt rate of return.
Mr. Flanagan declined, however, to say whether the commission was considering such a controversial proposal, which would likely rile the powerful funds as well as pensioners around the country.
Several bond professionals at the hearing, including Mr. McBride and Financial Guaranty Insurance Co. President Ann C. Stern, suggested that one of the most efficient ways to spur infrastructure investment would be to enlarge and enhance the tax exemption for municipal bond interest.
Ms. Stern suggested relaxing the 1986 tax reform act's arbitrage rebate requirements for infrastructure bonds. And Mr. McBride recommended eliminating tax-exempt interest on those bonds as a preference item subject to the individual and corporate alternative minimum tax.
But Mr. Flanagan said Congress has been reluctant to backtrack on the 1986 tax reforms, so the commission is not inclined to push them. "That is why we're installed here to look at the pension funds," he said.
Another alternative discussed by commission members, and endorsed by most of the bond professionals who appeared as witnesses, is the creation of state revolving funds dedicated to infrastructure investment, like the Environmental Protection Agency's Clean Water Act revolving funds.
Mr. Flanagan questioned the effectiveness of the agency's program, noting that it has been slow in getting off the ground since being enacted in 1987. But another commission member, Ralph Stanley of the Virginia Toll Road Corp., lauded it as "successful."
Mr. Stanley said creating a new state program modeled on the environmental agency's program would be one good way to carry out Democratic presidential candidate Bill Clinton's proposal to invest $20 billion a year in infrastructure development.
The commission's deadline for presenting recommendations to the President and Congress, he noted, coincides with the presidential inaugural early next year. Mr. Flanagan agreed, and added that he has discussed some of the commission's ideas already with the Clinton campaign.
"We're like a surfboard riding on the crest of the waves right now," he said, referring to the commission's hoped-for impact on next year's infrastructure debate.
William Chew, vice president of Standard & Poor's Corp., said the revolving fund idea could be successfully applied to transportation and other infrastructure projects in the same way it has been applied to the wastewater treatment projects financed under the environmental agency's program.
But, he noted, that program is "still overwhelming lending to established investment-grade credits," rather than to the many weaker municipal credits that the program was to help.
He and others at the hearing pointed out that any federal program should be aimed at widening the existing market for infrastructure securities.
Joseph M. Giglio, managing director of Smith Barney, Harris Upham & Co., said the new highway law enacted last year already enables states to funnel their federal highway grants into revolving loan funds that can leverage both municipal and private infrastructure deals.
He said the highway lending provision is "not well understood," but it could double the federal, government's $15 billion yearly investment in highways. In light of that, it is "very powerful" and "far superior to the 1987 EPA program," he said.
