The United States is underinvesting in infrastructure -- the highways, bridges, transit systems, airports, wastewater, drinking water, and solid waste disposal facilities essential to our economy's long-term, noninflationary growth. Increasing our national investment in infrastructure will enhance our mobility, reduce pollution, improve productivity and competitiveness, create jobs and economic growth.
Congress and the Clinton Administration must, however, fund the needed increase in infrastructure investment without new taxes. The recent 4.3 cent increase in the federal gas tax funded deficit reduction, not surface transportation. There are no new federal revenues or loan guarantees to pay for additional infrastructure investment. State and local government budgets and tax and debt capacities are also constrained.
Structured municipal bonds and grant-backed credit enhancement are two innovative financial tools developed by Commonwealth Development Associates that will help efficiently fund additional infrastructure investment.
Structured bonds securitize state and local loans and municipal bonds into bond-backed securities. They aggregate diverse user fee and tax revenues into debt service payments structured to improve bond credit ratings, reduce interest costs, and enhance the liquidity and leveraging capacity of state and local debt financing. Structured bonds securitize state and local debt by pooling infrastructure loans, by structuring principal and interest payments into different classes of securities aimed at different groups of investors, and/or by giving bondholders credit enhancement. Single-issuer revenue bonds also benefit from the cashflow structuring and credit enhancements of structured bonds.
Grant-backed credit enhancement uses the authorized flow of federal and state formula grants to repay and/or credit enhance state and local loans and bonds, particularly structured bonds. It accelerates the capital availability and investment of future grant dollars to more rapidly reduce infrastructure project backlogs. The use as grant-backed credit enhancement of the $10 billion apportioned to the states in the current unobligated balances in the Federal Highway Trust Fund could, for example, generate as much as $30 billion in current, best interest rate investment in surface transportation facilities.
Structured municipal bonds and grant-backed credit enhancement will help the federal, state, and local governments increase our nation's investment in transportation and environmental infrastructure by providing the widest range of states, communities, and projects with bestrate investment capital.
Congress and the administration should develop, enact, and enforce the statutory and regulatory changes needed to empower state and local governments to use structured municipal bonds and grant-backed credit enhancement to efficiently and cost effectively provide new capital for vital infrastructure investment. Structured Municipal Bonds First, we must level the legal playing field so that the emerging markets for structured municipal bonds will not be hampered by the outmoded federal tax and securities laws that impeded the market development of mortgage-backed securities -- and currently mandate financial inefficiency in the municipal bond market.
Congress revolutionized the market for mortgage-backed securities -- making it more efficient and cost effective -- with two measures.
Through the Secondary Mortgage Market Efficiency Act of 1984, Congress clarified certain federal and state securities law and legal investment issues for investment-grade mortgage-backed securities, making securities issuance more certain and efficient and broadening the investor pool for mortgage-backed securities.
By creating real estate mortgage investment conduits in the Tax Reform Act of 1986, Congress eliminated the risk of double taxation when mortgage payments are structured to better meet issuer and investor needs. The market for mortgage-backed securities exceeds $1.5 trillion and may be saving home owners 50 or more basis points in their mortgage interest costs.
Congress' indicated intent in the legislative history of the Tax Reform Act of 1986 was to extend the Secondary Mortgage Market Efficiency Act and Remics to other loans and receivables, if Remics proved successful. Remics have more than doubled the size of the mortgage-backed securities market, making it the second largest capital market in the world, trailing only Treasury bonds in the dollar value of securities outstanding.
Several bills are pending in Congress that would extend the act and/or Remit treatment, and the financial benefits accorded mortgages, to payments on small business and other loans. For example, the conference committee on the Community Development and Financial Institutions Act (HR 3474) has just authorized applying the Secondary Mortgage Market Efficiency Act to small business and commercial loans. The conference committee report has passed the House by a vote of 410 to 12. A favorable floor vote in the Senate is expected this month.
Properly designed federal legislation extending this treatment to the loans and bonds of state and local governments must be sensitive to the imperatives of the municipal bond tax exemption and the disclosure, reporting, and suitability issues for municipal bonds being addressed by the Securities and Exchange Commission and congressional committees.
To bring the full benefits of securitization to state and local infrastructure developers, users, and taxpayers, Congress and the administration should assure state and local officials that federal law will no longer impede them from garnering the maximum benefits of innovative structured finance. New legislation should also permit public-private infrastructure developers to use securitization to access best-rate capital.
Federal law should not only facilitate the pooling of outstanding municipal bonds. It should also enable borrowers to structure their loan payments by maturity, flow of funds priorities, and other criteria. Borrowers could then divide and distribute investment risks and returns among themselves and their bondholders with more efficiency than typical municipal bonds.
The pending clean water and sate drinking water reauthorization bills should enable state revolving loan funds to use structured municipal bonds to securitize portfolios of their loans and issue best-rate bonds. Portfolio securitization will increase capital availability and reduce the capital costs of the revolving funds' investment projects. It will enable the funds to sell some or all of the loans they make to private investors, rapidly recovering the public capital committed to those loans and recycling that capital into new investments.
Grant-Backed Credit Enhancement
Second, Congress and the administration should develop the legal guidelines and administrative tools necessary to implement grant-backed credit enhancement.
Credit enhancement is an additional assurance to investors against borrower default and delinquency. Loan guarantees, bond reserves, bond insurance, and letters of credit are forms of credit enhancement.
Credit enhancement may also be derived from a state or local pledge of current and future federal grants as loan repayment, as funding for municipal bond debt service reserves, and/or to acquire junior class structured municipal bonds.
The enhancement extends me use of federal and state grants as credit support for infrastructure investment. The "capitalization grants" authorized by the Clean Water Act of 1987 have been used by state revolving loan funds as credit enhancement for wastewater bonds. Funded with current appropriations, Clean Water Act capitalization grants and state matching dollars have been used by at least 16 state revolving funds to finance reserves for their bonds.
State-aid intercepts have been used to enhance local infrastructure financing. Advanced construction bonds have been used to cover the short-term cash needs of surface transportation projects. The Federal Transit Administration and Federal Aviation Administration have each issued letters of intent to help repay state and local authority bonds. The Federal Highway Administration is reviewing several letter of intent proposals under its new Test and Evaluation Demonstration Project. Recommendation DOTO5 of the National Performance Review calls for the Department of Transportation to use its grants as credit enhancement.
Grant-backed credit enhancement will require no new federal revenues, expenditures, or contingent liabilities. Grant-backed credit enhancement should be scored as a budget outlay only in the year of appropriation. Unlike federal guarantees or letters of credit, such enhancement should not jeopardize the state or local municipal bond tax exemption. The enhancement will not affect Congress' discretion to authorize, obligate, or appropriate infrastructure grants.
Future capitalization grants to state revolving funds, financed through the clean water and safe drinking water reauthorization bills, may also serve to enhance wastewater treatment and safe drinking water facilities bonds. Grant-backed credit enhancement accelerates the investment of federal and state funding in these needed environmental infrastructure projects.
The municipal bond market is being securitized. Wall Street firms are seeking approval from the Internal Revenue Service and the SEC to pool outstanding tax-exempt bonds into inverse floaters and other derivative securities. This market is emerging under the same federal statutes and regulations that governed mortgage-backed securities before the Secondary Mortgage Market Efficiency Act and Remics.
New ways of applying federal dollars to support and expand state and local infrastructure investment are being developed and placed in use. Capitalization grants, letters of intent, state-aid intercepts, and advanced construction bonds have become accepted forms of security for infrastructure debt financing.
New laws for structured municipal bonds and grant-backed credit enhancement should not only capitalize on these trends. They should also bring the financial efficiencies of securitization to our nation's infrastructure investment and ensure state and local governments the authority to capture those efficiencies for investment in needed transportation and environmental facilities.
Scott M. Reznick is the president of Commonwealth Development Associates, a Philadelphia-based public policy and financial advisory firm. This article is adapted from his recent testimony before the subcommittee on economic development of the Committee on Public Works and Transportation of the U.S. House of Representatives.
