Statement of James A. Lebenthal at Field Hearing on State of Municipal Securities Markets
December 7, 2010
My name is James A. Lebenthal. I am the co-founder, with my daughter Alexandra Lebenthal, of Alexandra & James LLC. I am appearing today on behalf of its wholly owned subsidiary, the broker/dealer Lebenthal & Co. LLC, successor to the Lebenthal & Co., Inc., founded by my mother and father in 1925 and acquired by Merrill Lynch in 2005. Lebenthal LLC reacquired the Lebenthal brand name in 2007.
I am happy to have this opportunity to share with the Securities and Exchange Commission my experience as a municipal bond retail salesman and marketer of municipal bonds in mass media for 47 years. Lebenthal & Company's long-time use of information and education as a sales tool, could be illuminating for the regulator seeking to improve municipal investor protection, at a time when individuals constitute the mainstay of the municipal bond market, bond structures are ever more complicated, the full impact of the national recession may not have hit the cities and towns where the people, their homes, jobs, factories and farms are…and there is a 900-pound gorilla in the room. The Internet. In my opinion, a good gorilla. Investor information has never been more disclose-able and education more readily accessible.
I was 35 in 1963, when I joined the Lebenthal family bond business. That was before landlords in the South Bronx started walking away from buildings that were worth less than the bills for back taxes. It was before New York City began borrowing hand over fist for daily operating expenses. It was before the City dug itself into a hole and declared a "moratorium" on the repayment of $1.6 billion municipal notes, and before the flag touched the ground in Washington, Oregon, and Idaho, the home states of the Washington Public Power Supply System, and WPPSS left investors holding the bag on $2.25 billion Projects 4 and 5 bonds.
My own education in tax free municipal bonds began long before the inroads were made on their hallowed exclusion from income tax, before the Social Security tax on municipal bond interest, before the alternative minimum tax on "private activity bonds," and before the outright ban of tax-exempt bonds for ballparks, convention centers, liquor stores, and private jets. Municipal bonds still had twenty-five glorious years to go before the Supreme Court would knock tax exemption off its constitutional high horse and rule in South Carolina v. Baker that municipal bonds were tax free only by the grace of Congress, not by any constitutional right.
In 1963, there was no pass-through of tax exemption to the shareholders of municipal bond mutual funds. There were no municipal bond mutual funds, no such thing as municipal bond insurance, no book entry, no DTC, no MSRB, no real time pricing of most recent trade.
Seventy-five percent of the new issues that came to market in 1963 were general obligation bonds, backed by the full faith, credit, and taxing power of the issuer (versus 36% today). Long and short term issuance of both G.O.s and Revenue bonds came to $15.5 billion (versus $394 billion so far in 2010 through October alone). The Bond Buyer 20-Bond Index, an average of the yields of 20 representative 20-year G.O.s, ranged between 3.11 percent and 3.31 percent — 20 basis points — versus a range of 89 basis points so far this year (from 3.83 percent on September 16 to 4.72 percent on November 10). The all-time BBI-20 high was 13.44% in 1982.
Municipal bonds are not the stodgy, plain vanilla fare they were when I sat across the desk from my mother Sayra Lebenthal, the firm's co-founder, and learned her verities: municipal bonds are safe, tax free, and "you buy them for income, not to make money from market moves, dear." In 1963, who would have known what this disclosure statement in a recent municipal bond fund prospectus was talking about?
A Portfolio may use derivatives to earn income and enhance return, to hedge or adjust the risk profile of a portfolio, to replace more traditional direct investments and to obtain exposure to otherwise inaccessible markets. A Portfolio's use of derivatives may involve risks that are different from, or possibly greater than, the risk associated with investing directly in securities or other more traditional instruments. These risks include the risk that the value of a derivative instrument may not correlate perfectly, or at all, with the value of the assets, reference rates, or indices that they are designed to track. Other risks include the possible absence of a liquid secondary market for a particular instrument and possible exchange-imposed price fluctuation limits, either of which may make it difficult or impossible to close out a position when desired; the risk that adverse price movements in an instrument can result in a loss substantially greater than the Portfolio's initial investment in that instrument (in some cases, the potential loss is unlimited); and the risk that the counterparty will not perform in its obligations.
There may already have been a rule in place then for giving investors the information for making informed decisions. I thought I discovered a municipal bond information gap empirically, when I stood up on radio and TV announcing, "I'm Jim Lebenthal, with the most un-understood investment in America." The former journalist, adman, and compulsive explainer in me set out to close the gap with full page ads and commercials, advertising "free, good horse sense on municipal bonds." Between 1967 and 2005 we distributed thousands of copies a year of the Lebenthal Municipal Bond Information Kit, putting un-understood details of municipal bonds, like yield-to-maturity, prior lien, ladders and barbells, municipal bond arithmetic, safety, spreads, within the reach and comprehension of our target market: the average individual investor.
It's may not be your Ma's municipal bond market anymore. But disclosure and education — selling by telling — are still the best marketing tools I know of, for expanding the municipal bond market, preserving the role of the bonds of our great American cities and states in rebuilding America, and getting this magnificent country of our off its magnificent bottom — all the while, protecting the individual investor, as well. Today, with the existence of the Internet…with real time price transparency online from the MSRB…with offerings from broker/dealers all over the country on sites like The MuniCenter online…with official statements from EMMA online, giving the investor the information to decide, not just "Yes…" but "Yes…" or "No!" is not only an ideal. Full disclosure and fair dealing are eminently achievable, accessible, doable, and practical.
(To demonstrate what giving equal time to the whys and why nots of investing in municipal securities would sound like, I am including with these remarks a hard copy and an electronic disc of Lebenthal On Munis, Straight Talk About Tax-Free Municipal Bonds For The Troubled Investor Deciding, "Yes or No!" Morgan — James Publishers, 2009.)
As for suitability and "knowing your customer," the day is here when a computer program — online — can do what I do when I listen to someone's goals and analyze their tolerance for risk, net worth, taxable income, need for current income, and when they want to put their hands on their money again, and then come up with a bond or portfolio that fills the bill.
Want to have fun? Go to Lebenthal & Company's website www.lebenthal.com. Click LEBENTHAL MUNICIPAL BONDS FOR THE INDIVIDUAL INVESTOR. Then click MUNIPROFILER. Fill out the questionnaire. Hit submit. In nanoseconds, The MuniProfiler will scan an inventory of 376 municipal bonds that were in the market in September 2010, stored in its memory for demonstration purposes, and come up with a recommendation reflecting your answers. The recommendations are intended solely as hypothetical examples of matching individual bonds to individual needs, right now. However, the day is but weeks away when The MuniProfiler will be scanning live offerings from dealers all over the country and matching individual bonds to individual needs on www.Munigo.com, Lebenthal's online brokerage.
I couldn't be more serious.
In my opinion, the day is here when a mechanism for matching bonds to individual needs online and transacting trades in municipal bonds online can live up to the same standards of know-your-customer and suitability as those required for transacting business with clients in an office or on the telephone.
The day is already here, when an investor can go to www.Munigo.com, click BONDS FOR SALE and together with our offerings in the secondary market bring up a link to the MSRB's real time price data and compare the price of a bond we're offering to the price at which that same bond may have traded, anywhere in the marketplace, going back for two years to as recently as 15 minutes ago.
The day is already here, when an investor can click NEW ISSUES on Munigo and together with the new issue at the original new issue offering price in the retail order period, bring up the Preliminary Official Statement with everything an investor could conceivably want to know to decide, "Yes…" or "No" about investing in that bond.
This is not the occasion for me to disparage the two- and three-hundred page Official Statement, a mother lode of whys and why nots for investing in a bond. Plain English and brevity can only accomplish so much in reconciling, say, a conflict between a state's constitution and the laws of necessity. (A reference to a seeming contradiction that comes up all the time with appropriation bonds, between such words as "the state's rental payments securing the bonds are 'absolute and unconditional,'" and then such disclaimers as "subject to annual legislative appropriation," and "not a debt of the state…the state is not liable thereon…and neither the state's faith and credit nor taxing power are pledged to payment of thereof….") Besides a constitutional amendment to resolve that kind of seeming double-talk, easier access to Official Statements, even on EMMA, leading to wider use, could create popular demand for tighter wordsmithing. Until then, if there is one thing I've learned about paraphrasing an official statement, it is never follow a disclaimer with the words, "Yes, but…"
Again, thank you for the opportunity to suggest that the Internet, with its ability to inform and educate… to put the Official Statement and real time price data at the investor's fingertips concurrently with a live offering…to scan and search listings from dealers all over the country for individual bonds that meet the personal needs of an individual investor… is inherently better investor protection, as well as the best way today for selling municipal bonds. I would be happy to expound.