THE BLOG
10/07/2014 01:40 pm ET Updated Dec 07, 2014

Pay to Play: Reforming Municipal Finance

Dr. Craig Holman contributed to this blog.

In addition to blowing up the world economy occasionally, Wall Street sometimes sets local fires as well. Consider Jefferson County, Alabama. Here, JP Morgan arranged finance deals to fix its sewer system that proved so expensive to the county that it declared bankruptcy. Bribery of public officials played a role, resulting in the conviction of 21 individuals. Another example is Detroit, where onorous deals with Wall Street are part of its bankruptcy story. The Detroit mayor was convicted of a major scheme of bribery and kickbacks leading up to these dire straits. The common factor in these tales is corruption and subsequent financial hardship. Private firms hoping to profit from municipal deals pay public officials -- through bribes or campaign contributions -- to choose their firm even when the firm's profits come at unnecessary and even crippling taxpayer expense.

In good news, the Municipal Securities Rulemaking Board (MSRB) is writing a rule that strengthens its anti-corruption policies. Already, under Rule G-37, Wall Street firms that sell municipal securities generally can't make contributions to elected officials who have the power to select specific municipal securities dealers. These are the bonds that fund sewers, schools and streets, and must be repaid by taxpayers. The new rule will apply these same contribution restrictions to muncipal securities advisors. These are the consultants who advise a municipal government on which dealers to use, or how to structure finance.

The new rule isn't perfect. One loophole is that if a firm has two divisions, one providing municipal securities sales, and one providing municipal funding advice, each can make political contributions to the portion of the government that doesn't oversee its work. The advisors could contribute to a public official who only has control over the selection of the municipal securities dealing. And the advisor department could only make contributions to an official with power over selecting the municipal dealer. This is a problem.

Another issue is that the small municipal securities business might be part of a larger company. And that larger company can make political contributions to any of the officials. This is also a problem. Case in point, a filing by JP Morgan Securities on the MSRB website shows that the firm peformed underwriting services for the Delaware River Authority in 2013. In answer to the question about whether it made political contributions to any municipal finance official related to this service, JP Morgan Services reports "none." At the same time, the JP Morgan PAC filing at the Federal Election Commission (FEC) shows a contribution to State Treasurer Chipman Flowers in 2013. Further research shows that JP Morgan officials helped Flowers with his campaign.

Why do the rules permit this? Because the MSRB provides that if contributions aren't "controlled" by the municipal securities division of JP Morgan, that doesn't pose a quid pro quo danger. Presumably, the JP Morgan PAC feels justified in making the contributions because the firm determines that the PAC contributions are not "controlled" by its securities affiliate, JP Morgan Securities. But that's a problem for two reasons. First, its not obvious who makes the decisions at the JP Morgan PAC. The Federal Elections Commission, which regulates PACs, doesn't require any information about who makes decisions. Second, even if the folks at JP Morgan Securities don't communicate with the parent company PAC, they wouldn't need to. The PAC folks know their firm provides prodigeous municipal finance services, and making contributions could help win business.

Public Citizen joined with important groups such as AFSCME, the Consumer Federation of America, Harrington Investments, the Roosevelt Institute and Americans for Financial Reform to promote the MSRB proposed expansion of Rule G-37 to include municipal securities advisors as well as dealers, along with needed adjustments to address some of the shortcomings. Ideally, the MSRB final rule will be stronger than what it proposed and close the above loopholes.

Reforming what's generally known as "pay to play" will require enforcement zeal for the rules on the books, and additional initiatives. There are some 100,000 US political districts with the ability to commit future tax dollars to fund bonds. Wall Street preys on the fact that many are governed by honest people who make lack financial savvy and succumb to a slick sales pitch. Protecting them from the wolves of Wall Street deserves our help.

To read the comment submitted by Public Citizen et al., click here.