Mispriced Municipal Bonds Cost Mutual Fund Shareholders And Taxpayers Billions Of Dollars

In a market where at least 99% of trillions of dollars of fixed income securities have no trades to offer price discovery and the financial data to assess credit risk cannot be readily downloaded to a spreadsheet for analysis and comparison, how can there be “fair market value” in pricing?

That question has vexed investors, issuers, and regulators in the $3.9 trillion municipal bond market for decades. The market’s lack of trade data is only matched by its lack of digitized financial data. This “dual data void” compounds the problem, causing municipal bonds to be mispriced and undervalued and it costs mutual fund shareholders and taxpayers alike billions of dollars.

On Your Mark to Market, Get Set, Go

At the close of every business day, billions of dollars of municipal bonds are “mark to market”, that is, valued at the closing price of the bonds that day. If you own shares in a municipal bond mutual fund, the prices of those bonds determine the net asset value of that fund and, in turn, the value of your shares.

Determining the price of a bond is not that complex; it’s all based on an equation that every first-year MBA student learns. Each bond’s structure—coupon, maturity, redemption features—may change up the variables a bit, but the fundamentals stay the same.

While the bond math is no different for the municipal bond market, this market has what is politely called a “structural problem” that affects accurate valuation.

What’s the structural problem? With $3.9 trillion of outstanding debt of over 50,000 municipal and public authorities with over 1 million separately identified bond series, there are plenty of bonds to trade. Moreover, the Municipal Securities Rulemaking Board’s 2021 Factbook notes the average daily number of fixed rate bond trades was 28,985 in 2021, totaling more than $6,200.9 million par value. Based on year-to-date 2022 numbers from those same metrics, some $2,350.8 million par trades have taken place. No paucity of trades to establish prices, right?