A battle that started decades ago and has been highlighted with such flareups as the California teachers’ retirement system opposing gun sales and a Texas comptroller pushing back against an alleged boycott of fossil fuel companies is now spreading across the country, a sharp contrast to a time when public finance was considered much less controversial.
The rise of environmental, social and governance-based investing, or ESG, is the latest and most acronymically friendly political dividing line that many believe was first drawn when the Democrats lost forty years of control over the House of Representatives in the 1994 mid-terms. Prior to that “Republican Revolution,” public finance measures to build bridges and pave roads were typically rubberstamped by bipartisan politicos anxious to crow to constituents about moving the country forward. That era came to an end in the mid-1990’s.
“Everything got more difficult to pass when Speaker Newt Gingrich, R-Ga., unveiled his brand of confrontational and vitriolic politics, beginning in 1995,” said Bill Oliver, a municipal research consultant whose career as an analyst stretches back more than 40 years.
“Transportation bills were routinely re-authorized. Once he shut the government down on a debt ceiling reauthorization, politics has never been the same. We never used to have the need for Infrastructure Week every year in Washington to promote the benefits of public infrastructure.”
With the Republicans in charge of both houses in 2017 another log got laid onto the public finance political fire. The pandemic added another. “The first was the 2017 Tax Cuts and Jobs Act which eliminated the ability of public finance entities to use tax-exempt bonds for advance refundings,” said Tom Kozlik, head of municipal research at Hilltop Securities. “The second was the 2021 American Rescue Plan which allocated at least $650 billion to various public finance sectors.”
Municipal bonds issues have been tagged as political boondoggles benefiting populous states and large cities that are often Democratically controlled.
“It is sometimes seen that way but it’s an unfair characterization,” said Chuck Samuels, an attorney who has spent decades involved in public finance lobbying. “It is true some of the blue states are big bond issuers but there are certainly plenty of red states, like Texas, Florida, and Arizona, which require major public financings to support their growing populations. And, in many smaller red states, local governments and nonprofits, such as hospitals, need support, particularly in rural areas.”
Samuels also believes gerrymandering, the practice of redrawing congressional districts so that they become more partisan, has made things worse as both parties pull towards the extreme. “Redistricting and the sharp divide between red and blue states and districts has meant the loss of virtually all Republican moderates and many Democratic moderates,” he said. “Most current members of Congress are more fearful of the far right or the far left than seeking the benefits of cooperation and bipartisanship.”
Joseph Krist, another municipal credit consultant and longtime analyst, traces political rumblings in public finance back to the environmental movement of the 1970’s and the continued evolution of the media. “The real difference is the volume of political-driven news that’s available,” he said. “We used to have equal time rules from the FCC and those were being eliminated in the 1980’s. People began to realize that twenty-four-hour news could be effective changing policy and changing point of views. Then we had the advent of the internet and Citizens United case which created an infrastructure and funding stream that basically didn’t exist.”
The political tension affecting every facet of modern life has already been baked into what should be coolly calculated funding decisions. Politics has always played a role. “In a democratic system, there is no other way,” said Frank Shafroth, an attorney and educator who previously managed congressional affairs for the Municipal Securities Rulemaking Board.
“One cannot get elected or re-elected without committing to assisting local leaders and communities in meeting their needs,” Shafroth said.
“There is almost nothing related to public finance that is not enmeshed in politics,” said Oliver. “The sheer size of public borrowings dwarfs many local budget activities, so everyone wants a piece of it. This goes from the selection of projects to be funded to the choice of underwriters, bond counsel, feasibility consultants, contractors, suppliers, minority business participation and so on.”
The challenge of trying to regulate the effects of politics on fiduciary issues is also happening globally. “The question with regard to whether environmental issues are impacting credit ratings, especially with regard to oil and guns, is sensitive,” said Shafroth. “There are differences between the U.S. and the E.U., where investors are mandated to comply with the Sustainable Financial Disclosure Regulation, while corporations face stricter mandates in the form of the Corporate Sustainability Reporting Directive.”
As the Securities and Exchange Commission tries to sort things out in the U.S., exploring regulations aimed at ESG, the industry remains insulated by years of regulatory inertia.
“The fact that states and local governments still have discretion over what and how much they disclose to investors is mind-boggling,” said Oliver. “The decision on what is material to investors is a question for investors, not underwriters and their various counsels who are employed by the issuers.”
The market may be facing another chapter in the saga as the midterm elections approach next month, with control of both chambers appearing to be up in the air. Republicans have already promised a close examination of President Biden’s infrastructure spending should they gain control of committees.
The notion of trying to regulate politics out of the muni market seems like bad policy to Samuels.
“We have so much diversity and complexity in our issuances that trying to apply rules across the board at this point, particularly the federal level, is not a good idea,” he said. “We need more experience with actual financings before we can think about setting federal rules on ESG disclosures. On the other hand, there is no question that those who promote green bonds will probably face more questions and scrutiny than general financings.”