Municipal bond sales via the Internet: the story of Pittsburgh's electronic auction.

• Author: Hennigan, Paul
• Position: Pittsburgh, PA

Extensive planning and communication with market participants and the added attraction of maturity-by-maturity sales helped overcome reluctance of most major bidders for the city's first electronic bond issue.

Tom Murphy, the mayor of the City of Pittsburgh, Pennsylvania, campaigned in 1993 on a platform of change, and one of the things he promised to change was the way in which municipal bond sales were conducted by the city. Prior to his election, the city used the negotiated method, which had stimulated numerous allegations of impropriety and inefficiency in the city's debt management. He favored the competitive sale method, and he was fond of repeating the remark that he did not trust all the municipal bond professionals who suddenly wanted to be his friends. As a legislator in the state capitol for 15 years prior to becoming mayor, he had witnessed embarrassing examples of pandering and influence peddling by bond merchants and their "agents" seeking patronage from elected officials.

After his election he was pursued by underwriters armed with statistics and arguments intended to convince him that appointing them as the city's bond underwriter would result in lower interest rates for the city than selecting an underwriter through competitive sale. They explained that the city's deteriorating credit ratings, the size and complexity of anticipated borrowings, and his desire to encourage underwriting participation by minority and women-owned enterprises mitigated against competitive sales. This logic, however, defied his rudimentary understanding of the capital markets in particular, and capitalism in general. Quite simply, he reasoned: competitive sale implies more competition, and more competition has to result in lower rates and lower costs.

Between January 1994 and January 1997, all city long-term general obligation (GO) bonds and water and sewer revenue bonds, four issues totaling $610 million, were sold successfully using the competitive sale method. These included subordinated water revenue bonds, advance refundings, and taxable pension obligation bonds - all completed in the midst of successive credit rating downgrades.

Introduction to the Internet

In the fall of 1997 the city's financial advisor gave the finance director a private demonstration of the firm's Internet Web site prototype which it had developed for the purpose of conducting competitive sales of new municipal bond issues. Although he had little experience with computers and even less with the Internet, the finance director liked the concept of Internet bidding, based on what they showed him. During the city's short history of competitive bidding, there had been several occasions when underwriters submitted fax bids that were illegible, late, or otherwise failed to conform to specifications in the official notice of sale. Looking at the Internet municipal bond auction prototype, it was immediately evident to the finance director that the Internet could be used as a medium to avoid these problems - and possibly increase bidding competition for Pittsburgh's bonds.

The bond auction prototype introduced the feasibility of maturity-by-maturity (MBM) bidding. In other words, the city could allow bidders to submit bids for selected maturities in its issue rather than requiring that buyers bid for the entire issue on an all-or-none (AON) basis. The State of New Hampshire had conducted an MBM competitive sale in 1995, but the limitations of fax bidding made the process overly complex, and opposition from Wall Street underwriters made it unpopular.

This maturity-by-maturity feature showed promise of allowing Pittsburgh to achieve one of its objectives, which seemed to have been suffering with the city's new competitive bidding policy: more participation by local, minority, and women-owned underwriting firms. "Unbundling" an issue in this fashion makes underwriting risk more manageable and purchase price more affordable for smaller, undercapitalized firms. Normally, these firms must join AON bidding syndicates run by Wall Street firms and then hope that lead managers will be generous when allotting bonds to them. Generally, they seem dissatisfied with their treatment and have expressed their dissatisfaction to city officials on more than one occasion.

Issues

In May 1997, Pittsburgh's finance director watched the first public demonstration of this Web site bond auction prototype to the Government Finance Officers Association's (GFOA) Committee on Debt and Fiscal Policy at the GFOA's annual conference. Committee members in attendance included high-ranking public finance officials from a number of states...