If you’re a certain age, it’s likely that you’ve never given a second thought to buying a municipal bond or the process of bond buying, even if you’ve intuited, rightly, that’s it’s an intentionally opaque business.
Yet there could be a big opportunity for startups, and for people looking for places to invest, and for cities with crumbling infrastructures, in disrupting the status quo — if only everyone starts playing closer attention.
First, there’s a strong case for buying bonds. Earlier this year, the Trump administration capped at $10,000 the amount that taxpayers can deduct in property tax and local and state income tax. Most people with hefty tax bills are benefiting in other ways from that same new tax bill, but this aspect of it isn’t so great for them, and municipal bonds can help. The reason: interest income paid on muni bonds is exempt from federal tax. (Bonds issued within one’s state can also be free of state tax.)
What about people without hefty tax bills? For one thing, bonds are a very safe investment. They’re not sexy, it’s true ( they typically deliver interest in the single digits), but they also feature low default rates. Whether debts from states, cities, or counties, they’re typically government guaranteed and paid back in full at the end of their term. In fact, muni bond default rates have been as low as below .03 percent over the last decade. What’s also compelling — perhaps even more so — is that bonds can give residents an opportunity to help out the community where they live. For example, Oakland, Ca. voters in 2016 overwhelmingly approved a $600 million bond to fix old city streets and build affordable housing.
You might be wondering at this point where the new opportunity lies and what role tech can play. Let’s start with the moolah, which there happens to be a lot of sloshing around the municipal bond market. Last year, Morningstar Direct reported $34 billion in net inflows to municipal bond funds and exchange-traded funds, and there’s a lot of action happening outside these kinds of products, which package up a bunch of bonds to create a diversified portfolio for investors.
Like any financial services disruptor, the idea here is to offer what the big financial institutions are offering but to do it at less cost.
There’s also room to create many more bonds than are currently available. As the New York Times reported earlier this year, fewer municipal bonds have been hitting the market ever since the financial crisis of 2008. More, the Trump administration’s new tax law revision eliminated something called “advance refunding issues,” which the Times describes as a type of municipal bond financing that accounts for around 15 percent of the market. Where there’s constrained supply, there’s demand.
Right now, there aren’t tons of startups paying attention to public finance, and perhaps just one company laser focused on bringing the muni bond market into the 21st century: Neighborly , which is a six-year-old, Bay Area-based company that’s very progressive, to say the least, for a bond broker. In 2017, its technology enable the city of Cambridge, Ma., to create $2 million of “mini bonds” that allowed residents to earn tax-exempt interest for smaller check sizes than typically possible, and the residents were able to invest that money directly in a variety of projects, without going through a middleman. (Apparently, it was successful; Cambridge staged a second mini bond sale earlier this year.)
Earlier this year, Neighborly convinced the city of Berkeley, Ca., to stage an initial coin offering that it dubbed an “initial community offering.” The idea is to deliver crytocurrency tokens in exchange for investments into cash-strapped projects in Berkeley — tokens that will be backed by municipal bonds. (Bond holders can receive their money back in digital coins or cash.) The project is still in development, but if it works, it could certainly provide a roap map for other cities.
Whether Neighborly winds up being a pioneer in the space- – or else trampled by a newer entrant — remains to be seen, but a recent on-stage sit-down with a longtime political strategist turned investor, Bradley Tusk, opened our eyes to the possibilities. You can check out part of that conversation below. Note that Tusk is not an investor in Neighborly but has more recently begun advising the company.
TC: You think the muni bond market is broken. Why?
BT: We have a system now that, on the one hand works. Governments can issue debt. People will pay for it. You can build projects and people will get paid back. That basically works. But it’s a very opaque, very closed system. And in the way that tech has managed to disrupt other very closed industries and force change and make them more cost efficient and transparent there’s no reason that can’t happen in public finance as well.
[Earlier in my career], I was at Lehman Brothers . . . and they didn’t know where to put me so they stuck me in public finance. The people who worked there were honest, they weren’t the people who bankrupted the global economy. But they made a lot of money, and effectively, it was just all layered on top of the taxpayers. It’s built into [banks’] underwriting costs. And you just don’t need that any more.
TC: So right now, bonds are mostly made available through brokers who charge fees and that’s not good in your view. But isn’t skipping straight to “initial community offerings” or employing blockchain technologies from now the right way to go? You could see that scaring people.
BT: I think blockchain gets confused with crypto and ultimately, it’s just a better system of piping, a more efficient way of moving data across a ledger from Point A to Point B and do it in a way where it’s distributed across lots of different places so that it’s more secure and less hackable. But it’s plumbing; it’s infrastructure at the end of the day. So it will evolve to the point where it will just make a transaction that’s complicated and has lots of different parties and pieces just easier and faster. It’s no different than how the Internet makes it faster to do things we used to do. Email is faster than writing a letter. Text is faster than email.
[To your point], what Neighborly is trying to achieve isn’t solely dependent on blockchain. I don’t think it existed in the form it does now when [Neighborly founder and CEO Jase. Wilson] first came up with this idea. The main notion is you have a public finance system that’s expensive and opaque and not particularly democratic. You meanwhile have a lack of awareness by the people most impacted by the decisions [about where bond money should go], and those are real inefficiencies in the marketplace that Neighborly and other companies are trying to do address. Blockchain should just help them do it more efficiently over time.
TC: Is Neighborly making already available bonds to users of its platform or is it out there or creating new bonds?
BT: Both. It can participate in a process and make bonds available or it can work with a municipality that, say, wants to create community-owned broadband.
TC: What about challenges in persuading governments to work with startups like Neighborly? Aren’t there a lot of special interests and existing relationships to overcome?
BT: Yeah, there’s a huge problem right now, which is that you have all these firms that advise government on issuing debt or participate in the process that, even though a lot of them are prohibited from giving money directly to candidates, they are very, very entrenched. They have relationships with mid-level people at budget offices everywhere.
This is a cartel that has to be taken on, just like Uber has had to take on the taxi industry and Airbnb has taken on hotels. In some ways, it’s an even harder cartel to fight because it’s so opaque. No one really understands how the budgeting process works internally, so it’s a big cartel and it’s a silent cartel, which in some ways is the most powerful of all, so it’s a pretty big fight. I give Neighborly a lot of credit for taking it on.
TC: Is there a precedent here? Who else is taking on public finance in a way that you admire?
BT: This is the most innovative [startup]. One company does it well, then 15 more pop up. The first one has to do all the heavy lifting and take on all the fights and that’s probably what’s going to happen here, too. When market opens up, and people realize there’s money to be made, you’ll see more come in, but right now, there’s just one company that I’m aware of that’s doing most of the work.
Public finance departments are good at really working over who gets to issue and underwrite the debt, and Neighborly would rather live in a world where they didn’t have to play that game, but to some extent, the real world of politics still exists.