In this post, recent HKS grads and Ash Center research fellows Sarah Tesar and Pitichoke Chulapamornsri write about a democratic (and financial) innovation called minibonds in Vancouver Washington and Denver, Colorado. Struck by the exclusive nature of the municipal bond market, the authors explore minibonds as a means of making public finance more inclusive.
By Sarah Tesar and Pitichoke Chulapamornsri
The Golden Gate Bridge was built because the people of San Francisco and the surrounding bay area believed that their city could and should be a bustling economic metropolis. During the peak of the Great Depression, the city backed itself and issued forty-year municipal bonds, paying 5% interest to construct the bridge and render it operational. It took over four years to build the bridge, and construction was mostly a local effort. Contracts were granted to local companies and suppliers, strengthening the area’s economy from the beginning.
The municipal bonds were astoundingly popular and from the moment construction began on January 5, 1933, the Golden Gate Bridge provided employment, access and opportunity. It’s red stone and steel has in many ways become a permanent testament to the American spirit.
Fast forward nearly a century and we see the municipal bond market playing a very different role. We see a closed market where cities turn to big banks to underwrite their bonds. These bonds are then largely sold to institutional and high net worth investors, not every day Americans. This is due to the bonds being sold in $5,000 denominations, which is an access point that is far too high for many Americans. In addition, broker-dealers are also reluctant to trade in small volumes.
In a recent Brookings working paper, Daniel Bergstresser pointed out that the share of overall households with municipal bonds fell from 4.6% to 2.4% between 1989 and 2013, while the share of total municipal bonds that are held by the wealthiest 0.5% of households rose from 24% to 42% over the same period.
This is unfair for multiple reasons. Municipal bonds frequently present a very attractive investment proposition, but a proposition few Americans can access. For investment grade bonds, the yields often range from 2% to 5%. This compares favorably to the highest current savings account rates of less than 1%. The interest is often tax-exempt as well. While there is greater risk in investing in bonds as compared to an FDIC-insured savings account, there have been no AAA municipal bond defaults in the past 40 years. Moreover, the default rate for AA municipal bonds is only 0.01%.
Enter minibonds. Minibonds are municipal bonds sold in lower and more accessible denominations of $500 instead of $5,000. They are sold directly from cities to citizens.
In recent years, two US cities have offered their residents an opportunity to invest directly in minibonds in these lower denominations of $500. The City of Vancouver in Washington State most recently in 2015 issued their first minibond, or as they termed it a “Heritage Bond”. The funds were used to renovate four former U.S. Army buildings of the West Barracks at the Fort Vancouver National Site.
The City of Denver in Colorado has been issuing minibonds for 18 years. They are incredibly popular with the latest and first online issuance so well liked that the $12 million needed was raised from the residents of Denver within 36 minutes. They were oversubscribed by $9 million and had to return money to some unlucky investors. The funds were used as part of the Better Denver Project and directed towards renovations of two cultural attractions and building a new recreational centre.
Both cities believe that the bonds fundamentally increased civic engagement and the connection between the cities and their residents. Minibonds became a tool for helping residents feel good about where their money was going. “Denver residents — and these bonds were also open to all Colorado residents — really appreciated the opportunity to invest their money in good projects in their own community that they see everyday when they drive around town,” says Deputy Mayor Cary Kennedy, who is also the city’s chief financial officer.
In addition, neither city used underwriters, saving a lot of money that for decades has been chained to large investment banks. Pat Sabol, a senior policy and research assistant at the Brookings Institute’s Metropolitan Policy Program, believes that two additional advantages to minibonds include generating community enthusiasm about infrastructure improvements and also demonstrating to the market that there is demand.
In scaling these success stories to more US cities, technology is the biggest barrier. A major headache both Vancouver and Denver faced was the administrative burden in selling so many more individual bonds.
The right technology and online platform would mitigate this extra administration required by city staff to issue these minibonds. In a world where online platforms like Rocket, LendingClub and Earnest are re-democratizing mortgages, consumer credit and student loans, it seems like it is only a matter of time until public finance is enhanced by an online city-to-citizen platform.
Sarah Tesar is a former public finance lawyer, and Pitichoke Chulapamornsri is a former senior analyst at Goldman Sachs. They are both recent graduates of the Master in Public Policy Program at the Harvard University Kennedy School of Government and research fellows with the Ash Center exploring the ways that technology can make public finance more inclusive.