Feature Articles and Resources

• Investment Strategies for the Current Environment
  
• Federal Government May Become New Ally in Credit Card Vendor Fee Issue
  
• SEC Mulls Changes to SROs
  
• Suggest a Conference Session Topic
  

• Economic Outlook
  
• Panel of Economists: Is the Economy Headed for a Hard Landing?
  
• Interest Rate Outlook
  
• Snapshot of Economy and Interest Rates

• Performance Benchmarks
  • 10-Bill Index
  • Money Market Fund Index
  • LGIP Index
  • Key Rates: Cash Markets
  • Relative Value Yield Chart

Investment Strategies for the Current Environment

Current Environment

Inflation and growth remain the major topics for the market. The Fed has stated that its policy will be “data dependant” going forward. That is in contrast to what had been a “measured” pace of rate hikes. This language change is a subtle way for the Fed to signal that tightening of monetary policy is close to a pause or completion.

• The most recent (June) Core CPI reading revealed that prices had risen more than expected, 0.3 percent month-over-month; expectations were for a 0.2 percent increase. The 2.6 percent year-over-year difference is higher than the Fed’s stated comfort level.
  
  
• Consumer discretionary spending is expected to slow and could further dampen economic growth throughout the second half of 2006.

Prudent Investment Strategies

For investors in the money market space, this market continues to provide challenging hurdles. With growth moderating for the remainder of 2006 and inflation still a concern, portfolio strategies should stay defensive. Here are some strategies for the rest of 2006:

• Without clear evidence that the Fed is pausing, a short duration stance remains a conservative policy. With high demand for short-dated product and spreads staying tight, extension trades remain unattractive and keeping cash bulleted inside of two months appears prudent.
  
  
• An extension will likely be appropriate near the end of the third quarter as two Fed meetings will have come and passed as will approximately three months of additional economic data. With all expectations heading towards slowing growth and contained inflation, the Fed is likely near the end of this tightening cycle. The nine- to 12-month area of the curve would become more attractive if this scenario plays out.
  
  
• Floating rate debt is unlikely to add value beyond 2006 if the Fed does complete this rate hike cycle since the short-end curve would likely flatten or even possibly invert.

Byron Gehlhardt is a portfolio manager for MBIA Asset Management Group. The opinions expressed in this article are solely those of the author, are based upon sources of information believed to be reliable, and are subject to change without notice.

Federal Government May Become New Ally in Credit Card Vendor Fee Issue

Background. For many years the GFOA has encouraged its members to support the use of credit cards for payment of state and local government taxes, fines, and other charges by their citizens (GFOA Recommended Practice: Acceptance of Credit Cards). Not only does this promote convenience to constituents, but it also increases collections made to governments. However, at a time when most non-cash payments are made electronically, the rules that govern credit card payments to governments remain confusing and sometimes costly. Many governments find it difficult to accept credit cards due to: (1) unreasonable vendor fees (also known as convenience or interchange fees) charged by the credit card companies and (2) the inability of governments to pass these fees directly to citizens or absorb the costs into their budgets.

One approach that enables some governments to accept credit card payments is to contract with a third-party vendor for non face-to-face transactions (e.g., Internet, phone payments, kiosks). The third-party vendor can then charge citizens a fee to process the transaction on behalf of the government. However, when it comes to “face-to-face” transactions, most governments are not able to accept credit cards because it is too costly to absorb the vendor fee.

For many years, the GFOA and other state and local government organizations have tried to find a solution to this problem (GFOA Public Policy: Fees for Use of Credit Cards in Payment of State/Local Government Charges). One solution would be to allow governments to pass on the credit card vendor fee to the customer paying with a credit card. Another solution would be to exempt governments from being charged vendor fees since credit cards are being used for the payment of involuntary taxes and fees, which makes it different than private-sector transactions.

New Developments. Recently, the GFOA and the National Association of State Auditors, Comptrollers and Treasurers (NASACT) met with the U.S. Department of the Treasury to determine how all three levels of government could work together to find adequate solutions for accepting credit card and electronic payments in the future. Treasury officials noted that, with credit card transactions growing about 20 percent a year, a solution to the fee problem needs to be found and working collectively is a positive step forward.

On July 19, the Senate Judiciary held a hearing entitled, Credit Card Interchange Rates: Antitrust Concerns? The hearing provided an opportunity for merchants to express their varied concerns about the negative impact interchange fees have on their businesses, the possible anti-trust issues within the interchange fee regime, and also the lack of transparency regarding the price setting of interchange fees. While there was universal recognition of the importance of accepting credit cards, the chief concern that was raised is the unfair playing field that exists for any merchant—or government—who must pay high interchange fees. These costs force many merchants to charge higher prices for their goods and services to all of their patrons, regardless of the method of sale. In fact, one merchant testifying at the hearing stated that “last year alone, American consumers paid Visa and MasterCard around $30 billion in interchange fees.” Visa and MasterCard representatives also provided testimony that the interchange system is vital for ongoing commerce, especially e-commerce, and that price controls or other restrictions to the interchange fee system are unnecessary. Complete testimony from the hearing may be found on the Web.

Other countries, such as England and Australia, have recently reviewed their interchange rates laws and are beginning to change the manner in which credit card companies may apply the interchange rates, with special consideration given to governmental entities.

The GFOA is working closely with NASACT and its Multi-State Alliance for Electronic Receipts Task Force to determine the best strategies for future discussions with the credit card companies, explore alternative methods for acceptance of payments online, and reach out to our international colleagues and Congress for possible solutions. The GFOA Federal Liaison Center will continue to monitor and participate in these discussions, and as the situation develops, will work with the GFOA’s Cash Management Committee for possibly new or updated recommended practices and public policy statements.

Susan Gaffney is the director of the GFOA Federal Liaison Center. If you have any questions about this issue or other federal government activities, please feel free to contact her at sgaffney@gfoa.org.

SEC Mulls Changes to SROs

Do you know which organization directly regulates your brokers? No, it is not the SEC, but SROs. SROs stand for “self-regulatory organizations.” Self-regulation is a key element of the U.S. securities markets. SROs carry out many regulatory duties that might otherwise be performed by the Securities and Exchange Commission (SEC). Due to changes in the securities markets, the SEC is reconsidering the role and operation of SROs. The outcome of the SEC’s deliberations may have a profound impact on the regulation of the markets and on how broker-dealers are regulated. Because government investors depend on broker-dealers to invest funds, they should be aware of these potential changes. The purposes of this article are to:

• provide an overview and general understanding of the SRO component of securities markets regulation;
• explore the regulation of fixed income markets;
• review areas of controversy or disagreement with the current structure; and,
• introduce alternatives considered by the SEC in its “concept release” regarding securities market regulation.

Role of self-regulation. The SEC serves as the definitive regulatory authority of the U.S. securities markets. However, many of the regulatory duties, including setting standards, conducting examinations, and enforcing rules of members, have been delegated to the SROs, which are often exchanges or registered securities associations. For example, stock exchanges, such as the New York Stock Exchange (NYSE), regulate the activities of their members and promulgate their own rules. The National Association of Securities Dealers (NASD) and Municipal Securities Rulemaking Board (MSRB) are the self-regulatory bodies that make rules governing over-the-counter securities dealers and municipal securities dealers, respectively. All firms and broker-dealers must register with the NASD, and sometimes there are multiple SROs regulating a broker-dealer.

SRO Regulation of the Fixed-Income Market

The NYSE, the NASD, and the Municipal Securities Rulemaking Board (MSRB) regulate most fixed-income activity in the United States. The MSRB develops rules regulating firms involved with municipal securities and is composed of members from municipal securities dealers and the public. Unlike other SROs, however, it does not have inspection or enforcement authority. Regulation of the offering of fixed-income securities depends on the nature of the entity issuing the securities, the issuer, and the types of products that the issuer offers. As an example, government securities (as well as those of government agencies and government sponsored enterprises), are exempt from registration. In general, the broker-dealers active in fixed income securities are regulated by the SROs.

Rationale for self-regulation. The rationale for self-regulation primarily rests on the following:

• The perception that government regulation would be prohibitively costly. Shifting regulatory costs from taxpayers to users or participants is equitable from a policy standpoint.

• The view that industry participants bring unique expertise and intimate knowledge of the circumstances of the securities industry.

By its very nature, self-policing involves conflicts of interest. Recent changes in the securities markets have called into question both the fairness and effectiveness of the SRO structure. These changes include:

• the development of more competition amongst the exchanges;
• the emergence of for-profit, stockholder-owned exchanges;
• failures or perceived problems with SROs fulfilling their regulatory obligations in the well-publicized scandals of HealthSouth, WorldCom, and Enron.

As a result, the SEC initiated an exploration of the SRO structure. This culminated with the publication of an SEC concept release in which it examined the current self-regulatory system, considered alternatives, and sought public comment on a range of issues. The SEC has not yet announced any actions.

Conflicts of Interest with Self-Policing in the Financial Markets

By its very nature, self-policing has inherent conflicts of interest. The SEC’s concern centers on four primary areas: Conflicts with Members—SROs are responsible for rules governing all aspects of their members’ businesses. However, conflicts can arise because SROs are funded by members, their governance is controlled by members, and members can influence regulatory and enforcement staff. Conflicts with Market Operations—Regulatory responsibilities may come into conflict with an SRO’s own market operations. For example, conflicts may arise when an SRO’s own exchange products compete with its own members’ products. The conflict can be as simple as promoting trading on the SRO’s own exchange. Conflicts with Issuers—SROs are responsible for the listing requirements for issuers. However, exchanges compete very aggressively for new listings as this is a source of revenue. Conflicts with Shareholders—A stark example of potential conflict exists with an SRO’s own shareholders. The profit motive may distract from regulatory obligations. Further, a shareholder-owned SRO may commit less funds for regulatory activities. As for-profit SROs enter into broader businesses, opportunities for conflict multiply.

Proposed alternatives. The SEC outlined numerous alternatives for reforming the SRO structure in the concept release. All entail keeping SRO Boards independent of member firms. One alternative proposes that all SROs separate regulatory activities from market operation functions by creating separate subsidiaries. A second alternative calls for the creation of an SRO that regulates all members, with the SROs maintaining regulatory oversight over market related activities. Yet another option transfers the authority of the current SROs to a single SRO. Also being contemplated is the complete termination of the SRO structure in favor of direct SEC regulation.

Conclusions. Agreement appears to be developing that there is a need for greater independence of exchanges' self-regulatory functions from their commercial activities or the business of the markets. SEC decisions in this area will affect how broker-dealers will be regulated.

Sofia Anastopoulos, CFA, is manager of GFOA YieldAdvantage.