Feature Articles and Resources

• Washington Update
  
• Credit Card Companies Change Rules on Convenience Fees
  
• Useful Resources on Accepting Credit Cards
  

• Panel of Economists: Economists Highlight Factors to Watch
  
• 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

Washington Update

By Susan Gaffney

Congress has been busy in recent months, trying to complete as much work as possible before the long August recess and the anticipated session adjournment at the end of September. With the presidential elections and many heated congressional races on the horizon, a majority of significant legislation – such as the appropriation bills – will likely wait to be completed until after the new president takes office in January. However, various housing, tax, and financial services bills have seen a great deal of action. Below is a snapshot of some of the issues the GFOA's Washington, D.C., office is monitoring.

Capital Markets Turmoil. Congress and various regulatory agencies have been addressing problems associated with the recent turmoil in the capital markets. Congress has held many hearings, and has eyes on significant financial services reform, but that will likely wait until 2009. Administration officials have been busy responding to congressional inquiries about the activities in the subprime market, investment banking practices, and the role the credit ratings agencies played throughout the crisis. In March, Treasury Secretary Paulson outlined a Blueprint for Modernized Financial Regulatory Structure that would streamline many of the oversight functions of the financial services industry, including a significant restructuring of the financial markets' regulatory bodies, including the Securities and Exchange Commission, Commodities Futures Trading Commission, U.S. Federal Reserve, and the Federal Deposit Insurance Corporation. It will be important for the state and local government community to keep a close eye on these developments.

This summer, the Securities and Exchange Commission (SEC) released proposed regulations aimed at various rating agencies' practices and investor reliance on credit ratings. The SEC is authorized to designate rating agencies as a Nationally Recognized Statistical Ratings Organization (NRSRO) and ensure that they maintain certain standards to keep that designation. However, the SEC is now recognizing that investors and the SEC itself have placed too great of significance on ratings, and has proposed rules to “increase investor protections by reducing reliance on credit ratings.” The proposed rules note that “the SEC has considered whether the inclusion of requirements related to ratings in its rules and forms has, in effect, placed an "official seal of approval" on ratings that could adversely affect the quality of due diligence and investment analysis. The SEC's proposal would reduce undue reliance on credit ratings and result in improvements in the analysis that underlies investment decisions.” The GFOA is planning to comment on the proposed rules later this summer.

On July 8, the SEC reported shortcomings in credit rating agencies' practices and disclosure to investors. A 10-month investigation into the rating agencies' practices resulted in findings that showed “significant weaknesses in ratings practices and the need for remedial action by the firms to provide meaningful ratings and the necessary levels of disclosure to investors.” The investigation centered mostly on the ratings of mortgage-backed securities and collateralized debt obligations. It found that conflicts of interest were not always disclosed, nor were proper policies and procedures in place to manage the rating process of these securities. SEC Chairman Christopher Cox stated that “the recent events affecting our economy and our markets have galvanized regulators around the world to re-examine the regulatory framework governing credit rating agencies, but ultimately the responsibility for providing meaningful ratings to investors begins with the credit rating firms themselves." In June, the SEC proposed three additional sets of comprehensive reforms to regulate the conflicts of interests, disclosures, internal polices, and business practices of the rating agencies.

Bond Insurers and Credit Ratings. The House Financial Services Committee is examining the problems that the market turmoil and bond insurer downgrades are causing state and local governments. Most of the major bond insurers have been downgraded, which has not only affected their bond insurance products, but also their guaranteed investment contract (GIC) businesses. Many of the bond insurers strayed away from their traditional business model of only insuring municipal bonds and started insuring and investing in collateralized debt obligations, a market that has crumbled over the past few months. This has put pressure on many of the bond insurers to find new capital, in order to stay viable.

House Financial Services Chairman, Barney Frank held a hearing on the bond insurers' practices in March, and the committee passed legislation in July that calls on the Secretary of the Treasury to gather information on the financial stability of the bond insurance industry and report back to Congress. The legislation, H.R. 6308, the Municipal Bond Fairness Act, also requires the SEC to create a uniform standard for credit ratings, so that comparable scales are used when rating securities. Currently, ratings agencies use different standards for rating municipal securities and corporate securities. H.R. 6308 would not allow ratings agencies to receive the SEC's NRSRO accreditation unless they use uniform scales for all products. The GFOA sent a letter to Chairman Frank supporting this legislation.

Federal Home Loan Bank Letters of Credit. Authority for Federal Home Loan Banks (FHLBs) to support their member banks' letters of credit (LOC) for tax-exempt bonds was recently enacted as part of the Housing and Economic Recovery Act . The bill was signed by President Bush on July 30 and allows FHLBs to provide their member banks with a letter of credit for tax-exempt bond issues, without causing the bonds to become taxable.

Delinquent Local Tax Collection Legislation. In July , the House Committee on Oversight and Government Reform approved H.R. 1865, which would create a pilot program where some states, on behalf of local governments, or some local governments themselves, would notify the Department of the Treasury of individuals who owe past-due legally enforceable local tax obligations. The Treasury Department would then reduce the amount of an individual's federal tax refund by the amount of the outstanding debt and remit that amount to the state for transfer to the local government. The legislation was introduced in the House by Congressmen Jim Moran (D-VA) and Tom Davis (R-VA), and has bi-partisan support. The GFOA, the National League of Cities, the National Association of Counties, and the U.S. Conference of Mayors sent a letter in June to House Oversight and Government Reform Committee Chairman Henry Waxman (D-CA) and House Ways and Means Committee Chairman, Charles Rangel (D-NY) supporting the legislation. Companion legislation has yet to be introduced in the Senate.

Credit Card Merchant Fees. Also in July, the House Judiciary Committee approved H.R. 5546, Credit Card Fair Fee Act of 2008, introduced by Committee Chairman John Conyers (D-MI). H.R. 5546 would allow merchants (including governments) to negotiate with the credit card companies, rather than be “forced to enter take-it-or-leave-it contracts before they can accept Visa and MasterCard at their stores.” Although companion legislation has not been introduced in the Senate, the Senate Banking Committee is looking at credit card fee issues in general.

Withholding on Government Payments. A one-year delay on the implementation of a 3 percent withholding requirement on government payments for goods and services, H.R. 5719, passed the House of Representatives in April. The withholding provision included in the 2005 Tax Increase Prevention and Reconciliation Act, mandates that state and local governments that spend more that $100 million per year on goods and services must withhold 3 percent of the payments made to vendors and contractors, and remit that 3 percent to the federal government. The GFOA is working to have the provision repealed, but also supported H.R. 5719.

Legislation to Increase Bank Qualified Debt Limits. Legislation has been introduced that would increase the municipal bond bank qualified limit to $30 million. Since 1986, banks only have been able to deduct the costs of purchasing and carrying bonds if issued by governments whose annual bond issuance does not exceed $10 million. That amount has never been increased, even for inflation, for the past 22 years. H.R. 6333, the Municipal Bond Market Support Act of 2008, would increase the limit to $30 million and then have it indexed to inflation in subsequent years. The Act would also allow the bank-qualified exemption to apply at the borrower rather than issuer level, so that it benefits the small entities that borrow through conduit authorities, such as non-profit education and health care authorities. Additionally, the legislation would allow banks to carry up to 2 percent of their holdings in municipal bonds in addition to their bank qualified debt holdings, providing an important new purchasing power for municipal bonds.

Susan Gaffney is the Director of the GFOA Federal Liaison Center.

All of the regulations, legislation, and GFOA comment letters referenced in this article may be found on the Federal Government Relations page of the GFOA’s Web site. Please contact Susan Gaffney if you have any questions about GFOA’s legislative efforts.

Credit Card Companies Change Rules on Convenience Fees

By Jim Plunkett

This article highlights new programs that allow governments to pass along a credit card “convenience fee” to customers in face-to-face transactions.

Background. In a retail environment, a transaction fee is charged to the merchant whenever a customer makes a purchase using a credit card. Merchants are prohibited by the credit card companies from passing this transaction fee to the customer who uses the credit card, so merchants typically hide this fee in the price of their goods or services. Thus, all customers bear the burden of the fee. This is appropriate because merchants have control over the price of their goods and customers are making voluntary payments (i.e., they are not required to make the purchase).

In contrast, in most governments, fees are set by ordinance or statute and 100 percent of the fee must be collected by the government, which leaves no room to budget the transaction fee. In addition, government taxes are “involuntary payments,” that is, the citizen does not have the choice to make the payment. Furthermore, many local governments collect payments for another level of government. For example, in Minnesota, cities and counties collect fees for the State Division of Driver & Vehicle Services and Department of Natural Resources, and in Missouri, county tax collectors collect revenues for cities and towns.

State and local governments, wrestling with how to budget the transaction costs for credit cards, began passing along the transaction fee to card holders. Visa and MasterCard became aware that this had become widespread practice, and in 1993 began enforcing their bylaws which prohibit passing along transaction fees to cardholders. To enforce this policy, Visa and MasterCard ordered their member banks to cut off service to those governments passing along the transaction fee.

Following these actions, the GFOA and other state and local government associations entered into discussions with Visa and MasterCard concerning their policies for government-sector transactions. The state and local government side of the debate put forward a number of arguments. A key argument on the government side was that taxpayers who choose to pay their taxes by credit card should pay the cost of the transaction. Taxpayers who choose another payment means should not pay the transaction fees of those who use credit cards.

Visa and MasterCard also put forward a number of arguments to support their position. Their main argument was that an important precedent would be set if governments were allowed to pass along transaction fees. If governments are able to pass the credit card transaction fee along to credit card users, then the private sector also would seek the same privilege.

This standoff continued until 1996 when Visa and MasterCard began to allow governments to charge a “convenience fee” to customers who pay by credit card on the Internet or through an automated phone system. Recently, in November 2007, MasterCard decided to allow governments to charge a convenience fee to customers who pay by credit card in face-to-face transactions. American Express adopted a similar policy in January 2008.

The Programs. MasterCard and American Express each have a convenience fee program for participating government entities (or their third-party agents collecting fees for them). Participants in the MasterCard program must meet the following requirements:

• Participants that store or process MasterCard account data for Internet-based transactions must provide evidence of compliance with the MasterCard Site Data Protection (SDP) program's underlying Payment Card Industry (PCI) Data Security Standard to their payment processing company.
  
• Participants using a third party for storage and processing of MasterCard account data must document this on their registration form so MasterCard can ensure that the third party is SDP compliant.
  
• Cardholders must be notified of the convenience fee at the time of payment and be given the opportunity to opt out of the sale. In no case may the entity collecting payment be allowed to charge the fee without disclosure to the cardholder prior to finalizing payment.
  
• Payments and convenience fees must be processed under a merchant category code that is eligible.
  
• A customer service phone number must be transmitted to citizens on their monthly statements.

Note: Additional requirements from both MasterCard and American Express may apply and you should check with your payment processor or third-party service provider before assessing a convenience fee.

What You Need to Know. First, credit card companies differ in their rules on when governments can pass on a convenience fee to their customers. The table below summarizes the current rules.

Second, MasterCard and American Express do not allow a convenience fee to be assessed on their brands and not on Visa and Discover Cards. Since Visa does not allow a convenience fee for face-to-face, non-tax payments, this means that if a government accepts Visa cards, then it cannot charge a convenience fee on any credit card in face-to-face transactions.

Third, there are two types of companies that you can work with to take advantage of these convenience fee programs: credit card processing companies and third-party service providers. Credit card processing companies underwrite you, set you up, and deal with any issues that result from transactions with your citizens. Credit card processing companies also directly deposit your funds usually within 24 hours and no later than 48 hours.

Third-party service providers partner with credit card companies to do your payment transactions. Some third-party service providers have invested substantially in information technology that may offer your government advantages such as interfacing with your citizen database. Because third-party service providers usually do not process your payments, they have to set up up their own merchant accounts with a payment processor, collect your money, and then transfer your funds to you, which adds additional costs and usually delays collection of your funds at least an additional day and as much as 10 days. If you choose a third-party processor, make sure you ask how quickly your funds will be deposited.

Fourth, MasterCard has strongly recommended that the convenience fee be processed as a separate and unique transaction (what they call “Best Practice”), and not be included in the total charge for the good or service. This helps minimize the amount of customer service inquiries and effectively insulates the municipality from accounting issues related to the fee.

Authorization and settlement of two separate transactions with one card swipe requires new technology. A payment processor that offers this technology collects the convenience fee in one account and the resident's payment in another, remitting payment to the government quickly and separately managing transaction fee payments in their own deposit account. Alternatively, payment processing companies that offer traditional retail terminals require governments to collect the fee themselves and then pay their credit card processor.

Previous articles about public sector credit card payments usually ended with a statement like: “Until the transaction fee debate is resolved, governments should conduct a cost/benefit analysis to determine if accepting credit card payments make sense for them.” However, a new era in local government payments and customer service for their citizens has begun. Because of the position MasterCard and American Express have taken, state and local governments can now accept credit and debit cards without having to absorb the cost of credit card transaction fees.

Jim Plunkett is the program manager for Nationwide Payments Solutions Government Acceptance Program. Nationwide Payment Solutions processes greater than $3 billion in transactions annually for more than 20,000 merchants. He can be reached at: jplunkett@nwgov.com or 877/290-1975, ext. 2213.

Economists Highlight Factors to Watch

This month Treasury Management asked its panel of economists what factors are likely to play the most important role in the direction of interest rates over the next six months and what news public investors should watch most closely.

Eugenio Alemán of Wells Fargo Bank says that the financial markets and the intervention by the Federal Reserve and the Bush administration will play a key role in the economy in the coming months. He adds that current policy is pointing towards higher inflation and a weaker dollar, which could put further pressure on commodity prices.

John Silvia of Wachovia Securities states that credit risk will be a key factor driving and keeping Treasury rates low over the next six months.

Lacy Hunt of Hoisington Investment Management notes that long-term interest rates have declined over the past 12 months even though the consumer price index has increased from 2.6 percent to 4.1 percent. The reason for the decline in yield in an inflationary environment is that insufficiency of demand has overwhelmed inflationary forces, creating deflation in many categories. In addition, Hunt notes that the decline in the stock market and a 15.3 percent contraction in home prices have caused a total wealth loss of approximately $5.2 trillion. This loss in wealth over the past year is more than 14 times the increase in GDP due to price increases.

According to Scott Brown of Raymond James, the key factor that will affect interest rates in the coming months will be whether the economy begins to lean more toward the downside risks to growth or upside risks to inflation. Brown expects economic growth to be sluggish in the near term and improve gradually into 2009. He predicts that labor market conditions will continue to weaken even as the economy improves. He notes that while inflation expectations are up, they have not taken root in the labor market. Brown predicts that the Fed will likely increase rates later this year or in early 2009.