The use of minibonds, small denomination municipal bonds, to fund public projects is appealing to government officials since they are believed to broaden local investor access and strengthen the connection between residents and the projects. But how do they compare to traditional, higher denomination municipal bonds in terms of costs?
Recently, I published an article with my colleague, Christine Martell, at the University of Colorado Denver on the use of small-denomination municipal bonds by local governments in the United States. The article’s title, “Costs of Raising (Social) Capital Through Mini-Bonds”, is a not so subtle jab at the inherent conflict between improving small investor access to municipal bonds and the expected inefficiencies of borrowing using small-denomination bonds. Given the continuing budget constraints on governments, we set out to quantify the additional costs associated with the use of these bonds.
The paper concludes that some previous small-denomination bond issuances have violated many of the efficiency objectives of raising capital in the public sector, but new ways of issuing these bonds that are more compatible with efficiency objectives are emerging. Meanwhile, we find that small denomination bonds serve other social purposes beyond borrowing that should be considered but are difficult to quantify.
In the City and County of Denver, Colorado, a pioneer in the practice of using small-denomination bonds, these bonds were a substantially more expensive approach to borrowing than traditional municipal bonds. For the additional cost, the improved access to resident and small investors was limited. Part of the additional expense was due to the novelty and infrequent nature of these issues. Technology helped Denver complete the bulk of its most recent minibond sale online and continued innovation has the potential to make municipal bonds more accessible to local investors.
Cambridge, Massachusetts has issued small-denomination bonds with Neighborly. The Cambridge experience demonstrates that some of the traditional challenges of these bonds can be avoided. The pricing of the Cambridge bonds followed the market without paying artificially high interest rates to help promote the bonds. Unlike minibonds, the Cambridge bonds were current interest bonds – a structure favorable to a broader group of small investors compared to zero coupon bonds. The Cambridge bonds can also be sold in the secondary market. Providing liquidity to investors improves the suitability of municipal bonds for smaller investors. Many minibond sales include restrictions to favor local buyers, although the definition of “local” often extends beyond the issuing jurisdiction to the state level. In the Cambridge case, the sale was precisely targeted solely to City residents.
Public infrastructure remains a salient concern at all levels of government. State and local governments, including school districts and special districts, continue to use municipal bonds and the associated income tax exemption to incentivize residents to invest in physical improvements to their own communities. The recent experience in Cambridge suggests that supporting local public projects can be a more feasible option for a broader cross-section of citizens.
Author: Todd L. Ely is an assistant professor in the School of Public Affairs at the University of Colorado Denver where he directs the Center for Local Government Research and Training. Todd’s work on mini-bonds can be found in the Fall 2016 volume of Municipal Finance Journal. He can be reached at firstname.lastname@example.org.
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