Traditionally, cities sold their municipal bonds exclusively to one of seven giant investment banking firms in a system that offered the bonds in an expensive "all or none" bidding process. This process restricted competition and could cost the city a large amount of money in bidding fees and negotiation. While other bond industries have adopted Internet-based trading that permits a more competitive auction process, governments have avoided the innovation, fearing that the giant investment firms would boycott future sales.
In 1997, with their Electronic Bond Bidding Initiative, the City of Pittsburgh took on Goliath. They decided to issue their municipal bonds in smaller and more affordable bundles to attract smaller investment firms. Then they utilized a local Internet company, MuniAuction, to conduct the sale. Since the whole auction process was electronic, the City was able to provide all potential bidders a formula for ensuring consistent calculations of the bonds' cost and to quickly display explanatory error messages to brokerage houses in the event of a non-conforming bid. Effectively, the new system saves the City a significant amount of money and encourages a wider selection of finance firms to enter the auction.
The program is relatively simple: the City takes bids on bonds over the Internet. The bids are submitted via web-page templates that assure accurate and timely submissions. The MuniAuction website displays the best bid and permits revised, more aggressive bids. The privacy of the bidder is maintained through several security features, but the transparency of the best bid creates healthy competition in order to secure the lowest interest rate.
Another benefit lies in the privacy of the bidder. In an auction where millions of the city's dollars are in play, the anonymity of the bidder can protect the city officials from allegations of any conflict of interest. Another protection lies in the electronic confirmation which indicates that bidders have read essential disclosure materials as part of the sale.
The program's impact has been significant. In the first sale, the underwriter's fees dropped more than half and commissions dropped by 70 percent. MuniAuction's fee, $2,500 per auction, is miniscule compared to the traditional method's costs an estimated savings of a million dollars or more. Further, for each issue, the printing and mailing fees under the old system could range from $50,000 to $100,000 whereas now all data is transmitted and processed over the Internet. Also, the transparency in competition enables the acquisition of a lower interest rate, saving the City millions more over the life of the bonds.
About $200 billion in municipal bonds are sold and purchased every year in the United States. Only 25% percent of those bonds are sold competitively. There is great potential for Pittsburgh's innovation to be replicated at many levels across the country. Customizing the bidding procedures to suit their particular requirements, within a year of Pittsburgh's initiative, state and local governments in Oregon, Utah, California, Florida Virginia, Louisiana, and others, have already adopted the program. In conclusion, with the Electronic Bond Bidding Initiative, the City of Pittsburgh has harnessed the technology of the future to create and maintain a more transparent system of government lending and finance, ultimately saving the taxpayer money.