Municipal securities

A municipal bond is a bond issued by a local government or territory, or one of their agencies. It is generally used to finance public projects such as roads, schools, airports and seaports, and infrastructure-related repairs. The term municipal bond is commonly used in the United States, which has the largest market of such trade-able securities in the world. As of 2011, the municipal bond market was valued at $3.7 trillion. Potential issuers of municipal bonds include states, cities, counties, redevelopment agencies, special-purpose districts, school districts, public utility districts, publicly owned airports and seaports, and other governmental entities (or group of governments) at or below the state level having more than a de minimis amount of one of the three sovereign powers: the power of taxation, the power of eminent domain or the police power.

Municipal bonds may be general obligations of the issuer or secured by specified revenues. In the United States, interest income received by holders of municipal bonds is often excludable from gross income for federal income tax purposes under Section 103 of the Internal Revenue Code, and may be exempt from state income tax as well, depending on the applicable state income tax laws. The state and local exemption was the subject of recent litigation in Department of Revenue of Kentucky v. Davis, 553 U.S. 328 (2008).

Unlike new issue stocks that are brought to market with price restrictions until the deal is sold, most municipal bonds are free to trade at any time once they are purchased by the investor. Professional traders regularly trade and re-trade the same bonds several times a week. A feature of this market is a larger proportion of smaller retail investors compared to other sectors of the U.S. securities markets. Some municipal bonds, often with higher risk credits, are issued subject to transfer restrictions.

Outside of the United States, many other countries in the world also issue similar bonds, sometimes called local authority bonds or other names. The key defining feature of such bonds is that they are issued by a public-use entity at a lower level of government than the sovereign. Such bonds follow similar market patterns as U.S. bonds. That said, the U.S. municipal bond market is unique for its size, liquidity, legal and tax structure and bankruptcy protection afforded by the U.S. Constitution.

Historically, municipal debt predates corporate debt by several centuries—the early Renaissance Italian city-states borrowed money from major banking families. Borrowing by American cities dates to the nineteenth century, and records of U.S. municipal bonds indicate use around the early 1800s. Officially the first recorded municipal bond was a general obligation bond issued by the City of New York for a canal in 1812. During the 1840s, many U.S. cities were in debt, and by 1843 cities had roughly $25 million in outstanding debt. In the ensuing decades, rapid urban development demonstrated a correspondingly explosive growth in municipal debt. The debt was used to finance both urban improvements and a growing system of free public education.

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