The issue of municipal bond disclosures (or the lack thereof) has been increasingly attracting attention from regulators. A few days ago, Dian ElBoghdady with the Washington Post wrote that more enforcement is on its way. “SEC cracks down on disclosure in municipal bond sales” (June 28, 2013), includes a tally of cities and states that have been accused for not providing enough information to the investing public. With nearly $4 trillion at stake, the assertion that effective transparency is key makes sense.
A few days ago, a colleague sent an email with a link to a June 15, 2013 article in The Economist, entitled “Ruinous promises: States cannot pretend to be in good financial health unless they tackle pensions.” Its premise is threefold. First, numerous public sector plans are underfunded. Second, current government financial accounting rules often fail to provide information about the “true” economic costs associated with providing benefits to public government employees. The article suggests, for example, that the use of a 7.5% expected return on pension portfolio assets may be hard to swallow at a time when U.S. treasury bond yields are in the neighborhood of 2%. Third, taxpayers will have to make up any shortfall. The article concludes that “States need to wake up.” The gentleman who sent the link to me conveyed a similar sentiment, stating that [He] “doubts many people are up in the middle of the night worrying about this…but maybe they should.”
In a recent press release, Moody’s Investors Service described an increase in municipal bond defaults from an average of 1.3 per year between 1970 to 2007 to an average of 4.6 defaults per year for the period from 2008 to 2012. While “extremely infrequent” so far, Anne Van Praagh, Chief Credit Officer for Public Sector Ratings is quoted as saying that “…risks are tilted to the downside going forward.” She adds that “Growing pension costs, increasing exposure to the capital markets and changing attitudes towards default and bankruptcies” are important reasons why local governments are feeling anxiety. See “Municipal bond defaults have increased since financial crisis, but numbers remain low” (Moody’s press release, May 7, 2 013).
With recent municipal bond market selling and a postponement of new issues over concerns about rising rates, opaque disclosures and higher than reported benefit plan costs could reinforce bad news. In “Municipal Bond Market Rocked As Interest Rates Spike,” Reuters’ Lisa Lambert (June 21, 2013) quotes financial advisor Ric Edelman as intimating that retail investors who favor muni bonds are going to be shocked when they realize that they must contend with interest rate risk.
Yet another factor is a possible cap on the rate at which affluent taxpayers can lower their liability. In “U.S. Treasury stands behind cap on municipal bond exemption,” also by Lisa Lambert with Reuters (June 25, 2013), U.S. Treasury under secretary for domestic finance, Mary John Miller, is quoted as pushing for the termination of numerous “sacred cows” in order to improve the federal budget situation.
Morningstar analyst Jeff Westergaard paints a grim picture in “Our Outlook for the Municipal Markets” (June 26, 2013). He describes the state of the municipal market as one of “extensive uncertainty.”