In the present financial crisis, the municipal bonds arena has been remarkably calm. Municipal bond holders so far have been spared the roller coaster ride that mortgage security owners had to endure. With tax revenues declining and operating conditions strained, there are strong indications that things may change soon. What happened in Jefferson County, Alabama, could just be the tip of the iceberg: on August 29, the sewer authority in Jefferson County received a one-month reprieve to renegotiate $3.2 billion in debt. It has repeatedly been on the verge of default. Without the reprieve, it would have been the biggest municipal default in U.S. history.
In 2007, municipal issuers had $2.6 trillion of debt outstanding – most held by individual investors. Investors have little way of recognizing when trouble is brewing. There is a severe lack of financial disclosure by municipal issuers – the municipal bond market is a place where disclosure is pretty much voluntary and investors receive only spotty financial reports.
A recent study by DPC Data concludes that disclosure among municipal issuers in both annual filings of financial statements and other reports of material changes that are of concern to investors are dismal. From 1995 through 2006, more than half of the municipal bonds failed on one or more occasions to file required financial statements. More than 25% missed three or more years of disclosures.
Laws from the 1970s restricts the Securities and Exchange Commission from going after issuers that do not make the required disclosures. The SEC can regulate only brokerage firms that underwrite these bonds, holding them to a requirement that no issuer can sell debt without being up to date on filings for the most recent five years and can pursue only issuer fraud.
Issuers tend to shrug off disclosure failings, pointing to historically low default rates among municipal issues of around 1.5%. In today’s world, past default performance means little in the here and now.
In the municipal bonds market, nondisclosure appears to be an established practice. It is a breach of the fundamental principles of investor protection, suggesting hidden problems or potential fraud.
The lawmakers in Washington, D.C., need to wake up to these indications before a major crisis hits the market. There is a lot at stake. The municipal bond market is enormous with roughly 54,000 municipal issuers with debt outstanding, and 25,000 of those issue debt about every two years. Disclosures must be made mandatory, and new legislation must be passed to give SEC the authority to enforce the disclosure requirements. The right of investors to know material facts on a timely basis is the foundation of a fair market, enabling them and their advisers to take rational actions to protect their financial interests.
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Hmmm… interesting facts indeed. I am kind of shocked.