No Excuse to Keep Rule-Breaking Munis

09/14/2011 7:30 am EST

Focus: BONDS

Marilyn Cohen

President & CEO, Envision Capital Management, Inc.

Caveat emptor applies whether you’re at your local supermarket or shopping in the municipal bond universe, Marilyn Cohen observes in Bond Smart Investor.

A camel is a horse designed by a committee…and this one is toothless. In this case, the toothless camel is the MSRB—Municipal Securities Rule Making Board.

You have probably heard about the MSRB, but perhaps never really thought about this regulatory body. Their charge is to make the rules and regulations governing the very municipal bonds that reside in your investment portfolio at this moment.

The MSRB is a 21-person committee whose membership representation includes banks, dealers, and public representatives. They write the rules that supposedly protect us, the municipal bond investors.

I had never seen nor met a member of this committee—perhaps they remain nameless, faceless people deliberately. Then, earlier this month I attended a Fidelity conference…and low and behold there sat on a panel Jay Goldstone, Chief Operating Officer for the City of San Diego—an actual living, breathing member of the MSRB.

The question I’ve waited to ask the MSRB since the 2008 credit crisis was, “Why is it there are no enforcement disciplinary actions against municipal issuers that do not file timely financial statements, or that don’t file at all?”

My follow-up question was, “If the MSRB’s mandate is to protect investors, then how can they allow municipal issuers to get away scot-free when they don’t file Material Events, Financial Statements, and losses in interest-rate swaps that drive them to the financial edge?”

Mr. Goldstone’s answer was that the MSRB only makes the rules. It has no enforcement authority or capability whatsoever. He went on to explain that Dodd-Frank originally had some enforcement language. Perhaps.

But it’s clear to me that enforcement actions have dropped out of sight like DB Cooper.

Why is this so painfully important? The answer is, because rating agencies are more punitive now than ever before. Their swiftness in assessing super downgrades has been breathtaking of late.

They call it recalibration. Whatever its name, a three- or four-notch downgrade in bonds you own would mean devastating price erosion.

With less money coming from the Federal government to the states, there will be less trickle down to the cities, counties, and schools. Couple less government largesse with an economy that continues to weaken and increasing political wrangling as we approach elections, and you have a recipe for municipal bond disaster. You must stay on top of your municipal credits.

Study your “Continuing Disclosure Submissions.” If your issuers haven’t filed financial statements, either currently or during the past two years, sell those bonds. There’s no excuse for not filing. You don’t know what you don’t know. No financials is bad news.

This is so important that if you can’t stay on top of your bond issuer’s financial information, then hire a professional whose business it is to protect you from such avoidable losses. If you must and insist on buying municipal bonds, stick with large, serial issuers who file financials every time they come to market.

We are in a seriously awful financial time for states, cities, counties and various municipal issuers. If the US slides into recession, their financial condition will only worsen.

Thus far issuers continue to make cuts in spending to pay their municipal coupon interest when due. Without knowing how razor-thin their coverage is by studying their financials, you may never know the depth of your issuer’s trouble until they default and it’s too late.

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