The SEC Warns About Muni Bond Risks. Is That Its Job?by
When it comes to financial regulators giving the public a heads-up, December has often been a doozy. It was 16 years ago this month that then-Federal Reserve Chairman Alan Greenspan cryptically warned of “irrational exuberance.” The dot-com bubble exploded in 2000, followed by a subprime bubble whose implosion cratered the global economy. Greenspan has said it wasn’t his job to curb either of those manias. Today’s Fed seems similarly unbothered about the possibility of new asset bubbles.
Four Decembers ago, as news of Bernie Madoff’s historic financial fraud hit the news, the Securities and Exchange Commission was castigated for having ignored multiple warnings about the scheme. The SEC has since worked to restore its tattered reputation, nabbing insider traders and, with the help of prosecutors, striking fear back into the hearts of ethically challenged hedgies—a financial sheriff restored.
So should the resurgent SEC be boosting its mandate by trying to save investors from asset bubbles?
I got to thinking of all this when, the morning after Christmas, the SEC issued an investor bulletin (PDF) “to help educate investors about assessing credit risks they face when purchasing municipal bonds.” The 23rd such dispatch the agency has put out this year, this one urged investors “to undertake their own independent review of the municipal bonds’ risk” and to “look beyond the short-hand label given to a municipal bond, such as ‘general obligation bond’ or ‘revenue bond,’ or the bond’s credit rating” while deciding whether to purchase municipal bonds.
“Investors should gather as much relevant information as they can before spending their hard-earned dollars on any investment,” said SEC Chairman Elisse Walter in a press release. “While I will continue to push for enhanced and more timely disclosure by those who issue municipal securities, investors should continue to learn all they can before purchasing them.”
This comes during flush times for munis. In a record year for all manner of debt issuance, the hunger for yield has never been stronger. Bond-fund managers and junk ETFs have been larding their holdings with questionable unrated and/or Puerto Rican bonds. Christine Thompson, Fidelity’s chief investment officer for fixed income, has warned that the muni sector will have “land mines that explode.” Financial columnist Allan Sloan recently called munis a “train wreck waiting to happen.”
The yield on top-rated 10-year munis fell to a record-low 1.40 percent this month before shooting up to 1.75 percent, according to Bloomberg data. Even in the face of state pension crises and California’s bout with Chapter 9 fever, investors—who represent 70 percent of muni bondholders—want more. According to Lipper, municipal mutual funds have taken in $50 billion of assets this year through Dec. 19, the most since 2009.
If Mom and Pop don’t know what they are getting into, should Washington be protecting them from themselves?
“I think it’s ridiculous,” says Michael Lewitt, editor of The Credit Strategist, a report popular with bond traders. “Seems to me that it’s not the SEC’s job to protect investors from their own stupidity. They can’t outlaw irrational exuberance or crowd-chasing behavior. I’m not sure it should be anyone’s role. Leave it to the market and stick to chasing fraud.”
Lori Schock, the SEC’s director of investor education and advocacy, says the idea of yield-chasing and huge, unquestioned inflows into bond funds “is certainly something we’re concerned about, especially in this low interest-rate environment.” But she says that the post-Christmas bulletin is part of a broader campaign to provide a greater amount of educational material to investors. In a single year under past SEC regimes, she notes, the commission might put out one-sixth of the research it has published so far in 2012. “We’re not going to be able to prevent or break up bubbles,” Schock says. “What we can do is redouble our efforts to get out information, to help investors be more proactive.”