Bond Holders Seek Governmental Transparency

Once upon a time buying a municipal bond was considered a safe bet. A decent rate of return with little risk ­– just the thing for junior’s college fund and grandma’s retirement account. But that was before Standard & Poor’s downgraded the U.S. government’s credit-worthiness, sending shock waves through the bond markets. And before governmental agencies increasingly defaulted on loans and threatened or declared bankruptcy, converting safe securities into junk.

That’s potentially a lot of junk. Investors hold nearly $3 trillion of municipal debt in the United States. One of those investors receiving a wake-up call is Irv Siminoff, a World War II veteran who served in the Pacific Theater and began investing in municipal bonds in the early 1980s to provide a stable income for his son’s tuition at Stanford.

“I started out investing in Wall Street right out of college, and in those days things were pretty calm,” he told the Securities and Exchange Commission at a hearing last year in San Francisco. “One could get 5 to 6 percent in dividends and could reasonably expect maybe a 5 to 10 percent annual return from the underlying corporation. In addition to income from my equity portfolio and my growing business, muni bonds seemed like an ideal, good security, a given income and investment return at some time in the future at a scheduled date. Boy, was I naive.”

His first municipal bond investment was in the Washington Public Power Supply System. It was not insured, but, he said, it “looked really safe. What could be better than revenue from power?” He wound up losing half of his money after delays, cost overruns, mismanagement and political opposition to nuclear power resulted in WPPSS defaulting on $2.25 billion in construction bonds. Investors and the public were largely kept in the dark about the problems. Siminoff was luckier than some investors who only received 10 cents on the dollar.

While Siminoff was naive at the outset, even sophisticated investors can suffer from insufficient knowledge about the risks in these supposedly safe investments. Peter Kuhn, a former accountant for Price Waterhouse whose wife calls him a “municipal bond geek,” bought from a professional trader a general obligation bond issued by the Hayward School District, getting a very good yield. “However, Hayward is having some financial challenges, and their certificates of participation were just downgraded to nearly junk, if not junk status,” he said.

“The municipal securities market lacks many of the basic investor protections that exist in most other sectors of our capital markets,” said Andy Gill, senior vice president at Charles Schwab. “It is time for this circumstance to change, beginning with an improved disclosure regime that will boost investor confidence and improve access to information about the municipal securities market. Financial reporting by municipal issuers can take up to 270 days to reach an investor.”

Institutional investors have an advantage because they are exclusively treated to investor road shows in which bond issuers may provide financial information that never appears in financial statements, according to Mary Colby, representing the National Federation of Municipal Analysts. But they share the complaint about being kept in the dark.

The situation is even worse in the secondary market in which bonds are resold; for example, Chicago takes 13 months to file its financial information. A lot can go wrong financially for a government agency in the meantime.

A lack of transparency and deceptive practices were unveiled in the Los Angeles Community College District’s $140 million bond construction program. An audit by State Controller John Chiang released in August 2011 concluded that the district “could not produce complete and timely records, spent funds outside voter-approved guidelines, ignored its own procurement rules, failed to plan effectively, and provided poor oversight of bond funding. Shoddy fiscal management and sub-par oversight of a project of this magnitude will undermine the public’s trust and threaten billions of public dollars.”

But to listen to the government representatives at the SEC hearing, you would not think there was any problem. They argued that, as public entities, they are even more transparent than private corporations.

The problem actually may be much worse, given the under-reporting of unfunded pension and retirement health care liabilities for state employees. Taxpayers may be on the hook nationwide for more than $2.5 trillion in pensions, according to David Crane, an economic advisor to former Gov. Arnold Schwarzenegger, with perhaps $500 billion of that in California alone.

“State and local governments utilize a misleading method for reporting the size of public pension obligations,” said Crane, calling it “the Alice in Wonderland world of government pension accounting that allows governments to hide liabilities.”

“California wasn’t alone in this regard,” Crane told the SEC. “Unrealistic reporting of pension promises is a systemic problem. That’s why the SEC must require realistic accounting of public pension promises. For that to happen it must insist upon a realistic discount rate when reporting pension liabilities.”

Nothing contained in this blog is to be construed as necessarily reflecting the views of the Pacific Research Institute or as an attempt to thwart or aid the passage of any legislation.

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