KEEGAN: SEC report reveals house of bonds turned into den of thieves

By   /   August 2, 2012  /   3 Comments

By Frank Keegan | State Budget Solutions

Frank Keegan

The word “taxpayer” appears only 14 times in 165 pages of the Securities and Exchange Commission’s Report on the Municipal Securities Market released Tuesday. Only two of those mentions refer to looking out for our interests.

In her statement introducing the report, SEC Chairman Mary Schapiro made it clear that bond buyers are primary beneficiaries of the recommendations: “While we have put in place measures to help investors make more knowledgeable decisions about municipal securities, we could do more for investors with statutory authority to improve disclosure and muni market practices.”

She initiated the study and hearings around the country two years ago, after egregious scams revealed systemic and pervasive failure of current regulations and standards for municipal bonds and related derivatives.

About 75 percent of the estimated $3.7 trillion in municipal bonds are owned by individuals, 50 percent directly and another 25 percent through mutual and money market funds, according to SEC. The rest are held by institutional investors.

According to Schapiro’s study, “The mission of the SEC is to protect investors — including investors in municipal securities — maintain fair, orderly, and efficient markets, and facilitate capital formation.”

The SEC mission does not explicitly include protecting taxpayers from unscrupulous politicians, bureaucrats, bond dealers, financial advisers, consultants or any other predators who have turned a solid house of prudent public finance into a den of thieves.

From the mass of regulatory and legislative reforms proposed in this report, it looks as if that house is so rotten at the foundation it could fall any time.

Bottom line is that right now, there is no way to tell which among more than a million municipal bond issues by 44,000 issuers — among 87,000 government “entities” — is any good.

That is because, among other problems: “… disclosure of audited annual financial statements … is particularly slow. … There are no uniformly applied accounting standards. … conduit borrowers provided substantially less continuing information than issuers … . The accuracy and adequacy of disclosure regarding pension and OPEB (Other Post Employment Benefits) funding obligations … . Exposure to Derivatives … Disclaimers of Responsibility … . undisclosed payments, political contributions, and bid rigging….”

Complicating this bond ruin beneath a façade of safety are chilling acknowledgments of abuses, such as “negotiated offerings” that “create opportunities for municipalities to allocate underwriting business on the basis of political contributions rather than on the price and quality of underwriting services.”

Those “conduit” entities and “derivatives” secretly put taxpayers on the hook for billions and let politicians slip around legal borrowing limits.

The “… conduit bonds have represented approximately 70% of all municipal bond defaults despite representing a relatively small percentage of municipal bonds issued,” according to the report.

As for derivatives, “The special and significant risks posed by derivative instruments to municipal issuers has underscored the need to consider enhanced disclosure … .”

Considering just one common type of derivative, the report said, “there currently is no comprehensive data on how many municipal issuers are active in the $162 trillion U.S. dollar-denominated interest rate swap market,although anecdotal evidence suggests a relatively wide use.”

That is $162 TRILLION, in notional value, putting taxpayers at risk for incalculable billions in losses.

Anyone who believes current regulation is enough to protect taxpayers from these deals, take a look at the State Attorneys General Muni Bond Derivatives Settlement Website. Those are just the ones who got caught, so far.

However, the most tragic scam acknowledged by this report is politicians looting municipal and state worker retirement funds to bypass legal debt restrictions. Public pension funds are at least $4.6 trillion short as of 2011, and falling fast.

“Obligations to provide pension and OPEBs can significantly affect a municipal issuer’s financial health and may impact its ability to make debt service payments on municipal securities,” the report states, confirming numerous recent studies proving that fact.

Right now, according to state constitutions, statutes and case law, public pensioners generally are first in line when it comes to taking taxpayer money. That puts them ahead of municipal bondholders, who invested under the delusion they get paid first.

Just the need for this report reveals that this prudent fiscal instrument of safe investment for the greater public good through the building of schools, roads, bridges, utilities and other good and essential structures of government has been turned into an insidious machine to enrich a few at the expense of the many.

Beyond the merits of any specific recommendations for new laws and regulations is the overwhelming fact that, taken as a whole, it indicts the entire system.

Whether this system fundamentally is corrupt beyond reformation remains one assumption SEC leaves unquestioned in this report.

Another is whether docile taxpayers and dedicated public workers will go along with the massive tax hikes and crippling service cuts required to pay for the follies of politicians and their cronies.

Schapiro must recast the SEC mission within the context of history and realize she cannot consider those assumptions immutable.

If SEC refuses to put taxpayers first among those it must protect, ultimately investors, financiers, politicians and public workers will lose.

In America, citizens can demolish any house turned into a den of thieves and rebuild.

For more information:

Frank Keegan is editor of a project of The State Budget Solutions Project is non-partisan, positive, pro-reform, proactive and anchored in fundamental-systemic solutions. The goal is to successfully engage political journalists/bloggers, state officials and opinion leaders in a new way of thinking about state government and budgets, fundamental reforms, transparency and accountability.

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  • crosspatch

    I agree, the traditional mandate of the SEC to protect investors does not directly transfer from the private debt market to the public debt market. In the case of public debt, both the issuer and the buyer are “the public”. There needs to be a much different set of rules for public debt or it should be regulated by a different organization altogether.

  • Well, you’re right about underfunded pensions being the most trragic scam, but the rest of your piece is smoke with no fire. Surely if the bond business is a den of thieves, you could illustrate the investor being scammed by unscrupulous dealers even once.
    The AG’s settled a case against brokers scamming issuers by price-fixing reinvestment instruments. In those cases, investors weren’t hurt, though in theory the taxpayer could have been saved a minute sum if the deals had been legit.
    And that’s it. That’s the sum total of your indictment of the industry. The rest of your concerns are with issuers, in other words government. Don’t peg the bond industry with the corruption inevtiable with government. You just didn’t make that case.

  • Indignant Citizen

    Mesquite Texas caught rolling extravagant New York City trips into City bonds for City Council members their friends and family. Increasing bond cost 11%. No charges filed or taxes paid.