MuniLand

The SEC held a fixed income roundtable on Tuesday to discuss two important issues: market structure and ways to improve it for municipal and corporate bonds. The SEC has as much authority to regulate this market as it does for equity securities, and it appears to be finally flexing its muscles with a little structure for the $18.7 trillion fixed income market.

I tweeted the roundtable all day (you can read the whole thread here), and I’ve posted the best ones here (parentheses are my editorial comments):

Good sign… new @sec chair Mary Jo White is attending the Fixed Income Roundtable 1.usa.gov/15cEjRm

— Cate Long (@cate_long) April 16, 2013

SEC Walters: “Why have the technology advancements of fixed income not flowed to retail investors?” #muniland

— Cate Long (@cate_long) April 16, 2013

SEC Walters: “Dealers trade selectively with counterparties” “Lack of pricing transparency” #muniland

In his State of the Union address, President Obama sketched a broad outline of the need to rebuild 70,000 “structurally deficient” bridges and other infrastructure in the country, but never got more specific. In a follow up, the White House announced the specifics of his infrastructure proposal.

The sum of his proposal, $50 billion, is barely enough to excite a huge amount of support or a significant fight in Congress. For 2013 the budget of the Department of Transportation is $98 billion. State and local governments issued $54 billion of municipal bonds to fund transportation last year. The president’s proposal is about 1/3 of current annual transportation spending, and he proposes no way to pay for it. It’s rhetorical fluff meant to sound good to voters, but it has little chance of going anywhere.

One part of the Obama proposal is a replay of his “National Infrastructure Bank,” which has been proposed twice and received no traction in Congress. The NIB would begin with $10 billion of federal funds to guarantee private investments made for public infrastructure. The main Senate sponsors – Massachusetts’ John Kerry and Texas’ Kay Bailey Hutchinson – have both left the Senate, and no sponsor has stepped forward to take over, according to Politico. It is unlikely that any prominent sponsor will step forward, seeing as the National Infrastructure Bank seems like a ruse to give public guarantees to private investors. Using the nation’s balance sheet to increase private profits would be a very unpopular political position to defend at election time. There are other concerns, which Politico details:

The stampede into municipal bonds has been strong since the market hit a low point after Meredith Whitney’s famous prediction in 2010 of hundreds of billions of dollars in defaults. Her words caused a run out of muniland, which damaged a lot of retail investors who sold their holdings at market lows.

The rebound in demand since then has pushed down yields to near historic lows, as investors stampeded back into muniland in a search of security and returns. This excellent chart of yields for AAA general obligation bonds from Daniel Berger at Thomson Reuters Municipal Market Data is worth a thousand words.

Further:

Bloomberg writes,  “State-Local Government in Best of Times for Finance: Muni Credit”

Last week the New York Fed put out a controversial report claiming that the default rate for municipal bonds is 36 times higher than one cited by credit rating agencies. Using data sets from S&P Capital IQ and Mergent that tracked defaults for unrated bonds, the New York Fed report created a big stir among muniland commentators and probably a small amount of concern among retail investors. The data cited by the New York Fed is well known among market professionals and has been thoroughly dissected, but so far the discussion hasn’t focused on why these unrated bonds default at higher rates. Specifically, no one has linked the high default likelihood of this sector, private activity bonds, to the fact that Congress has exempted them from rigorous disclosure since 1968.

Randall Forsyth at Barron’s pulled the right information from JPMorgan municipal bond research to explain what this unrated sector of high defaulting bonds is. Take special note of that last section:

“The vast majority of defaults came from revenue bonds, which are backed by the cash flows from a specific authority or entity, such as a municipal hospital, or an industrial-revenue bond issued on behalf of a private entity. In other words, by far the diciest niche of the muni market.