A Call For More Disclosure in the Muni Markets
When it comes to municipal bonds, financial disclosure has been poor. Gretchen Morgenson devoted her column to this topic in yesterday’s New York Times. Ms. Morgenson is particularly critical of the failure of state, local, and other tax-exempt issuers to disclose properly their pension liabilities. In particular, she cites the SEC’s case against the state of Illinois in which the agency found that the state did not disclose its failure to fully fund the state’s pension plan.
While I’m sympathetic to Ms. Morgenson’s desire for greater disclosure, I don’t think it will do much to protect investors. In most instances, the requisite information is available in government reports if not in the offering memorandum. So for example, Illinois’s pension woes have long been known to anyone who consulted their annual budgets and comprehensive annual financial reports (CAFRs).
Admittedly it is hard to expect retail investors, the largest investors in munis, to dig through government filings in order to figure out the funded status of a public pension. However, I don’t think most retail investors are studying the existing offering memoranda, and I don’t expect they’ll be better investors because municipal issuers are offering more disclosure. While individuals own 44% or $1.6 trillion in municipal bonds, institutions own 56% or $2.1 trillion of tax-exempt paper. In other words, there are a huge number of supposedly sophisticated investors who should be able to analyze municipal issuances. Mutual funds, insurance companies, and banks have the resources and expertise to dig through public documents even if they’re not neatly package in the offering memoranda. In addition, most large tax-exempt issuers, such as Illinois, are evaluated by the rating agencies. Moody’s, S&P, and Fitch also have the resources to conduct thorough research. However, institutional investors and the rating agencies haven’t been too successful in navigating municipal pitfalls over the years (see, “Investment Lessons Courtesy of Puerto Rico [October 4, 2013])”. I doubt more disclosure will improve their record.
In my opinion, it would take significant and substantive political reforms to truly improve the municipal markets. After the Great Depression North Carolina created the Local Government Commission, which continues to approve debt issuance by municipalities and authorities. The Commission has made it more difficult for Wall Street bankers to saddle localities with poorly structured offerings and has ensured greater consistency between a locality’s debt offerings and its finances. The State Treasurer in North Carolina maintains a staff to oversee state and local financial issues. After a near bankruptcy in 1975, New York State imposed a Financial Control Board on New York City which helped clean up the City’s finances and restore its credit rating. These types of entities are unpopular with politicians because they strip them of power. ThusI don’t expect substantive reforms unless we’re in the throes of a crisis, and it’s too late to save retail investors from major losses.
We will probably get more and better disclosure. It won’t change anything.