Telling myth from reality in muniland.

• Author: Doty, Robert

Misunderstandings about municipal securities persist, especially regarding the proven safety of the market. It begins with inadequate recognition by some about the substantial diversity among municipal securities and their varying risks. Municipal securities are issued by states, cities, counties, school districts, water agencies, fire districts, road improvement districts, and a host of special districts, agencies, and authorities. Some municipal securities are payable solely by, or are otherwise dependent on the success of, private parties. There are many municipal security credits and a variety of bonds, notes, certificates of participation, warrants, variable-rate securities, commercial paper, lease-purchase obligations, and other forms of instruments. This diversity can make it difficult for issuers, investors, policymakers, pundits, and the public to make sense of the market.

The entire muni sector, including issuers and investors, needs to understand the types of municipal securities and credits, and the risks each one entails. This is especially important because the Securities and Exchange Commission continues to consider new ways of regulating municipal issuers and politicians are proposing a cap on the tax exemption, or eliminating it altogether. The truth is that the vast majority of municipal securities are sound and secure, with extremely low default risks. Traditional municipal securities--tax-supported general obligation bonds and essential purpose revenue bonds--have been using structures that were originated in the 1800s, with few defaults.

WHY THE MISPERCEPTIONS PERSIST

In 2010 and 2011, a relentless drumbeat of dramatic and at times irresponsible headlines alarmed municipal securities investors with serious and unwarranted exaggerations of market risks. Pundits predicted large-scale municipal securities defaults, of hundreds of billions of dollars, and even bankruptcies. News stories frequently highlighted the occasional valid criticisms of significantly underfunded public pension fund liabilities, unwise financings, and excessive spending in unbalanced budgets. Then, taking gigantic leaps of logic, some of these stories asserted that disastrous consequences overhanging the municipal market portended a municipal securities version of the financial crisis.

Those pundit and media "analyses" show fundamental misconceptions about the strength and enforceability of key municipal general obligation and traditional revenue securities structures. And as for other, less safe securities that are payable from the general funds of general purpose governments (cities, counties) and school districts, pundits seem to have assumed that large numbers of state and local governments would choose to serve their constituencies by defaulting. The choice to default has certainly not been the historical pattern, however, over the long term, during the financial crisis, or afterward.

Moreover, while there are certainly well-publicized defaults and examples of severe financial problems in a few communities, there is no evidence that the overall strength and stability of securities issued for governmental purposes will decline significantly, even in the face of fiscal stress. Issuers that chose such a path would have an extremely difficult time obtaining the funding needed to provide services. Overall, the debt service on municipal securities remains a low proportion of governmental budgets. At state levels, payment of debt service often has a high constitutional or statutory priority. Unlike private corporations, municipal governments must remain in existence and must have access to the market to obtain funds for their long-term projects, and cash flow on a short-term basis.

At the same time, some municipal securities structures and credits entail greater risks--sometimes substantially greater risks--than others. Market observers--including regulators--sometimes overgeneralize, incorrectly, by describing municipal securities merely as general obligation bonds and revenue bonds. This misses the significant distinction between general obligation bonds and general fund securities. It also completely misses more serious risks of default among land-based securities and tax allocation/tax increment securities that are payable from special taxes and special assessments within limited districts for, and dependent upon the success of...