CHICAGO - Investor confidence in municipal securities may have been shattered by the "liquidity freeze-up" in the auction-rate securities market earlier this year, as well as the contemporaneous downgrades to most bond insurers that caused the value of insured bonds to plummet, the Securities and Exchange Commission's municipal securities chief Martha Mahan Haines warned bond attorneys gathered here yesterday.
Haines said that thousands of investors have contacted the commission in recent months to express frustration about having invested in auction-rate municipal securities that they thought were safe. The $330 million ARS market dried up in mid-February when broker-dealers stopped propping up the securities' auctions.
"I know that the municipal ARS are technically safe because they rarely default - but ARS investors expected liquidity and apparently didn't get it," she said, speaking at the National Association of Bond Lawyers Bond Attorneys Workshop here, according to an advanced text of her remarks provided to reporters. "Believe me, they typically did not express warm feelings about ARS in particular, or the municipal market in general. Quite the contrary - many felt burned."
Haines addressed a general assembly of NABL on behalf of Erik Sirri, the SEC's director of trading and markets, who could not attend because of the ongoing financial crisis.
Referencing the bankruptcy of Lehman Brothers and the ongoing financial turmoil, Haines said that the municipal market is not immune from the powerful forces that have tested Wall Street more than any financial crisis in recent memory.
"Globally, major market changes are underway right now and I don't expect them to stop anytime soon," she said, adding that in the past decade the municipal market has become "inextricably interwoven" into the fabric of the financial system as a whole.
"While some may have considered it a quiet backwater market in the past, it is now clearly part of the mainstream - faced with many of the same problems and challenges as other markets," she said noting a laundry list of recent commission actions that will have a direct bearing on the muni market. The list included proposed rulemaking to boost the accountability and transparency of credit rating agencies, stemming from 2006 legislation, which obviously affects how both municipal and corporate securities are rated, she said.
In addition, she said the extent to which the municipal market has become entwined in other markets was recently brought home when the defaults in subprime mortgages and the consequent reduced value of many collateralized mortgage obligations resulted in the lowering of the ratings of a number of bond insurers - "ultimately leading, along with other factors, to a liquidity crisis in the municipal auction-rate securities market."
"Stop and think about that for a minute," she said. "Like a row of dominoes, the negative effects of defaults on some home mortgages and related securities entirely outside the municipal market ultimately led to many of your clients paying interest rates as high as 20% on their ARS."
In addition, the increased use of highly sophisticated and opaque products, such as derivatives, in connection with municipal offerings, has increased the complexity and risk associated with this market, she said.
"Just ask Jefferson County," she said, referring to the Alabama county on the brink of bankruptcy in part because of the liquidity crisis in the ARS market, which "disturbed" the historic relationships of ARS rates with the London Interbank Offered Rate and other reference indices used in some of its derivatives.
"How much more interconnected with other markets can you be?" she asked.
Turning to SEC chairman Christopher Coxe_SSRqs initiatives to boost municipal disclosure and accounting standards, Haines paraphrased Cox's recent remarks to The Bond Buyer that it no longer makes sense for the commission to regulate issuers indirectly through broker-dealers through the Rube-Goldberg device of its Rule 15c2-12 on disclosure.
Still, Haines said that at Cox's direction, the SEC staff is now considering the extent to which the muni initiatives may be addressed under existing law and drafting additional amendments to 15c2-12 for possible future consideration by the commission.
Though knowledgeable sources at the NABL conference said that the SEC is considering going beyond the scope of initiatives as they were unveiled last year, Haines declined to identify any specific proposals the SEC is considering.
