WASHINGTON — Securities and Exchange Commission officials have told a House Democrat that “the recent problems of municipal bond insurers and the direct and indirect impact on municipal bond investors illustrate once again some of the shortcomings of the regulatory structure of this market.”

SEC chairman Christopher Cox sent Rep. Paul Kanjorski, D-Pa., a Jan. 31 letter, along with a five-page memo dated Jan. 30 and written by Erik Sirri, the commission’s director of trading and markets. It said the SEC is monitoring the affect on the municipal bond market of the rating downgrades of monoline insurers, but noted that disclosure in the muni market “is substantially less comprehensive and less readily available than disclosure by public reporting companies.”

“Despite the size and importance of this market, it lacks a variety of the systemic protections found in many other sectors of the U.S. capital markets,” the memo said.

The memo said that the SEC is aware that some auctions of auction-rate securities in both the muni and corporate markets may have attracted too few bidders to establish a clearing rate as a result of the turmoil in the credit markets, resulting in higher interest rates on those securities for a period of time.

The SEC also said it has learned that some muni issuers and conduit borrowers have expressed an increased interest in converting their auction-rate bonds into variable-rate bonds backed by letters of credit or other credit enhancement, or into fixed-rate bonds.

“However, heavy demand for such credit enhancement instruments and market concern may have made them more difficult and time-consuming to obtain,” the SEC memo warned.

Kanjorski announced last month that he has launched an inquiry into the bond insurance industry and asked federal and state regulators for information, including whether statutory or regulatory reforms are needed. His staff released responses from the federal and state regulators yesterday afternoon, including the letter and memo from Cox and Sirri. Meanwhile, Kanjorski plans to hold a hearing to discuss the issues on Feb. 14.

In his memo, Sirri identified a number of other possible problems the commission is tracking. They include the potential impact of downgrades of securities held by municipal money market and other funds, as well as possible termination events or collateral posting events for swaps and other derivatives entered into by municipal issuers and conduit borrowers triggered by rating downgrades of insurers or swap counterparties.

The SEC also is monitoring problems experienced by some state and local government investment pools related to investments in structured investment vehicles, Sirri noted.

“We are maintaining close contact with market participants to keep abreast of market volatility, pricing, and other issues,” he wrote.

In other letters sent to Kanjorski, state insurance regulators and other federal regulators said they have the tools they need to monitor the situation. The state regulators — from Wisconsin, Maryland, and New York — said they would not support the idea of creating a guaranty fund for bond insurers.



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