SEC's Gallagher: No apologies for muni 'Armageddon' comment

Defaults unlikely, but credit, rate risk considerable, says commission member; made remark at roundtable

Apr 23, 2013 @ 12:01 am

By Jeff Benjamin

munis
+ Zoom
Gallagher: Doubling down on an ounce of prevention (Bloomberg)

A week after Securities and Exchange Commission member Daniel M. Gallagher was accused by some of exaggerating the looming risks in the municipal bond market with an “Armageddon” reference, he is making no apologies for attempting to raise awareness.

“I made the comment in the context of credit risk plus interest rate risk being two major factors that maybe investors don't fully understand,” he said. “The population of investors in this space means we have to double down on investor education.”

A week ago, at a SEC-sponsored fixed-income round-table discussion, Mr. Gallagher caught some observers off guard when he pointed out that by combining rising rates with the recent California muni bankruptcies, “we've got Armageddon on our hands.”

Although the reference wasn't quite as startling as analyst Meredith Whitney's 2010 prediction of sweeping defaults, it did trigger some comparisons.

“I thought the comments were way too strong, bordering on irresponsible,” said Anthony Valeri, a fixed-income strategist at LPL Financial LLC. “This is along the lines of the Meredith Whitney comments, but it's a different approach because [Mr. Gallagher] is talking about rising rates instead of defaults.”

Actually, by referencing the recent California bankruptcies, Mr. Gallagher was touching on both credit risk and rate risk with regard to muni bonds.

But his larger point remains that three-quarters of the $3.7 trillion muni market is made up of individual investors, and it is anybody's guess how those investors will respond if rates start rising.

“Defaults are certainly the more remote scenario — we hope,” Mr. Gallagher said. “I definitely think interest rate risk for investors who will sell before the bonds mature is a big deal.”

Mr. Gallagher, who has been an SEC member for 18 months, said that fixed-income in general and the muni bond market in particular is and will continue to be among his main areas of focus.

“A big purpose of the round table was for the SEC to get up to speed on the fixed-income markets,” he said. “We have traditionally not resourced the fixed-income market anywhere close to the way we resource the equity markets, and my goal is to raise awareness and push education.”

The muni bond market is quick to point out that defaults are rare and bankruptcies are even rarer.

But what concerns those such as Mr. Gallagher is the trend of credit quality in the muni bond arena, combined with an environment where rates can only go up, thus driving down the value of existing bonds.

According to Moody's Investors Service, muni bond downgrades have outnumbered upgrades for 16 consecutive quarters, which is the longest period that has occurred since Moody's began tracking the data.

“We've seen a very slight increase in defaults, but that is still a very, very small portion of the overall muni market,” said Bob Kurtter, a Moody's managing director.

Although Mr. Gallagher's “Armageddon” remark didn't trigger anywhere near the media attention or reactionary sell-off that Ms. Whitney's inaccurate prediction did, it did accomplish his objective of shining some fresh light on the muni market.

“We know there's a lack of understanding by investors for how the muni markets really work, and here at the SEC, we have very few employees that focus on fixed income,” he said. “I'd like to catch up for lost time and force some hard questions to be asked.”

0
Comments

What do you think?

View comments

Recommended for you

Sponsored financial news

Upcoming Event

Sep 12

Webcast

Longevity Lifestyle Preparation: What advisors need to know to prepare female clients for living well to and through retirement

Featuring Mary Beth Franklin from InvestmentNewsYour clients are living longer and spending more time in retirement than ever before — especially female clients, who often outlive their spouses or partners.... Learn more

Featured video

Consuelo Mack WealthTrack

How to maximize the effectiveness of your charitable giving

Donor-advised funds let you take the tax deduction for charitable donations now, while postponing when you give the money away. Pamela Norley, president of Fidelity Charitable, and Elda Di Re, partner at Ernst & Young, discuss the strategy.

Latest news & opinion

Will Jeffrey Gundlach's Trump-like approach on Twitter work in financial services?

The DoubleLine CEO's attacks on Wall Street Journal reporters is igniting a discussion on what's fair game on social media.

Fidelity wins arb case against wine mogul but earns a rebuke from Finra

In the case of investor Peter Deutsch, Fidelity doesn't have to pay any compensation, but regulator said firm put its interests ahead of his.

Plaintiffs win in Tibble vs. Edison 401(k) fee case

After a decade of activity around the lawsuit, including a hearing before the U.S. Supreme Court, judge rules a prudent fiduciary would have invested in institutional shares.

Advisers get more breathing room to make Form ADV changes

RIAs can enter '0' in some new parts of the document before their annual filing next year.

Since banking scandal, Wells Fargo advisers with more than $19.2 billion leave firm

Despite a trying year, the firm has said it will sweeten signing bonuses for veteran advisers.

X

Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print