SEC member Gallagher defiant on comment

By Jeff Benjamin

Apr 28, 2013 @ 12:01 am (Updated 5:01 pm) EST

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 an 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.”

DUAL RISK

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.”

jbenjamin@investmentnews.com Twitter: @jeff@benjamin

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