SEC Report: Municipal Bankruptcies Poses Threat to Municipal Bond Market

SEC Report: Municipal Bankruptcies Poses Threat to Municipal Bond Market

A new report suggests that the pace and threat of municipal bankruptcies poses threat for investors and the municipal bond market.

The Securities and Exchange Commission released an analysis of the municipal bond market and its response to some of the largest city bankruptcies to befall the country, including San Bernardino and Stockton, California. In a recent roundtable discussion among market participants, SEC commissioner Dan Gallagher said the market – which is made up of roughly $3.7 trillion in investor funds – could face “armageddon” if municipal bankruptcies continue and interest rates experience an unexpected spike, according to Forbes.

“The commission has to pay attention to both of these issues,” said Gallagher, as reported by Reuters. “What role does the protector of investors have with respect to bondholders getting wiped out who thought they were buying inherently risk-free products?”

Further, unlike other types of bonds that are considered more liquid, such as U.S. Treasuries, municipal bonds may be more challenging to unload. The comment sparked outrage from several financial analysts, some of whom said the remarks were “irresponsible,” Forbes noted.

However, the recent decision of San Bernardino to continue its payments to the state pension fund at the expense of municipal bondholders, may lead many investors to begin questioning the financial security of investing in these particular type of bonds. Moreover, if interest rates continue to rise and more distressed cities are forced to seek bankruptcy law protection, it is unclear what recourse bondholders might take to ensure their clams are prioritized over other creditors.

“We can debate around the edges about what role the commission plays when it comes to systemic risk  but for things that are just so squarely in our jurisdiction this issue, exit risk to retail investors when interest rates go up, is probably the biggest thing I worry about,” said Gallagher.