–Rep. Frank: Municipalities Almost Never Default
–Rep. Campbell: Will Probably Have 9 More Bankruptcies ‘Very Soon’

By Yali N’Diaye

WASHINGTON (MNI) – Lawmakers Friday disagreed over the level of
default risk in the municipal sector, at a time when recent bankruptcy
filings in California raise the question of the eroding stigma
associated with taking that step.

Rep. Barney Frank, the Ranking member on the House Financial
Services Committee, brought up the issue in the context of what he deems
the unfair treatment of municipal issuers by rating agencies.

Municipalities “almost never default,” said Frank, whose personal
investment portfolio is nearly entirely in Massachusetts municipal
bonds, “because they are double tax exempt and because the rating
agencies inaccurately tell people that there is a risk of default, which
is not existing.”

He noted that in the recent bankruptcies, “the bondholders are
getting paid,” adding in Rhode Island, pensioners were “put behind”
bondholders.

Barney indicated municipalities do fear the contagion risk
associated with a bankruptcy and “communities can’t afford that
contagion that would be there.”

However, Rep. John Campbell strongly disagreed and even warned of
more to come.

“I could not disagree more, coming from California where we’ve had
three municipal bankruptcies — we probably will have nine more very
soon,” said Campbell.

Once municipalities and a lot of districts properly account for
their healthcare and pension obligations under the “new — and I believe
correct — government accounting standards” he continued, “many of them
will be on paper insolvent.”

In fact, he said, “most of them” in California that he knows of
will be likely be insolvent on paper.

Campbell referred to the new Pension Accounting and Financial
Reporting standards adopted in June by the Governmental Accounting
Standards Board, that are expected to make state and local governments’
balance sheet look weaker than they are today.

So “I think we have great concern about municipal bonds,” said
Campbell, who unlike Frank does not own any municipal bonds in his
personal investment portfolio.

“You can’t assume they are not going to be at fault, and when there
is as much trouble as there is out there and as many insolvent cities
and special districts this is a concern,” he said.

“There is a lot of risk out there,” he concluded.

Campbell represents California’s 48th Congressional District which
encompasses Newport Beach, Irvine, Tustin, Lake Forest, Laguna Beach,
Laguna Hills, Laguna Woods, Laguna Niguel, Aliso Viejo, Dana Point, and
portions of San Juan Capistrano, and Santa Ana.

However, Frank argued that when looking at the likelihood of
default, “municipalities pay an unjustified risk premium.”

He added that when the rating agencies rate municipalities, they
look at what seems to be sometimes “how well dressed the members of the
city council are, which is often not so good.”

Robert Doty, president of consulting firm AGFS and a
California-based municipal advisor, said “there really are very few
defaults overall,” with some sectors more vulnerable than others.

“Traditional governmental securities virtually never default,” he
said, adding that a key factor in defaults is the “feasibility” of the
project.

The recent bankruptcy filings in California prompted rating
agencies to comment.

“The looming defaults by Stockton and San Bernardino raise the
possibility that distressed municipalities — in California and,
perhaps, elsewhere — will begin to view debt service as a
discretionary budget item, and that defaults will increase,” said Van
Praagh, author of the report titled “Recent Local Government Defaults
and Bankruptcies May Indicate A Shift in Willingness to Pay.”

However “Our expectation is that unwillingness-driven defaults will
rise but remain rare, particularly among Moody”s-rated issuers.”

“Recent bankruptcies and defaults of distressed municipalities have
added to the headlines and default totals for 2012 but the amount of new
defaults is nowhere near the pace predicted by some analysts late in
2010,” said S&P Dow Jones Indices’ Vice President of Fixed Income
Indices, JR Rieger.

“As of the end of June 2012, outstanding monetary defaults based on
par value as tracked by the S&P Municipal Bond Index have risen to 0.62%
(over $8.4billion) of the index which tracks over $1.35trillion in
municipal bonds,” the note continued.

In the case of California, he said that despite the recent
developments, “munis issued within the State continue to outperform the
overall municipal bond market” on a year-over-year basis. That is not
the case on a monthly comparison, however.

Year-to-date, underperforming states have been Connecticut,
Georgia, New Mexico and Utah.

Friday’s hearing about “The Impact of the Dodd-Frank Act on
Municipal Finance” otherwise focused on the definition of Municipal
Advisors, with witnesses opposing the Securities and Exchange
Commission’s interpretation of the law, arguing the agency went beyond
Dodd-Frank’s intent.

In fact, Rep. Frank sided with them.

In particular, normal activities of a bank that work with
municipalities “should not trigger a registration requirement,” he said,
which is different from offering active investment advice or advising
another structure.

“The language of the law does not support a more intrusive effort
to put regular banking activities under this provision and I hope the
SEC will listen to this,” Frank added.

“The SEC should be listening to us and following the intent,” he
concluded.

American Bankers Association Chairman Albert Kelly said earlier
during his testimony that “the SEC has proposed rules that interpret the
scope of the ‘municipal financial products’ in Section 975 far beyond
the securities activities of state and local governments to reach all
‘funds held by or on behalf of a municipal entity.'”

He added, “This would mean that giving advice about traditional
bank products such as deposits and loans could trigger registration as
municipal advisors by most banks and each of their employees who may
give ‘advice’ to local governmental bodies such as schools, libraries,
hospitals, etc.”

** MNI Washington Bureau: 202-371-2121 **

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