By David Gambelin
In late July, the Securities & Exchange Commission (SEC) issued a comprehensive, 150-page report on how municipal bond issuers could be more transparent. If the report’s recommendations ever get implemented, they could ease the uncertainty that some muni investors have felt the last couple of years.

It’s been almost two years since financial analyst Meredith Whitney went on 60 Minutes and predicted that 50 to 100 states, counties and cities would default on their municipal bond obligations within 12 months. Whitney said there would be “hundreds of billions of dollars in defaults.” Whitney’s prophecy did not come true, but it did leave a lasting impact on the muni investors.

“Her appearance created one of the biggest buying opportunities in the history of munis,” said Christopher O’Dea of Morgan Stanley Smith Barney’s Capital Markets Division.  “There was a great sense of panic after she got on 60 Minutes. Since then, munis have probably been one of the best performing asset classes of the last two years.”

Though there had never been as many defaults as Whitney had predicted, her previous success as a financial analyst lead many investors to rapidly sell off their municipal bonds after her 60 Minutes appearance—even if their bonds weren’t in any danger of defaulting. The great sell-off created a large opportunity for more knowledgeable investors to snap up credible municipal bonds. That was great for knowledgeable investors, but not so great for the uniformed.

Even though Whitney’s prediction proved to be fruitless, in the past couple years, many bond traders have been quick to sell off their munis when bad headlines have arisen. The recent bankruptcies of Mammoth Lakes, San Bernardino, and Stockton caused many investors to drastically rethink their holdings in anything related to those cities.

“For instance, after the Stockton bankruptcy, people wanted to sell anything that said ‘Stockton’ in their portfolio without really understanding where the source of repayment was coming from,” O’Dea said. Though the City of Stockton issues its own municipal bonds, its utilities district and its school district issue their own separate bonds. The two districts have different sources of revenue than the City, but because of their association with the City, uniformed investors have hurried to get rid of their bonds because of the City’s bankruptcy. “People were kind of throwing the baby out with the bath water a little bit,” O’Dea said.

Though a good financial advisor can sort out these differences, an inexperienced financier may not be able to. The SECs’ suggested new regulations could make it easier for knowledgeable and unknowledgeable investors alike to choose credible munis. Among the suggestions laid out in the report: that Congress give the SEC the authority to standardize the amount of financial information municipalities have to share with potential municipal bond buyers; that municipalities be forced to share with the public their audited financial statements; and that the Internal Revenue Service be compelled to share with the SEC information it obtains from audits, returns and financial statements related to municipal bond purchases.

There is no guarantee that the SEC’s suggestions will ever get implemented. The SEC even admits in its report that, “we recognize that further action on specific recommendations will involve further study….” But, if the last two years of misinformation prove anything, it’s that there is a need for more transparency in the municipal bond market.

David Gambelin is a Wealth Advisor and Investment Consultant for Morgan Stanley Smith Barney in San Jose, California. Christopher O’Dea is the Executive Director of the Western Division Capital Markets Desk of Morgan Stanley Smith Barney in San Francisco, California.