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Q

Given the past scandals involving brokerage houses and their former star analysts who were found not to have the best interests of investors at heart, how confident are you that the municipal bond insurance companies are themselves completely above board, and when the inevitable financial debacle hits the muni bond investor, that these insurance companies won’t rely on the SODDIT defense (some other dude did it)? Put another way, who is watching those who insure the municipal bond investor against default and how can an investor be confident in the financial stability of these companies?

A

James A. Klotz responds:

While recent scandals on Wall Street have raised the eyebrows of investors everywhere, it is important to realize a number of facts. The brokerage houses and star analysts you allude to were on the equity side of the business, not fixed income. Unlike equities, analysts in the fixed-income markets have far less ability to impact market forces. Unlike in the equity markets, rating agencies tend to have a much greater influence on pricing than individual brokerage house analysts.

Your concern that there will be an “inevitable” financial debacle in the municipal market is difficult to substantiate. Remember, municipal bonds are used to finance capital improvements needed by states, cities, hospitals and other essential public functions. They are not issued by companies whose products may have limited “shelf life,” or based on a business plan unlikely to succeed. As a result, the default history in the municipal market is very small.

You also indicate unease with the headlines that have run recently regarding certain business practices of MBIA, the municipal bond insurer. However, the practices in question affect only a small portion of MBIA’s overall business. All three major rating agencies (S&P, Moody’s and Fitch) continually monitor the bond insurers for both adequacy of capital and credit quality of their insured portfolios. In fact, S&P released its annual review of MBIA last week (affirming its AAA rating) and noted that MBIA’s “management has a long history of maintaining a strong capital position to support business growth as it has expanded its underwriting.” It is also true that most of MBIA’s and other insurers’ credit portfolios enjoy underlying investment grade ratings on their own.

Finally, MBIA and other insurers are also reviewed by state regulatory bodies, investors, and others with a direct interest in the bond insurance industry. You can visit the Web sites of these companies and read their financial statements, SEC filings and other pertinent information to help you develop a comfort level with their operation and safety.