Municipal Bond? Safe or Sham?

State College, PA – It has happened again!  Investors depending on municipal bonds for a secure retirement should be concerned.  For the second time in three years, the Security and Exchange Commission has slapped another state with securities fraud.  Recently, the SEC charged Illinois with misleading its municipal bond investors.

In a press release, the Acting Director of the SEC’s Division of Enforcement stated, “Municipal investors are no less entitled to truthful risk disclosures than other investors…Time after time, Illinois failed to inform its bond investors about the risk to its financial condition posed by the structural under-funding of its pension system.”  

This is not the first time that a state has been charged with securities fraud with respect to its municipal bond investors.  In 2010, New Jersey had very similar charges filed. 

Specifically, the SEC had charged the state “for misrepresenting and failing to disclose to investors in billions of dollars’ worth of municipal bond offerings, that it was underfunding the state’s two largest pension plans.”

Both states, while neither admitting nor denying the allegations, quickly settled with the SEC.  Fortunately, there were no financial penalties levied against either state. So how does this affect a retirement plan that is heavily dependent on municipal bonds?  After all, they are supposed to be “safe” investments because they pay regular tax free income over the life of the bond, but their ability to do so is dependent on the strength of the state or municipality.

Some states are running into serious financial difficulties that could very well cause havoc with their obligations to municipal bond holders.  Many advisors, however, believe that if there is trouble, the Federal government will simply step in and bail them out.  In January, 2011, Ben Bernake, the Chairman of the Federal Reserve Board, had other ideas.  According to the Wall Street Journal, Mr. Bernake said that “We have no expectation or intention to get involved in state or local finance.”  Later, he emphasized that “states should not expect loans from the Fed.”

As you might have guessed, we have not been fans of municipal bonds, especially if they are part of a retirement plan. There are better ways to take income, both from a safety and/or return perspective. If what you thought the best way to plan for retirement turned out not to be, when would you want to know?