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Problems in municipal market extend beyond California firm

June 14, 2011 | 12:03 pm

A recent Times story looked at a private company in Walnut Creek that has made millions of dollars by issuing an odd type of municipal bond known as a conduit.

A follow-up story Tuesday looks at some of the broader problems in the conduit bond market.

Conduit bonds allow private entities such as United Airlines and General Motors -- as well as hospitals and real estate developers -- to get tax-free financing through the municipal bond market for projects that boost economic development. When they do so, they can borrow at cheaper rates and provide less financial disclosure than would have to if they borrowed through the corporate bond market.

It turns out that although conduit bonds account for a small percentage of all municipal bonds, they are responsible for a disproportionate number of the defaults in the municipal bond market -- 70% by some counts.

This is particularly important now, after municipal investors were spooked by analyst Meredith Whitney Whitney, who warned last fall and again this week that there will be a coming wave of municipal defaults. 

Though the defaults that Whitney warned about have not come, conduit defaults have continued to pile up -- and the conduit market has continued to grow -- leading some state and local officials to warn that the problems in the conduit market are driving up borrowing costs for cities and states.

In addition to whatever problems might be caused for the broader municipal market, conduit bonds have led to losses for individual investors, many of whom are not aware of the difference between standard municipal bonds and conduits.

As the article on Tuesday notes, the problems in the conduit bond market have caught the eye of the Internal Revenue Service and the Securities and Exchange Commission.

In California, a state assemblyman called last month for an audit of the Walnut Creek company and the public agency it runs, which has become one of the largest issuers of conduit bonds in the nation.

One municipal bond expert, Richard Ciccarone, told The Times that even if the authorities take no action, it is important for ordinary investors to become aware of the differences between conduit bonds and plain vanilla municipal bonds.

"It's too easy for the average investor to get burned in this area," said Ciccarone, the head of research at McDonnell Investment Management. "There's always somebody who thinks, 'It’s got the city's name on it, it must be OK.'"

-- Nathaniel Popper in New York

 Photo: Meredith Whitney. Credit: Louis Lanzano / Bloomberg News