Municipal Securities: The Crisis of State and Local Government Indebtedness, Systemic Costs of Low Default Rates, and Opportunities for Reform

84 Pages Posted: 12 Sep 2012 Last revised: 29 Jul 2013

Date Written: September 11, 2012


Municipal securities are securities issued by state and local governments to pay for public infrastructure, public services and to meet day-to-day funding needs. The conventional wisdom says that municipal securities are low risk because issuers rarely default. Municipal issuers rarely default because they pledge their taxing power or dedicated revenue streams for repayment, and thus must raise taxes and/or cut spending if necessary to avoid default. Other legal, political and economic constraints also make it difficult for issuers (and thus taxpayers) to obtain relief from municipal bond debt. This state of affairs means that when issuers take steps to avoid default and reduce investor risk of loss (as they must), they increase risks and costs for taxpayers responsible for paying back municipal bond debt. In this way, the low default rate for municipal securities increases risks and costs for those whose credit backstops municipal securities debt.

As it stands today, the federal securities regulatory regime applicable to the municipal securities market reflects an investor-centric, default-centric approach to risk. Under the current regime, obligated stakeholders must disclose certain facts relating to default risk to investors. Once that occurs, risk is an economic issue to be dealt with through pricing and deal terms, not a subject of regulatory concern. In this article, I argue that the conventional approach to risk is inadequate, because it ignores and externalizes risks and costs that issuers and taxpayers face when communities use debt and derivatives to finance infrastructure and public services. Since these risks and costs impact millions of taxpayers, and can have a devastating effect on public and private life, I argue that they ought to be subjects of regulatory scrutiny under the federal securities laws. This article proposes a series of regulatory reforms designed to bring taxpayer risk into the regulatory conversation, including the following: (i) apply fiduciary duties of care and loyalty to underwriters, derivatives dealers and public officials when they provide advice to issuers respecting the structure, timing and terms of municipal bond offerings and derivatives transactions or serve as derivatives counterparties; (ii) expand and formalize risk identification and tracking systems so that stakeholders will have a better chance of identifying systemic risks to all stakeholders (including taxpayers) before a crisis erupts; (iii) implementing systems to track and monitor the effectiveness of regulatory reforms, so that we can leverage successful strategies and avoid (or at least mitigate the impact of) mistakes.

Keywords: Municipal Securities, Public Finance, State and Local Government Finance, Securities Regulation, Systemic Risk

JEL Classification: H71, H72, H74, G18, G23, G28

Suggested Citation

Chung, Christine Sgarlata, Municipal Securities: The Crisis of State and Local Government Indebtedness, Systemic Costs of Low Default Rates, and Opportunities for Reform (September 11, 2012). 34 Cardozo Law Review 1455 (April 2013) , Albany Law School Research Paper No. 14 for 2012-2013, Available at SSRN: or

Christine Sgarlata Chung (Contact Author)

Albany Law School ( email )

80 New Scotland Avenue
Albany, NY 12208
United States

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