Megabank, Inc’s evil plan:
Bork AAA-rated widows-and-orphans investment classes into subprime status, then profit through gambling on whether the debauched asset classes are too-big-to-fail. Professor Bear’s prediction: Since mainly the rich invest in muni bonds, there is a high probability this asset class will ultimately prove to be too-big-to-fail.
* WEEKEND INVESTOR
* JANUARY 15, 2011
Munis: What to Do Now
By BEN LEVISOHN, JANE J. KIM And ELEANOR LAISE
The prices of municipal bonds are plunging to depths last seen during the financial crisis. At least one high-profile analyst is predicting widespread defaults. And a big asset manager is putting its expansion into munis on hold. Is the situation in muni-land really as dire as all that?
In a word, no. And investors who can see past all the hand-wringing and remain disciplined may even find opportunities to profit.
It has been hard to ignore all the bad news in the market of late. State budget deficits are expected to increase from $120 billion in fiscal 2011 to $140 billion in 2012, thanks in part to underfunded pensions and growing health-care costs. Investors, meanwhile, are bailing: Muni bonds have lost 5.3% since Nov. 10, while muni funds have seen outflows of $22.7 billion. Vanguard Group on Jan. 13 shelved a plan to launch three muni funds, while J.P. Morgan Chase & Co. CEO James Dimon this week warned that investors should be careful.
In the course of just a few years, muni bonds have joined a list of investments, from housing to money-market mutual funds and auction-rate securities, that have lost their safe-haven status.
“Historically, people have gone to the muni market because they believe they’re the safest things out there,” says Burt Hutchinson, a financial adviser in Wilmington, Del., who has been recommending that clients sell their muni bonds. “Today people are realizing maybe they aren’t as safe as we think they are.”
And yet the situation may not be as grim as some suggest.
Municipal bonds are issued by states, counties, cities or their agencies to finance public works, such as roads and bridges, housing projects, airports and hospitals. For years, individual investors, especially those in the highest tax brackets, have liked munis because the interest payments are generally exempt from federal and, in some cases, state income taxes.
In the past few years the fiscal outlooks for many states and cities have worsened, as governments struggle to balance their budgets and pay for essential services.
But that may be starting to turn around as some governments take action—sometimes extreme—to plug budget gaps. In California, Gov. Jerry Brown on Jan. 12 announced $12.5 billion in spending cuts. That same day, Illinois raised its state income-tax rate to 5% from 3% to help plug an estimated $13 billion budget shortfall.
“We’ve never defaulted, not once in our entire history, including during the Great Depression,” says Tom Dresslar, spokesman for California Treasurer Bill Lockyer. He says paying debt service for the state’s bonds is the Treasurer’s second-highest priority, after schools.
Revenues for U.S. municipalities as a group rose during the first three quarters of 2010, and the trend is likely to continue, say economists, as the U.S. economy slowly recovers from the recent recession. Even strategist Meredith Whitney, who is among the most outspoken muni-market bears, predicts that not a single state will default on its debt.
That doesn’t mean investors are in the clear. Far from it. With budget season just beginning, investors should be ready for more bad fiscal news to hit the headlines for the next several months, as states try to plug those massive holes. That, says Chris Mauro, director of municipal bond research at RBC Capital Markets, could keep the market churning until midyear or longer.
“We advise people to remain mindful of this,” Mr. Mauro says.
…
“You could see … 50 to 100 sizeable defaults. More. This will amount to hundreds of billions of dollars.”
-Meredith Whitney, financial analyst
…
By the Numbers
- $350 billion Total issuance of municipal bonds expected in 2011, down from $430 billion in 2010.
- 3.12% The yield on a 10-year top-rated municipal bond, versus 3.36% on an equivalent Treasury note.
- $22.7 billion The amount of money withdrawn from municipal-bond funds since Nov. 10—about two-thirds of the $34.5 billion that had been invested since Jan. 1, 2010.
- $ 2.9 trillion The total dollar amount of outstanding municipal bonds, up from $1.5 trillion in 2000.
Sources: Municipal Market Advisors; Investment Company Institute; ValuBond
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