Skip to comments.Just How Freaked Out Should You Be About A ‘Muni Meltdown’?
Posted on 12/24/2010 7:58:03 AM PST by TigerLikesRooster
Just How Freaked Out Should You Be About A Muni Meltdown?
Published: Thursday, 23 Dec 2010 | 11:31 AM ET
By: Jason Farkas
America is now officially worried about a municipal bond meltdown. In a piece called "Day of Reckoning," CBS 60 Minutes showcased financial analyst Meredith Whitneys bold prediction that we will see 50 to 100 sizable [muni] defaults...more. This will amount to hundreds of billions of dollars of defaults. Its a frightening forecast.
Another sign that the muni issue has captured Americas attention: the number of people searching for the term municipal bond on Google has spiked in the last week.
Even Goldman Sachs [GS 167.60 -2.00 (-1.18%) ] and Citigroup [C 4.68 -0.05 (-1.06%) ] analysts rushed out notes in the days following the broadcast, assessing the likelihood of Whitneys doomsday scenario.
The public debate on the subject of municipal credit is terrific and Whitney has helped to energize it even more, says Ben Thompson, who oversees $7 billion in tax-exempt debt for Samson Capital.
Not one to ignore the structural problems in the municipal market, Ben was early to alert CNBC's "Strategy Session" to these issues back in June. But hes quick to question the scope of Whitneys call: I disagree with the conclusion that the market is facing imminent defaults of the magnitude she described.
So should you be freaked out?
(Excerpt) Read more at cnbc.com ...
Muni’s have always been considered a “safe” play. Therefore many pention plans and cautious investors invested in Muni’s. If all those investments feel the need to sell, and I suspect many will, it could result in a total meltdown in the Muni markets and may spread...
When the criminals and Union thugs riot the market will crash, big time.
Hundreds of Billions in Losses? Really?
I have been asked what I think about the recent 60 Minutes piece where Meredith Whitney said there would be hundreds of billions of dollar of losses in the municipal bond market. Should we all sell our municipal bonds?
The short answer is that all bond risk is specific to the issuer, so you or your surrogates need to do their homework. But in general, I have real doubts that there will be "hundreds of billions" of losses in the municipal bond market. Whitney said she did not expect defaults from the states, so that leaves just local entities. The worst year on record for losses was 2008, with just over $8 billion. The municipal-bond industry insists bankruptcy filings will remain rare. There were 10 municipal filings in 2009 and five so far this year, according to James Spiotto, a lawyer at Chapman & Cutler. Since the law was created in the 1930s, there have been only about 600 cases.
"Most defaults in the modern era aren't governmental or what we might call municipal at all. The majority are corporate or nonprofit borrowings in the guise of some municipal conduit - nursing homes, housing developments, biofuel refineries - so they could qualify for tax-free financing." (Bloomberg) These are mostly deals where investors are reaching for yield and should pay attention to the source of funds for repayment.
It would take a default by almost every major municipal issuer, and a lot of small ones, to create a hundred billion in defaults, something not likely to happen. Will there be some? Sure. There always are. It is just hard to see it being anywhere close to that much in the next few years, which is her time frame.
As Joe Mysak of Bloomberg wrote:
"And yet - hundreds of billions of dollars in default? The number is in the realm of the fabulous. If pressed, I would say that we might see between 100 and 200 municipal defaults next year, maybe totaling in the $5 billion or $10 billion range.
"...'Debt levels for U.S. local and state governments are relatively low, with annual debt service representing a relatively small part of budgets,' Fitch Ratings said in a special report in November.
"Entitled 'U.S. State and Local Government Bond Credit Quality: More Sparks Than Fire,' the report said, 'The tax-supported debt of an average state is equal to just 3 percent - 4 percent of personal income, and local debt roughly 3 percent - 5 percent of property value. Debt service is generally less than 10 percent of a state or local government's budget, and in many cases much less.'"
That is not to say I don't see risk. I have written often that I think states, counties, and municipalities, hospital and school districts, etc. will come under increasingly intense pressure. The problems with New Jersey, California, Illinois et al. are well-known.
We are going to see massive cuts in all sorts of services and public employment and increases in taxes at all levels. As the stimulus to states winds down, the budget pressures will ratchet up. The part of the 60 Minutes presentation I think you should pay attention to is the section with Governor Christie of New Jersey. That is the reality many states face. They are forced to make spending cuts. Sooner or later every state will have to adopt that approach, even California. Although the idea of Jerry Brown facing down unions and slashing budgets is one that does convey a small sense of irony.
I think the risk is not from holding municipal bonds (although I am not discounting that risk) but in living in areas where budgets are going to be strained. If I were moving, I would want to check on the financial strength of the state and locality I was moving to. If street budgets gets slashed or taxes raised, if police and fire service becomes an issue, or reduced maintenance of parks, etc., then you might think about another locality. Things will normalize, and Whitney is right to call our attention to the severity of the crisis - getting back to a New Normal will be a bumpy ride for many localities.
On the "if there's a crisis there must be an opportunity" note, my friend David Kotok of Cumberland Advisors writes about finding AAA-rated (and checked by his firm) municipal bonds paying 6% tax-free. There is value out there if you or someone who manages your money can look for it
Ping and how do you find out who’s on a pinglist so that you don’t reping?
5.75% interest rate is the current level for good quality municipal bonds. This is up from 5% level of a couple of months ago.
The bond market is appropriately telling the state and local governments that they need to get their financial house in order or they will have to pay more to borrow money.
I think the bond market is also telling the state and local governments not to expect further handouts from Obama now that the Republicans are the majority in the House of Representatives.
I’ll say this: any entity that defaults its bonds should be forced to dis-incorporate and cease to exist. If a new entity should arise to replace it, so be it. But to me, defaulting on bonds should be tantamount to corporate death.
No life-support. No beating of dead horses. No squeezing the turnips.
“So should you be freaked out?”
No we should encourage it and do EVERYTHING in our power to see that GOVERNMENT DEBT is REPUDIATED. The very idea that citizens can BORN INTO DEBT laid on them by Politicians WHO ARE NO LONGER IN OFFICE is on it’s face REPUGNANT to everything this country was founded on. We used to call this INVOLUNTARY SERVITUDE.
The simple answer to this problem is as follows:
ALL CONTRACTS and AGREEMENTS SHALL EXPIRE AT THE END OF THE LEGISLATIVE TERM OF THE LEGISLATIVE BODY THAT AUTHORIZED SAID CONTRACTS AND AGREEMENTS.
No Legislative body is bound by the acts of a previous legislative body. One of our oldest SUPREME COURT PRECEDENTS, with that in Mind is not EVERY PUBLIC PENSION CONTRACT and PUBLIC DEBT ISSUANCE NULL AND VOID at the End of the Legislative term that entered into said agreement???
Most of the munis are probably held in funds. The way it’s probably going to work is that the defaults will be allocated to the widows and orphans, and the ones that are good will be allocated to Goldman and Soros. But how many folks are going to call up their plan administrators and say ‘get me out of munis’. And those that do will probably be talked out of it by folks emphasizing the risks and the lack of return from other investments.
The international banksters will be eating a lot of mutton this winter, as the sheep are going to get slaughtered.
What happens if the defaults are "only" 1/3 or 1/2 of the magnitude she described? Sounds like some of those guys in 1929.
I’m freakin’ out, Jerry! Well, I’m not quite yet ready to abandon my short term bond fund.
Freaked out? I am looking forward to the day!
Conspiracy theorists talk about “Cloward and Piven?” I say - bring it on. Bankruptcy of the bloated states and munis will only hurt the left.
Legitimate bond funds are insured.....that is why they are so safe.
Are you being tongue in cheek, here? That sort of thinking has led to all manner of problems in other areas.
In the face of widespread default, how will any insurance itself avoid the same fate? It can't eliminate systemic risk. It can only accomodate a limited number of specific instances.
Bonds have been approved and issued by a great number of municipalities under boom-time assumptions that are now proving tenuous for a lot of them. The possibility of default is not just an abstraction, it's looking increasingly likely.
Don’t fool yourself, the Obama administration will bail out any of the blue states that are in trouble due to the high cost of government union benefits.
They have already made inroads into subsidizing those states, first with the huge “green energy” hand out to California for passing the Cap and trade bill and then with the 9/11 health care bill that is really a union monopoly bill which bails out the under funded NY pension and benefit fund (actually, it bails out all the big blue city benefit and pension funds).
No..I’m not kidding.
The majority of my portfolio consists of MFS Municipal Bonds.
I had along talk with my broker,a year or so ago. I was concerned, as we all are, about the default of municipalities holding the bonds. As we have seen lately,cities are turning of street lights,furloughing police officers...etc. The end is near for some.
Bottom line...In order to borrow our money, the municipalities must purchase and maintain insurance on the bonds they are selling. That is why they are so safe. As my broker concluded,” Muni Bonds are the second safest investment in the country,the only safer investment is Government bonds”. They aren’t flashy or sexy, but they will make you wealthy.
If there were just ‘one’ area to pick that would be sure to cause severe calamity in the economy it would be Muni’s. As you state, they are ‘so’ embedded in portfolios, especially portfolios of the conservative and less than active investor, that this will go down largely unnoticed until the market collapse and only then will the aforementioned investor start to wonder about their empty accounts. This situation has crisis written all over it....
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