Municipal bonds are going through a rough patch right now. They are being attacked in the media, as featured in a “60 minutes” segment, and their values are falling in mutual funds that hold a portfolio of different issuers. I summed it up in this post but frankly you can just find it everywhere on the internet now.
A municipal bond specialist firm called FMS Bonds, Inc. attempted to defend the municipal bond market in the above full-page advertisement that they took out in the Wall Street Journal. This article calls out bloggers (like me) in the first sentence:
A steady drumbeat of opinions is prediction a muni market meltown. Bloggers, columnists and too many people with microphones have weighed in on what they proclaim is imminent danger in the municipal bond market. This fear mongering has spooked investors and disrupted the market.
Well first of all I am a tiny bit flattered; I didn’t think that BLOGGERS had the power to “disrupt” the municipal bond market. The total size of the US municipal bond market is approximately $3 trillion; does it make any sense at all that bloggers or even journalists should be able to impact this market?
One issue is that many bloggers and journalists live in states where municipal markets are particularly dysfunctional. Any resident of New York, California, New Jersey or Illinois (Chicago) sees up-close and personal that state, local, and county governments are being buffeted with high cost union labor and pension benefits at a time when revenues are flat or falling. While New York, California, New Jersey and Illinois don’t comprise the total universe of municipal bonds by a long-shot, they represent a significant portion of the total and many of the bellwether issuers.
We put a premium on common sense, which indicates that there is significant opportunity amid the hyperbole. Today, for example, investment grade, tax-free municipal bonds can be purchased to yield 5 1/2% or more. This is the equivalent of an 8.46% corporate bond yield for investors in the 35% tax bracket.
Now they are on to something. In any panic or disruption there is often opportunity. Should investors consider buying high quality US municipal bonds TODAY? Maybe. But what FMS Bonds fails to mention is that many firms that are cheerleaders for the US municipal bond market have been loading up clients with bonds at rates far below this; that is why in a month many investors in mutual funds (that hold a basket of bonds) lost an entire years’ worth of interest (4%) in a single month. If FMS Bonds said something along the lines of “We told our clients not to invest in bonds previously because we didn’t think fiscal risks were factored in correctly, but get in the market now” that would be useful information; but these types of firms have been proponents of municipal bond purchases at yields that the market today show did not reflect their true risks.
Another element to consider is that the governments are inter-twined; in Illinois the state is virtually broke, Cook County is virtually broke, and the City of Chicago is virtually broke. When one leg of a stool is bad you can lean on a different leg; but when they all collapse at the same time you are in real trouble. In the past the backstop has been the Federal government and the stimulus package; don’t look for the US House to approve many more of those.
Higher rates for new issues are going to push all of these factors even harder since the debt laden entities will need to get more and more debt at higher rates which is going to hit their average cost of borrowing and make the problem worse over time.
As a general rule it can be said that the markets are saying that municipal bond debt needs to reflect its true risk and this can be seen in the cost of recent issues (significantly higher than for previous issues for the same quality debt) as well as the cost to insure through CDS or other methods against default.
This letter attacked the messenger and failed to point out that today’s opportunities meant that past recommendations were wrong. A little more hubris would have made this a lot more effective. And it scares me more than anything else to think that a $3 trillion dollar market can get shaken up by a few bloggers and commentators.
Cross posted at Chicago Boyz