Municipal Debt

Doug Kass wrote up his list of 20 surprises in 2009 for theStreet.com. Included in the list is the following;


11. State and municipal imbalances and deficits mushroom. The municipal bond market seizes up in the face of poor fiscal management, revenue shortfalls and rising budgets at state and local levels. Municipal bond yields spike higher. A new Municipal TARP totaling $2 trillion is introduced in the year’s second half.

I don’t know about any muni Tarp but I have written a couple of posts expressing concern about going into this area. Many people in print and on TV are extolling the space for the yields available. I take the yields as a warning of something coming. There is some stat out there, I think I saw it on Barry’s site a while back, about 31 states either having a deficit or soon to have a deficit.

One could argue that treasury yields are so low because of the crisis/deleveraging/flight to safety trade which is of course true but we need to watch out for justifying abnormalities. An anomaly that lasts for months isn’t an anomaly it is something else–IMO it is a warning.

As opposed to trying to quantify what it all means I’d rather just heed the warning not have a meaningful commitment to the space. This is what I wrote about and did in the portfolio with financial stocks when the yield curve inverted. Just lightening up into an early warning is enough to reduce pain. Look at many of the famous value mutual funds that held on to (and probably still own) financial stocks too long.

One of these times someone will outsmart one of these indicators but it doesn’t have to be you and it won’t be me.

One last item; I’m scheduled to appear on Closing Bell on CNBC at about 15 or 20 minutes after the close of the market, I hope you can check it out.

21 Comments

  1. I couldn’t agree more with you and Kass, Roger. If I were to invest in this space, I’d favor a fund to spread my risk or select issues from different municipalities with differing characteristics, much like what you advise in the international space. But I won’t.

    Reply
  2. Roger, maybe you’re right but the yield on my Vanguard Intermediate fund has not spiked over the past year. Its NAV has declined some, raising the yield some. Relative to treasuries however, the yield is very high. Are we seeing unsustainably high prices in treasuries or impending doom in munis…don’t know the answer. The fund seems well diversified and it may well take a couple of default hits. Who knows? If you are a long term investor and the NAV sags for a couple of years, so what?

    What’s the alternative then for a long term investor? Move to taxable cash and have a huge negative real return (after taxes) while waiting for doomsday? Or stay the course and the accept volatility of the market? Move to “safe” treasuries and then get slammed by falling prices?

    What exactly is lightening up to you? Money moved from class has to go to another. Is there really anything “safe” in this world anymore?

    Can’t remember who said this, Bogle or Graham, but the markets are a huge distraction to long term investing.

    Reply
  3. You posted the other day that you were going to start buying corporate bonds. That’s scarier than buying munis IMO. Especially since corporate debt is much more highly correlated with equities than munis whose defaults are much more problematic. You are demonstrating characteristics of speculating, not investing. Maybe you will be the only one in the long term that “outsmarts” everyone else. We shall see.

    Reply
  4. A little O/T, but you should give Jim Jubak’s column a gander today at MSN Money. He’s advocating an interesting macro trend overlay to segment weighting, similar in some ways to the way you benchmark.

    Reply
  5. 649, IMO anyone with heavy muni exposure is heavy in something with a risk that not yet known but of course I could be wrong. I would ask you do you know what your exposure is to Cali or any of the other deficit states? If things it the fan how will you be impacted? Is that enough for you to care?

    7:07, right here right now i believe the corporate risk is much more quantifiable. I would note the the cash flow (and the cash position too for that matter) of the health care company whose shortish term note I bought exceeds the debt outstanding.

    Cashflow>Total Debt Outstanding

    A chicken’s way in if you ask me but “fortunately I keep my feathers numbered for just such an emergency.”

    Reply
  6. Roger – I agree completely in the muni space, mostly due to budget issues and problems…but does this logic translate into the corporate debt space as well since they are showing higher historical ylds?

    Reply
  7. the spreads are wider than normal yes which implies more risk than normal but wider spread, in my mind is different than the flip flop currently in the muni /treas market. It is a little easier to look forward in the corporate market than the muni market, at least for me right now WRT investment grade.

    Reply
  8. I only invest in State of ____ (any state) General Obligation Bonds. The day ANY state defaults on its GO bonds, we will have a lot more to worry about than credit worthiness and repayment.

    RW

    Reply
  9. If you want to anticipate 2009 developments I would look to the Fed or Treasury buying US equities and corporate bonds to help stabilize the markets.

    I am not saying it is the right thing to do. I am saying they will feel forced to try it anyway among a lot of other stupid government programs.

    Reply
  10. To follow up on a previous note on Jim Jubak…

    Tim Middleton, another financial writer on MSN, has jumped the shark. He’s going to start using leveraged ETFs in his model ETF portfolio. I guess I can read his column for comedy value now.

    Reply
  11. Let’s dial down the speculation here and look at the KNOWN historical facts….
    Even in the 1930s great depression, NO State general obligation bond has EVER gone into default. Revenue bonds are a bit riskier but if you compare 75 year default rates for any given Muni rating vs comparable Corporate bond rating, the default rate is much much lower for Munis.
    Now, factor in the left leaning, big Government Administration and Congress which is about to take over and do any of you really think that the Gov’t will allow widespread Muni defaults to occur? A situation like that would start to tear apart the fabric of society as municipalities would basically have to shut down…..
    Now, of course, it IS possible that this time it’s different, but history suggests not.
    Good quality 10 year Munis are now yielding double that of 10 year Treasuries. I, for one, view this as a historic buying opportunity. If I am wrong, I will be joining the rest of you on the bread lines as our society collapses.

    Reply
  12. “Accrued Interest” Blog offers insight into the Muni market in his latest post.

    OG

    Reply
  13. Funny how 10 years ago we talked about poorly run businesses failing. That’s what we were taught in business classes. Today we are discussing society collapsing. This is all so new for us. It’s definitely a sign of how bad things really are. Even if we pull ourselves out of this mess, the debt levels are unphanthomable.
    At one time I thought the experts were wiser than myself. But the older I got, I really did get smarter. I remember my CEO never being in his office when I had a question about a project….he was always “out of the office”, ie, golfing. When I did have contact, I realized he didn’t know that much. The same is true in the businesses that are blowing up today. Most looked good because of the underlings or due to a good PR staff.
    Now we have the perfect storm of all the knuckleheads failing at once.

    Reply
  14. Stephen Drone,

    Looks like a good aggressive call by Middleton to me. Your “jumped the shark” derision seems uncalled for at this time. That does not guarantee his being right or wrong.

    Reply
  15. I’m guessing you don’t regularly read his column. The derision is due to deviating from what his column has been about for a decade.

    Reply
  16. as an owner of intermediate (3-5 yr) aaa corporates and aa rated munis (both under 5% of total assets–so the risk is somewhat managed–but the view is unbiased), i agree with roger about the possibility of lower risk for corporates than munis. for example, i own four yr debt of a dow jones health care firm located in new brunswick–i can easily look at the 10ks and 10qs of this firm every 90 days and see how much risk the notes they owe me and all the paper due before that have relative to their balance sheet–for now, virtually none. i also own general obligations of individual school districts and counties (no states)–i have a very difficult time getting any financial info on those issuers. i see no comparison–the risk of a school district within a state is higher because i hold no visibility into how much financial stress the issuer might be experiencing right now.

    additionally, while i understand munis have had very very low default rates over the past twenty or thirty years, wasn’t that also true of mortgages until about 18 to 24 months ago?? further, i have read (but can’t verify–i’d be interested in any references anyone can give on this), that many muni bonds defaulted during the the 1930s depression and that something like 10 STATES went bankrupt during the depression of 1837. i suspect that if the financial condition of the state and local governments gets bad enough the new admin will offer a tarp-2 program to bail them out. why??–because if the feds don’t, then investors will no longer buy state/local debt issues and the fed will slowly become the only bank in the country (they will be the lender of only resort).

    –gjg49

    Reply
  17. Hats off to retiredinprescott and Winslow for bringing some reason to this issue and their sensible comments.

    I have been at work all day since commenting early this morning and haven’t had a chance to read the other comments. I am a farmer and spend almost all of my time alone, so I have lots of time to think. This particular issue is important to me.

    First of all, not every municipality is in economic dire straights. Secondly, defaulting virtually guarantees that no one will lend to them in the future. If that were to happen, the municipality would implode. Retired in Prescott is correct, aside from a handful of failures, we will not see widespread defaults. Thirdly, most muni revenue bond issues are subject to AMT and are therefore excluded from Vanguard’s intermediate term fund. I believe revenue bonds will be more adversely affect in the current state of economic affairs. Finally, the federal government is the only entity in the United States that can print its way out of insolvency. Local government will one way or another get their budgets under control. I predict massive salary and benefit reductions loom on the horizon.

    I believe individual investors should never ever purchase individual bonds unless they can assemble a portfolio of at least 30issues. Diversification is key.

    Finally, I do think people should learn to accept that asset values flucuate and not get so worked up over them.

    Reply

Submit a Comment

Your email address will not be published.

WP-SpamFree by Pole Position Marketing

Municipal Debt

Doug Kass wrote up his list of 20 surprises in 2009 for theStreet.com. Included in the list is the following;


11. State and municipal imbalances and deficits mushroom. The municipal bond market seizes up in the face of poor fiscal management, revenue shortfalls and rising budgets at state and local levels. Municipal bond yields spike higher. A new Municipal TARP totaling $2 trillion is introduced in the year’s second half.

I don’t know about any muni Tarp but I have written a couple of posts expressing concern about going into this area. Many people in print and on TV are extolling the space for the yields available. I take the yields as a warning of something coming. There is some stat out there, I think I saw it on Barry’s site a while back, about 31 states either having a deficit or soon to have a deficit.

One could argue that treasury yields are so low because of the crisis/deleveraging/flight to safety trade which is of course true but we need to watch out for justifying abnormalities. An anomaly that lasts for months isn’t an anomaly it is something else–IMO it is a warning.

As opposed to trying to quantify what it all means I’d rather just heed the warning not have a meaningful commitment to the space. This is what I wrote about and did in the portfolio with financial stocks when the yield curve inverted. Just lightening up into an early warning is enough to reduce pain. Look at many of the famous value mutual funds that held on to (and probably still own) financial stocks too long.

One of these times someone will outsmart one of these indicators but it doesn’t have to be you and it won’t be me.

One last item; I’m scheduled to appear on Closing Bell on CNBC at about 15 or 20 minutes after the close of the market, I hope you can check it out.

Submit a Comment

Your email address will not be published.

WP-SpamFree by Pole Position Marketing