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A Few Bond Stories and Thoughts



November 27, 2010 – Comments (3)

Over the last week, I ran across a couple of articles on bond issues I thought were interesting when taken together. 

Story summaries and some commentary follow.  The links are to The Wall St. Journal and probably require a subscription; sometimes Dow Jones posts the same or very similar stuff on if you want to try and track it down there.

California Accelerates Bond Sale Deal” by Kelly Nolan, 11/22

California was able to increase a bond offering and had good demand.  The article also mentions that California and some other states were scrambling to issue Build America Bonds because the program is set to expire at the end of this year.  Another article later in the week (can’t find it now) said the BAB program is likely to get extended for another year as part of the whole tax policy extension debate.

California did pay higher rates than in recent months, but that seems to be the overall bond market rates inching up, not a California specific issue.

Best quote –

Gary Pollack, head of fixed income and research for Deutsche Bank Private Wealth Management, said it made sense that individual investors seemed eager to snap up the last round of California's debt offering.

There hasn't been a tax-exempt California general obligation bond sale since March, and "there won't be another deal until 2011," Mr. Pollack said. "This is your one shot to buy the state at fairly attractive levels."

Yeah, right.  I’m thinking there will be plenty of shots to buy CA bonds at fairly attractive levels.

Illinois Looks to Tobacco Muni Bond Sale to Pay Overdue Bills” by Kelly Nolan, 11/24

This one was interesting because the deal needs to get done by the end of the year so the state can pay some past-due bills to vendors.  The vendors can take action against the state after 31 Dec, not sure exactly what action, but I’m sure it generates fees for lawyers.

Tobacco bonds are secured by state revenues from payments made by tobacco companies as the result of lawsuits related to healthcare expenses.  The revenues are dependent on tobacco sales, so in a way these bonds put the state in a position of wanting/needing to maintain tobacco sales at a level that will service the debt.

Treasurys Advance on Safety Bid” by Min Zeng, 11/27

Title sums it up.  Concerns over European financials and Korean hostility pushed money into US Treasuries last week.  I’m still keeping a CAPS red-thumb on TMF (the ETF, not The Fool).

Muni Tumult Ends a Fund-Inflow Streak” by Jeanette Neumann, 11/26

Again, title pretty well nails it.  Investors pulled money out of muni bond mutual funds.  No indication whether it’s a brief breather or a new trend.

My thoughts:

I’m far from a bond expert and even less of a muni-bond expert, but I think the next financial crisis will originate in state, other municipal or sovereign debt.  We’ve already seen how sovereign debt in Greece hit the markets.  Consider that California’s economy is many times the size of Greece.  IMHO, many municipal bond issues likely don’t accurately price default risk because historically there is a very, very low default rate and many investors are probably assuming there would be some kind of government backstop.

For all its appearances in the news, California isn’t likely to default.  The only state payout ahead of servicing the bonds is schools (I think, correct me if I’m wrong).  That said, it isn’t outside the realm of possibility for Californians to change the constitution and move other payouts ahead of bond servicing.  If I were dependent on some kind of payment from California, I think I’d do some research into the pecking order for payment priorities.

Illinois seems pretty scary.  They already can’t pay vendors without getting this new bond done.  If nothing else, the potential buyers of these new bonds aren’t likely to give IL much of a break with its back against the wall.

Finally, I hope our lawmakers understand that any bailout for the states is really a bailout of the bondholders, not the states.  Municipal bond holders tend to be higher income folks who should understand the risks of investing or certainly have the ability to get professional guidance.  I see no reason why taxpayers from one state should have to pay to bail out bondholders from another state.  After all, is anyone proposing a bailout to cover your investment losses?  Why should muni bond holders get special treatment?
I haven’t heard of any direct state bailout proposals (other than BAB and the transfer payments from the stimulus package), but it’s probably coming.

I think this is my first try at a news wrap-up format; it's a pretty good way to organize thoughts on a topic.  If you like it, let me know and I'll keep an eye out for opportunities to do it again.

Your thoughts and corrections are welcome as always. 

Fool on!


3 Comments – Post Your Own

#1) On November 28, 2010 at 6:59 AM, dbjella (< 20) wrote:

Russ -

I have read that the Fed makes "purchases" of bonds of foreign gov'ts.  Not sure if this is true, but is it possible that the Fed may buy bonds from states?

I am not sure that any "sane" investor would want to touch this stuff. 

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#2) On November 28, 2010 at 5:14 PM, rd80 (94.68) wrote:

Your question raised my curiosity and it appears that Section 14 of the Federal Reserve Act allows for Fed purchases of state, municipal and foreign debt with maturities of less than six months.

I know there is an emergency clause somewhere in the FRA that lets the Board of Governers bend the rules, but don't know if that would let them go past the six month maturity limit for munis.

I'm sure there are plenty of good investments in the world of munis, but the stress placed on many governments by lower tax revenues and higher demand for social services have made it a more difficult arena.


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