More Muni Madness
I’ve been spending a little time following municipal bonds lately and believe some of those markets have a good chance of being the next big trouble spot for the economy.
The great state of Illinois made a few headlines last week with a $3.7 billion taxable bond offering. These bonds are taxable because, as reported in some of the news stories, contributions to the state pension plan don't qualify for tax-free status. The proceeds from this bond sale were used to make the state's required contribution to its pension fund.
Borrowing money to fund the pension account. Sounds similar to investing on margin - what could go wrong?
According to the Wall St. Journal report on the bond sale, "Illinois officials were forced to promise a yield that is about two percentage points higher than was paid by companies with similar credit ratings in recent bond offerings." My interpretation of that is the bond markets believe IL is a worse credit risk than its credit rating would indicate.
WIFR TV from Rockford, IL reports the average rate for the bond issue was 5.56% and that the bonds have maturities ranging from 2014 - 2019. That’s getting up near junk bond yield territory for maturities in that range.
I don’t own any municipal bonds, but if I were planning to invest in some (and I’m not), I would look for a closed-end or mutual fund with an experienced management team rather than an ETF or other index vehicle. An fund tracking an index has no way to sift out anomalies like this recent IL bond yield indicating that the market thinks the bond is riskier than its rating. This is one area of the markets where active management makes sense.
I don’t believe we’ll see the full doom and gloom scenario predicted by some in the municipal markets. But, I think there’ll be some sizeable problems. And Illinois is one of the leading contenders to be the source of a sizeable problem.