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Municipal bonds in distress

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May 07, 2010 – Comments (6)

I am adding this as a follow up to my original blog post found here:

 

http://caps.fool.com/Blogs/ViewPost.aspx?bpid=341696&t=01001545002054304245

 

A very interesting article was posted on CNN Money that emphasized the current growing problems within the 2.8 trillion municipal bond market.  Once these were viewed as safe havens; however, now with swelling pension obligations and the performance of the stock market, many of these states are under severe distress and underfunded.  This has caused them to take extreme measures to achieve higher than average market returns such as commodity futures trading (these are not investments) and junk bonds.  The article on CNN Money can be found here:

http://money.cnn.com/2010/05/05/news/economy/state_budget_cuts/index.htm?source=cnn_bin&hpt=Sbin

While the media (and public's attention) seems to be focused on Greece and the EU boys, the current problems growing within the US are overlooked, but still present.  I am not an active bond trader; however, Harrisburg, PA (which I cannot find any news on) defaulted on their bond payments due May 1, and required Assured Guaranty to pay the coupon payment.  Interesting to note though, this is not Harrisburg, PA's first default on their municipal bonds.  Assured Guaranty has had to pay for the coupons in the past as well.  Equally bankrupt companies like AMBAC and MBIA insure other municipal bonds.  Seems like you need insurance on the insurance correct ?

 

Mr.  Warren Buffett states that the US will bailout distressed states.  He also makes mention regarding muni bonds and Harrisburg, PA in particular. 

http://www.reuters.com/article/idUSN0118355720100501

 

Fact of the matter is that the US is overleveraged and just took on another trillion in debt for the healthcare law, is it really plausible that the US can bailout nearly every single state ?  At the same time, when the market goes down, effectively money should run to the bond market.  Except if the market is underperforming, most likely states will issue new muni bonds driving up rates and down prices as more emphasis comes into light of existing problems.  Per CNN Money article, states have already recieved stimulus money and are still underwater.  James Altucher in this article says not to worry about the municipal market due to State Constitutions in terms of interest payment to bond holders.

The UAW was not senior debt holders, yet they made out.  Indiana filed a lawsuit regarding the way the bankrupcies were handled in Chrysler and GM and effectively lost.  If the bankrupcy law will be re-written for a private industry, does James actually think that states will not provide funding too all Government operations, police, fire departments, etc just to pay bondholders ?  While his analysis is correct, there is a large assumption by and large that these rules will be held to.

http://finance.yahoo.com/tech-ticker/don't-sweat-municipal-bond-defaults-altucher-says-454813.html?tickers=ago,tlt,tbt,brk-a,dia,spy

 

I don't think the municipal market will default completely, but interest rates for the bonds will go up, so unless you are planning to hold them to expiration, their price will eventually detoriate to a certain extent.  And while the likelyhood of municipal defaults is low, they still can default.  Unlike the Treasury bonds, the Fed can print money, municipalities cannot.  For our family's overall cash (one of my parents is a CIO for a public pension fund), we have been selling most of the muni bonds we own into the rips and diversifying them into short-term CDs and laddering Treasury bonds.  Also some has been invested throughout a few indexes.

 

6 Comments – Post Your Own

#1) On May 07, 2010 at 12:26 PM, Superdrol (97.18) wrote:

this one is for alstry

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#2) On May 07, 2010 at 2:19 PM, Superdrol (97.18) wrote:

bump

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#3) On May 10, 2010 at 12:19 PM, Superdrol (97.18) wrote:

bump

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#4) On May 13, 2010 at 7:07 PM, SharePlanner (< 20) wrote:

Hey - Read a few of the articles - enjoyed it!!! Keep it up!

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#5) On May 24, 2010 at 1:32 PM, Superdrol (97.18) wrote:

As always, I'm early to the party:

 

http://www.time.com/time/business/article/0,8599,1991062,00.html?hpt=T2

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#6) On May 26, 2010 at 2:26 PM, Superdrol (97.18) wrote:

http://finance.yahoo.com/news/More-Cities-on-Brink-of-cnbc-846713446.html?x=0&sec=topStories&pos=2&asset=&ccode=

 

I'll keep updating this until the municipal bond market fractures apart in the future.

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