Municipal bonds: a picture, or a thousand words?

15Jan/116

Municipal bonds: a picture, or a thousand words?

I had a monster pensions and public finance post to come.

And then I saw this plot:
Munis go off a cliff

Here's the two sentences that the Business Insider post decided to use as intro:

It's hard to look at this chart, and not have your heart skip a bit of a beat.

For three days now, munis have tanked, and this is the worst one yet.

You know why my heart skipped a beat? Because I was screaming WHAT THE FUCK TOOK YOU SO LONG so loud and long, that I became hypoxic.

I decided to look up a longer history of this bond ETF (and found out it only went back to Sept 21, 2007.... hey! great time to open a muni bond fund!) Here's where I got my data.

History of MUB municipal bond ETF from 2007 to Jan 2011

Current movement nothing compared to October 2008

Look at that deep dip in the end of 2008. Remember Stimulus 1.0, that Bush presided over? Yup, that's the one. Where John McCain got hysterical and rushed back to DC to "fix it fixitfixitfixitFIXIT!" while Obama "decided" to be aloof and continued campaigning. "How presidential"! proclaimed the MSM masses.

If House Republicans hold fast, Stimulus 3.0 [now with new, improved interfaces!] will not happen. So perhaps this is the bond market realizing "Oh shit - a federal bailout ain't happening!"

I hope that's the situation. As opposed to the other situation -- a goosing such that people screech "We need to bail out those poor, poor, [profligate] municipalities! We need more taxes taxes TAXES!" That's what the whining about Texas was about earlier - to say "Hey, if even Texas is screwed, we need to bail out Illinois/California/whatever blue state that's going under!"

Good luck with that, guys.

Meep

Meep is a member of the Irish Catholic mafia, having a suspiciously high number of green-eyed, red-haired friends. While she doesn’t have red hair herself [except when she goes into the sun (rare for any vampire)], she does have green eyes. She’s a raving Papist and is a life actuary on the side [i.e., she counts dead people]. An amateur pain-in-the-ass [willing to go pro!], she likes covering retirement, mortality, math, and education issues.

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Tom Bennett
January 15th, 2011 - 10:30

@Meep.

Per the above, what exactly does it mean?

TRB

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- Meep
  January 16th, 2011 - 05:32
  
  Can mean lots of things.
  
  As per this:
  http://www.suntimes.com/business/3275367-452/percent-cme-500-defaults-xxxxx.html
  
  There’s a claim that it’s not dropped due to thinking that there will be lots of defaults, but that someone is trying to goose the value to get a deal [buy low, sell high]. That does happen [ask George Soros about that].
  
  Think of it as any mutual fund or index — the value drops when the market thinks it’s not worth as much as it was before.
  
  In the case of bonds, lots of different things would move it: general higher interest rates in general or higher inflation make fixed income assets [as muni bonds are] worth less. So if interest rates actually do go up, the price would fall, but it doesn’t require that — you could just be anticipating an interest rate rise or increased inflation.
  
  The individual bond yields can rise [and price falls] if there is a perceived higher default probability on the bond. Just like with interest rates, it doesn’t require any actual defaults for this kind of movement to happen — just anticipation of defaults themselves or, more likely, a downgrading of the credit rating of the bonds. Something might bump from a 1% probability of defaulting in 10 years up to 10% probability of defaulting — still pretty unlikely, but it will move the price right now if that’s the view of the market.
  
  Finally, if you have a market that’s thinly traded, then all it takes is a few big players to put in some big trades to move prices greatly — or just a few people inspiring a GET OUT panic in certain circles. The link I put in this comment is positing something like that.
  
  Some of the largest muni bond investors are institutional investors…. like insurance companies and pension plans [private and public].
  
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Bob Reed
January 15th, 2011 - 10:46

It’ll be tough medicine, to be sure, but if it gives rise to a public comittment to getting our fiscal house in order, then there will be gain from that pain.

What I wonder is, will the FED effectively bail out the states by merely buying up all their bad debt, much like all of the MBS trash they purchsed in 2008 and 2009?

Let’s hope not, although, things will be tough in the ol’ heimat, since New York is one of the states with a debt problem too; just not quite as bad as CA and IL.

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- Meep
  January 16th, 2011 - 05:35
  
  You know who they’d be bailing out?
  
  Not the municipalities, per se. Just as with the AIG CDO issue, it wasn’t AIG that was being bailed out – it was their counterparties. To wit: Goldman Sachs. They didn’t have to take a haircut at all! WTF?!
  
  It would be those large institutional investors, mainly, and those who sold CDSs on muni bonds [these are assets that pay off if a bond defaults -- basically insurance against default].
  
  So, who are these large holders of munis? Insurance companies and pension funds [including private as well as public]. Including the proverbial little old ladies. Oh, and rich people who like avoiding taxes, like Teresa Heinz. [There's all sorts of tax advantages to investing in munis, but depends on the locality and the tax]
  
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pquilici
January 16th, 2011 - 16:52

If you can handle the risk on leveraged closed end muni funds (not ETSs), there are some decent federally tax exempt yields out there. And there are some state specific funds which allow some to avoid both fed and state taxation.

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- Meep
  January 17th, 2011 - 10:17
  
  In a previous post, I didn’t say avoid munis entirely, but that investors need to do their own homework on what they’re holding.
  
  They can’t trust the bond ratings, in my opinion, because I don’t think Moody’s/S&P/Fitch are taking retiree benefit risks seriously.
  
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