Thursday, June 3, 2010

Munis, the next thing?

Fear has begun to surface, again, among bond investors. Tax-free munis, usually regarded as the most suitable vehicle for conservative investors who desire a stable stream of returns, have lately been thought in trouble due to the weak economy and many states’ troubled fiscal situation. The following summarizes a few points on this spot of potential dangers:

1. High unemployment, lower income, badly funded pensions have pushed revenues, cash flows for bond payments significantly downward, and
2. Consequently some munis have not been able to avoid a default.
3. Since state government currently have very wild deficits, to finance their spending projects they have to look to the 3 trillion market for help;
4. “States by the end of 2008 had $1 trillion less than needed to pay for future pensions and medical benefits,” thus the upcoming supply of bonds further produces downward pressure on price.
5. This makes financing more costly and future defaults more likely.

Since 2008 we’ve seen hundreds of defaults among munis, and the situation looks indeed unpromising. A collapse in the municipal markets will be detrimental for the overall economy in the following ways:

• Given the depth and spread of the problem, foremost a bailout by the federal government may be necessary.
• Low bond prices going forward will give both the state government and the holders of these bonds a very hard time to endure.
• As defaults start mounting, insurers and reinsurers of these bonds will take a hit in their own books as well, and
• The most undesirable of all, a crisis in the municipal bonds market will create a tremendous sense of fear that will spread to every corner of the economy. Potentially as state governments crowd-out (the worst scenario is that they won’t have the power to crowd-out..) other contenders for credits, everyone’s cost of financing will go up.

Once again, marco level economics are basically unpredictable. The saying goes, while planning is useful, plans are useless. Anything is possible, as we’ve seen in the last two years. Moving on, we have ahead of us an age when the consequence accounts for more significance than the probability in tilting our judgment and actions.

P.S. For a fuller account, see articles, and

Yi Gao
Research Analyst
Analyze Capital LLC


  1. My man, gettin his work done early.

    So I guess you saying Short the Muni's!!??

    You know InteractiveBroker our platform we use will be offering muni's trading products soon :)

  2. There has even been recent talk that ratings agencies will downgrade particular states' muni bonds such as California...How can United States debt remain AAA rated if some of the independent muni bonds are downgraded to sub-investment grade?


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