Revisiting Municipal Bonds

February/09/2011 16:26PM
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Here is a reprise of the 12-9-11 blog on municipal bonds.

Why Is the Smart Money Dumping Municipal Bonds?

December 9th, 2010

Billions are flooding out of municipal bonds in the last few weeks. What does the smart money know that we don’t know?

Not being a smart money guy, I can only speculate. My guess is they know the cities that issue the bonds are in trouble. A friend tells me the Lansing(MI) school district is $11 million short on budget for next year? Where do they come up with the money? The Feds have gone on record that they are done bailing out states and cities. No help there. They can’t raise property taxes or they will be run out of town as real estate value keep dropping and appraised evaluations drop with them. They can’t borrow the money, the state is broke too. The only option is to cut expenses.

The money boys expect cities to start defaulting on munis. They see a domino effect. One goes, then more go and so on. Plus they see cities will need to raise interest rates on munis to raise money. That makes the present bonds harder to sell. Rates are already going up on treasury bills.

The burden of pensions that are underfunded for public municipal workers, lower revenues coming in ,and no help from the state or federal government is too much. Cities are bad risks. Bonds issued by cities are bad risks. The big boys who study this and project into the future are predicting bad times ahead for cities. They are getting out of municipal bonds while they still have value.

This is just simple math. When you can no longer lay off teachers, firemen, policemen, and public workers and still can’t pay the interest on your debt, you are broke.


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Here is a comment from a regular reader.

You wrote “Plus they see cities will need to raise interest rates on munis to raise money.” If interest rates rise on munis (or any other bond, for that matter), then the issuer either gets less money at issuance or pays out more in interest. Raising interest rates on bonds would cost municipalities MORE money, it will not raise money for them.

I think I might rather get my muni news from more credible sources, like say Bloomberg News -> I wouldn’t call a 1/2 of 1% decline in muni holdings a “flood”. And the reasons given in this article have more to do with a shift back into stocks due to the slightly improving economy than your reasoning.

You should probably stay out of the speculation business.
Chris Johnson


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Here  is the most recent data.
Since November, $34 billion has been withdrawn from muni funds. This is due to worries about sate and local finances. These worries have obviously intensified. The  1/2 of 1% Mr. Johnson referred  to is now 3% and counting.
Obviously, investors still see state and municipal debt, spending, revenue shortfalls, and entitlement commitment deficits as a concern.  Each week the outflows have continued. 
This is not an investment advice blog, but on occasion political perspective and investment decisions collide. Mr. Johnson, as most liberals do, supports bigger government, government spending, and believes there is no repercussions from these actions. Seems municipal bond investors are not all liberals. Nor, readers of Bloomberg.  
Comment: Doug Gordon:

I’ve witnessed what you are saying first hand here in the great state of “Tax”achusetts. The state income tax rate here is essentially 6%, except if you are rich enough to not spend every dime you have trying to live here, you must be rich enough to have some of your wealth re-distributed for the common good, so the tax rate on income earned on investments is 12%. (Fine plan to encourage people to not be a burden on society in their old age, I’m sure it really encourages saving and investement, but I digress).

Now, out state motto is “We were going broke with Romneycare (universal health care) before all the rest of you were going broke with Obamacare”

To escape some small portion of the investment tax, I hold shares in a Mass tax free municipal bond fund. Adjusting for dividends, etc. shares peaked last year on September 2. Since then until yesterday, the fund has lost 8% of its value, which is over 2 times the usual return from the bond interest.

Seems to me your point is valid, and the trends will continue until bankrupt governments everywhere stop paying and ridiculously gamed pension systems are “reformed”.

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