Beware Of The Muni Bond Bubble: States And Cities Can Fail As Well
Comment of the Day

September 21 2010

Commentary by Eoin Treacy

Beware Of The Muni Bond Bubble: States And Cities Can Fail As Well

Thanks to a subscriber for this interesting article by for the Investors Business Daily. Here is a section
You might think that investors would pause before pouring money into obligations of muni debt, particularly obligations of California, New York or Illinois. Like mid-2000s homeowners, state and local governments spent boom years using illusory gains to justify ever-higher spending and borrowing.

By 2008, state and local debt rose to $2.2 trillion - 49% higher, after inflation, than in 2000. The biggest partners in profligacy also promised more benefits to public workers in the future.

As the recession's severity became apparent, officials kept borrowing: States have already borrowed another $15 billion for operating costs over the past two years.

Yet gatekeepers consider municipal bonds low-risk. "We do not expect that states will default on general-obligation debt, even under the most stressed economic conditions," analysts at Moody's wrote in a February 2010 report.

Eoin Treacy's view Regardless of whether one believes that the US Federal government will step in to bailout profligate states with unmanageable budget deficits and excessive debt, municipal bonds such as those of California, Michigan, Florida or New York have had an impressive rally which appears to be petering out. California went through a painful process of negotiations with its creditors more than a year ago and it appears likely that more states will have to do something similar. (Also see Comment of the Day on July 13th 2009),

All of these yields have made new historic lows over the last month, are overextended relative to their 200-day MAs and are in the process of bouncing from quite depressed levels. The Blackrock New York Insured Muniyield Fund remains in a relatively consistent uptrend but is now testing the pre-crisis highs. A sustained move below $14 would confirm resistance in this area.

Prior to the credit crisis bonds issued by California, Michigan, Florida and New York State habitually traded at lower yields than Treasuries. Since the credit crisis that situation has reversed. To me at least this is a clear indication that the perception of risk has changed and in future states will have to offer more competitive terms to source the capital they require.

Back to top