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Municipal Bonds Crisis, I Get A Pat On the Back From Warren Buffett

Interest-Rates / US Bonds Jul 01, 2010 - 02:26 AM GMT

By: Graham_Summers

Interest-Rates

Best Financial Markets Analysis ArticleBack in February 2010 ago, I wrote an article titled, The Municipal Bond Crisis is About to Begin. The main points presented in that piece were all based on simple common sense. The were:

  1. Most state governments are broke or in the process of going broke
  2. Tax receipts were falling (so less money for state coffers)
  3. Muni bonds would collapse as governments chose to default rather than honor their payments

I should have added one other point:

  1. Politicians are TERRIBLE allocators of capital

None of this was rocket science. The entire political system in the US is essentially based on candidates, most if not all of whom fall under #4 above, promising to spend tax payer money in ways that the tax payers will like. “Vote for me,” they say, “and I’ll spend your money on awesome ideas!”

The awesome ideas, more often than not, are municipal projects. Some of them are needed (new sewers, new roads, etc), others are often just a giant waste of money (hotels, stadiums, etc). However, almost all of them seem to run over budget.

In fact, as a recent piece by Matt Taibbi in RollingStone pointed out, many politicians turned to Wall Street to help them engineer some of their municipal projects, a mistake that in the case of Jefferson County Alabama resulted in the cost of a sewer project increasing from $250 million to over $1.28 BILLION.

Gee, who would have thought that combining politicians with Wall Street would be a HORRENDOUS idea?

Again, none of this is rocket science. And yet my article generated quite a bit of attention including numerous interview requests from TV and print media outlets. Go figure, you point out that 2+2 doesn’t equal 5 and somehow you’re controversial.

Regardless, the “muni bond market is screwed” view has been getting a lot more attention in the mainstream media lately. Here are a few quotes from others concerning this issue:

Once a few municipalities default, there is a risk of a widespread cascade in defaults because the opprobrium will be lessened, all the more so if the defaults are spurred along by a taxpayer revolt – democracy at work.

Rick Bookstaber,
Policy Advisor, SEC

There will be a terrible problem, and then the question becomes will the federal government help

                                                                                                Warren Buffett
                                                                                                 UBER-rich Investor

The sad thing about all of this is that it will be ordinary investors, many of whom got into muni bonds because they’re retired or nearing retirement and needed additional income, who will be getting screwed when the muni bond market comes unhinged.

Indeed, bonds in general have become the asset of choice for investors. Already, they’ve piled more than $90 billion into bond funds this year.  This comes on the back of a record $396 billion in bond fund inflows in 2009.

And they’re very likely going to be massacred.

Remember, the last bear market in bonds ended in 1982. We’ve had nearly 30 years of low defaults, general appreciation, and lower interest rates. Because of this, there is an entire generation of professional traders/ analysts/ fund managers as well as individual investors who have NEVER invested during a bear market in bonds.

These folks have made their entire professional careers investing with the basic understanding that debt is cheap, defaults are rare, and bonds overall move higher.

Can you imagine what kind of impact a bond market collapse (and higher interest rates) would have on these folks? Their trading programs and algorithms were created decades AFTER the last bear market in bonds ended. They are totally unprepared for this.

And if they’re unprepared, their clients (individual investors, retirees, baby boomers) are even MORE unprepared. Having been screwed twice with stocks in the last ten years, these folks have fled to bonds, including municipal bonds, only to get screwed yet again.

If you’re one of them, there’s still time to prepare. Review every bond in your portfolio. If it’s a muni-bond, review in great detail the fiscal condition of the local government that issued it.

Good Investing!

Graham Summers

http://gainspainscapital.com

PS. If you’re worried about the future of the stock market, I highly suggest you download my FREE Special Report detailing SEVERAL investments that could shelter your portfolio from any future collapse. Pick up your FREE copy of The Financial Crisis “Round Two” Survival Kit, today at: http://www.gainspainscapital.com/MARKETING/roundtwo.html

Graham Summers: Graham is Senior Market Strategist at OmniSans Research. He is co-editor of Gain, Pains, and Capital, OmniSans Research’s FREE daily e-letter covering the equity, commodity, currency, and real estate markets. 

Graham also writes Private Wealth Advisory, a monthly investment advisory focusing on the most lucrative investment opportunities the financial markets have to offer. Graham understands the big picture from both a macro-economic and capital in/outflow perspective. He translates his understanding into finding trends and undervalued investment opportunities months before the markets catch on: the Private Wealth Advisory portfolio has outperformed the S&P 500 three of the last five years, including a 7% return in 2008 vs. a 37% loss for the S&P 500.

Previously, Graham worked as a Senior Financial Analyst covering global markets for several investment firms in the Mid-Atlantic region. He’s lived and performed research in Europe, Asia, the Middle East, and the United States.

© 2010 Copyright Graham Summers - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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