Best of the Week
Most Popular
1. Investing in a Bubble Mania Stock Market Trending Towards Financial Crisis 2.0 CRASH! - 9th Sep 21
2.Tech Stocks Bubble Valuations 2000 vs 2021 - 25th Sep 21
3.Stock Market FOMO Going into Crash Season - 8th Oct 21
4.Stock Market FOMO Hits September Brick Wall - Evergrande China's Lehman's Moment - 22nd Sep 21
5.Crypto Bubble BURSTS! BTC, ETH, XRP CRASH! NiceHash Seizes Funds on Account Halting ALL Withdrawals! - 19th May 21
6.How to Protect Your Self From a Stock Market CRASH / Bear Market? - 14th Oct 21
7.AI Stocks Portfolio Buying and Selling Levels Going Into Market Correction - 11th Oct 21
8.Why Silver Price Could Crash by 20%! - 5th Oct 21
9.Powell: Inflation Might Not Be Transitory, After All - 3rd Oct 21
10.Global Stock Markets Topped 60 Days Before the US Stocks Peaked - 23rd Sep 21
Last 7 days
Inflation Consequences for the Stock Market, FED Balance Sheet - 24th Oct 21
To Be or Not to Be: How the Evergrande Crisis Can Affect Gold Price - 24th Oct 21
During a Market Mania, "no prudent professional is perceived to add value" - 24th Oct 21
Stock Market S&P500 Rallies Above $4400 – May Attempt To Advance To $4750~$4800 - 24th Oct 21
Inflation and the Crazy Crypto Markets - 23rd Oct 21
Easy PC Upgrades with Motherboard Combos - Overclockers UK Unboxing - MB, Memory and Ryzen 5600x CPU - 23rd Oct 21
Gold Mining Stocks Q3 2021 - 23rd Oct 21
Gold calmly continues cobbling its Handle, Miners lay in wait - 23rd Oct 21
US Economy Has Been in an Economic Depression Since 2008 - 22nd Oct 21
Extreme Ratios Point to Gold and Silver Price Readjustments - 22nd Oct 21
Bitcoin $100K or Ethereum $10K—which happens first? - 22nd Oct 21
This Isn’t Sci-Fi: How AI Is About To Disrupt This $11 Trillion Industry - 22nd Oct 21
Ravencoin RVN About to EXPLODE to NEW HIGHS! Last Chance to Buy Before it goes to the MOON! - 21st Oct 21
Stock Market Animal Spirits Returning - 21st Oct 21
Inflation Advances, and So Does Gold — Except That It Doesn’t - 21st Oct 21
Why A.I. Is About To Trigger The Next Great Medical Breakthrough - 21st Oct 21
Gold Price Slowly Going Nowhere - 20th Oct 21
Shocking Numbers Show Government Crowding Out Real Economy - 20th Oct 21
Crude Oil Is in the Fast Lane, But Where Is It Going? - 20th Oct 21
3 Tech Stocks That Could Change The World - 20th Oct 21
Best AI Tech Stocks ETF and Investment Trusts - 19th Oct 21
Gold Mining Stocks: Will Investors Dump the Laggards? - 19th Oct 21
The Most Exciting Medical Breakthrough Of The Decade? - 19th Oct 21
Prices Rising as New Dangers Point to Hard Assets - 19th Oct 21
It’s not just Copper; GYX indicated cyclical the whole time - 19th Oct 21
Chinese Tech Stocks CCP Paranoia, VIES - Variable Interest Entities - 19th Oct 21
Inflation Peaked Again, Right? - 19th Oct 21
Gold Stocks Bouncing Hard - 19th Oct 21
Stock Market New Intermediate Bottom Forming? - 19th Oct 21
Beware, Gold Bulls — That’s the Beginning of the End - 18th Oct 21
Gold Price Flag Suggests A Big Rally May Start Soon - 18th Oct 21
Inflation Or Deflation – End Result Is Still Depression - 18th Oct 21
A.I. Breakthrough Could Disrupt the $11 Trillion Medical Sector - 18th Oct 21
US Economy and Stock Market Addicted to Deficit Spending - 17th Oct 21
The Gold Price And Inflation - 17th Oct 21
Went Long the Crude Oil? Beware of the Headwinds Ahead… - 17th Oct 21
Watch These Next-gen Cloud Computing Stocks - 17th Oct 21
Overclockers UK Custom Built PC 1 YEAR Use Review Verdict - Does it Still Work? - 16th Oct 21
Altonville Mine Tours Maze at Alton Towers Scarefest 2021 - 16th Oct 21
How to Protect Your Self From a Stock Market CRASH / Bear Market? - 14th Oct 21
The Only way to Crush Inflation (not stocks) - 14th Oct 21
Why "Losses Are the Norm" in the Stock Market - 14th Oct 21
Sub Species Castle Maze at Alton Towers Scarefest 2021 - 14th Oct 21
Which Wallet is Best for Storing NFTs? - 14th Oct 21
Ailing UK Pound Has Global Effects - 14th Oct 21
How to Get 6 Years Life Out of Your Overclocked PC System, Optimum GPU, CPU and MB Performance - 13th Oct 21
The Demand Shock of 2022 - 12th Oct 21
4 Reasons Why NFTs Could Be The Future - 12th Oct 21
Crimex Silver: Murder Most Foul - 12th Oct 21
Bitcoin Rockets In Preparation For Liftoff To $100,000 - 12th Oct 21
INTEL Tech Stock to the MOON! INTC 2000 vs 2021 Market Bubble WARNING - 11th Oct 21
AI Stocks Portfolio Buying and Selling Levels Going Into Market Correction - 11th Oct 21
Stock Market Wall of Worry Meets NFPs - 11th Oct 21
Stock Market Intermediate Correction Continues - 11th Oct 21
China / US Stock Markets Divergence - 10th Oct 21
Can US Save Taiwan From China? Taiwan Strait Naval Battle - PLA vs 7th Fleet War Game Simulation - 10th Oct 21
Gold Price Outlook: The Inflation Chasm Between Europe and the US - 10th Oct 21
US Real Estate ETFs React To Rising Housing Market Mortgage Interest Rates - 10th Oct 21
US China War over Taiwan Simulation 2021, Invasion Forecast - Who Will Win? - 9th Oct 21
When Will the Fed Taper? - 9th Oct 21
Dancing with Ghouls and Ghosts at Alton Towers Scarefest 2021 - 9th Oct 21
Stock Market FOMO Going into Crash Season - 8th Oct 21
Scan Computers - Custom Build PC 6 Months Later, Reliability, Issues, Quality of Tech Support Review - 8th Oct 21
Gold and Silver: Your Financial Main Battle Tanks - 8th Oct 21
How to handle the “Twin Crises” Evergrande and Debt Ceiling Threatening Stocks - 8th Oct 21
Why a Peak in US Home Prices May Be Approaching - 8th Oct 21
Alton Towers Scarefest is BACK! Post Pandemic Frights Begin, What it's Like to Enter Scarefest 2021 - 8th Oct 21
AJ Bell vs II Interactive Investor - Which Platform is Best for Buying US FAANG Stocks UK Investing - 7th Oct 21
Gold: Evergrande Investors' Savior - 7th Oct 21
Here's What Really Sets Interest Rates (Not Central Banks) - 7th Oct 21

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

Investors Beware of Municipal Bonds as Defaults Soar

Interest-Rates / US Bonds Jul 28, 2010 - 05:57 AM GMT

By: Money_Morning

Interest-Rates

Best Financial Markets Analysis ArticleMartin Hutchinson writes: Of the speculative excesses that misguided monetary policy and a prolonged recession has caused, the one that poses the most danger to investor wealth is the financial bubble in state and local municipal bonds.

Municipal bonds - usually referred to as "munis" - are very popular portfolio plays because of tax advantages that, in effect, enhance their rates of return. There's also an allure because of their local nature: Investors can invest in specific bond issues that provided the money for projects such as schools, highways, bridges, hospitals or housing that actually affects the community in which the investor lives. That makes them a very tangible investment.


But there's a problem.

State-and-local-government finances have taken a bigger beating during this economic downturn than during any other recession since World War II. Even worse, that beating came after the easy money available during this stretch encouraged those same governments to venture well beyond any reasonable limits in terms of their borrowing. They're now stuck with a bigger-than-warranted debt load - which can't be covered by the property tax stream that's been reduced by record-level housing defaults.

The bottom line: At the present time, "munis" may not be the benign - or even alluring - investment that they've been in the past. In fact, thanks to continued fallout from the worst financial crisis since the Great Depression, some munis may be more akin to bombs than bonds - ticking away and just waiting to blow up your portfolio.

Broken Rules, Broken Budgets
Brokers will tell you that particular state and municipal bond issues are "safe," meaning that they are rated highly by the rating agencies. However, the rating agencies got it wrong on subprime mortgage instruments, and it seems pretty clear that they are getting it wrong on states and municipalities.

Theoretically, state governments should not have this problem. All the states - with the sole exception of Vermont - have prohibitions against running budget deficits. Those prohibitions are in place for a reason: By avoiding deficits during healthy periods, the budgetary strain won't be nearly as severe when tax receipts and other revenue drops off during a downturn.

Unfortunately, states have discovered various accounting dodges to get around the deficit prohibition, meaning the supposed safeguards aren't all that tight.

The state "funding gap" for the fiscal year that began July 1 is $144 billion, which is 8% larger than the $133 billion shortfall for the just-concluded 2009-10 fiscal year.

But the outlook is actually going to get even worse: The federal stimulus spigot gets turned off in December, ending a flow of funds that states had been using to offset their revenue shortfalls and narrow their budget deficits. Make no mistake: The end of the stimulus money will leave a huge funding gap going forward.

In most cycles, energetic economic recovery rescues state budgets, although state budgets typically lag - for example the state budget gap peaked in 2004 after the 2000-2001 recession.

Given the poor current financial condition of so many of the U.S. states, a drawn-out/sluggish recovery - or even worse, a "double-dip" recession - could upend state finances for years to come.

At the municipal level, the primary revenue source - aside from "direct transfers" from state coffers - is local property taxes. Property-tax rates are set as a percentage of home values. When the housing bubble caused stratospheric increases in housing values in the middle part of the decade, property-tax revenue soared in kind - enabling municipalities in thriving areas to expand lavishly.

Since 2007, needless to say, this has all been reversed. What's more, if municipalities respond to declining house prices by jacking up property tax rates, as many are doing, they run the risk of causing a wave of regional mortgage delinquencies.

Homeowners who were already struggling to make ends meet now find themselves facing an additional cash-flow demand that they cannot meet. Some in this predicament may gamely stick with it for awhile, attempting to meet the additional demand in order to keep their mortgage current - before finally succumbing to the inevitable realization that they just can't do it. Others literally walk away from an asset that has declined in value and become a burden.

In either case, the homeowner defaults on their mortgage.

Needless to say, any further decline in house prices following the ending of the $8,000 buyer subsidy will strain municipal finances further.

Muni-Bond Defaults Soaring
Municipalities - like many homeowners - are struggling to make ends meet. Municipal-bond defaults may soar well beyond 2009's $6.4 billion, the most since 1992.

Last year, the state in most difficulty appeared to be California, because of the severity of the real estate decline and because of its dysfunctional state government, in which spending restraint appears to be almost impossible.

This year, investors should turn to Illinois, where the recession has been severe, producing a current unemployment rate of 10.4%. Here the quality of state government is indicated by five of the last nine governors having served prison sentences (not counting ex-Gov. Rod Blagojevich, who's currently on trial.)

Illinois just borrowed $900 million in a bond issue that was very well received, being priced at a yield 0.15% lower than expected. However, that is much more a function of the high yield offered - nearly 7%, or 4% above equivalent U.S. Treasuries - as well as the excessive liquidity in bond markets right now. Much of the demand for the bonds came from foreign institutions, which have a strong preference for government over corporate financing, because they don't understand the risks involved.

In reality, the $900 million bond issue was borrowed to make Illinois's required contribution to its state employee pension fund. This came in addition to a $2.4 billion bond issue earlier this year to fund previous contributions to the pension fund, and an earlier issue of as much as $10 billion in 2003 - for this very same purpose.

Meanwhile, on the spending side, Illinois state spending has risen from $56 billion to $80 billion in the four years since 2006, according to National Review's Kevin Williamson, who has been following this case.

There has been neither a state moratorium on payment since Arkansas in 1933, nor a full default since Pennsylvania in 1841. Nevertheless, the combination of poor-quality state governments, reckless overspending during the boom years, state pension systems that are totally out of control and a deep-and-prolonged recession following a severe housing downturn have lined the stars up for one or more state defaults in the next few years, unless the U.S. economic recovery really gains strength.

Some states, like New Jersey under new Gov. Chris Christie, may be able to drag themselves back from the brink - but it will require Herculean efforts to do so.

Nevertheless, it seems hopelessly unlikely that all the vulnerable states - and there are perhaps a dozen with considerable degrees of vulnerability - will be able to save themselves this time around. Only a few states - such as North Dakota, which is conservatively run, and which has oil-shale and mineral resources cushioning its recession - seem completely invulnerable at this time.

This will all come back to bite investors.

A Once-Benevolent Investment - With Fangs
With interest rates at historic lows (the U.S. Federal Reserve continues to hold the benchmark Federal Funds rate target down near 0.00%), investors have been searching for - and often reaching for - higher yields to boost their returns.

Last year, for instance, investors in that predicament poured $7.8 billion into high-yield municipal bond funds, pushing assets to a two-year high. But they may pay for that aggressiveness this year as default risks grow.

"People are starving for yield because rates are at zero," Paul Tramontano, co-chief executive officer of New York- based Constellation Wealth Advisors, which manages about $4 billion, told Bloomberg News. "They're taking [on] more risk than they think."

As we mentioned earlier, just because brokers say that the muni bonds they're trying to sell you are "safe" because they were rated as such by the credit-rating agencies, those are the same agencies that got it wrong on the subprime-mortgage sector.

They're getting it wrong again on states and municipalities. Avoid the sector.

[Editor's Note: Money Morning's Martin Hutchinson has been on a global hot streak.

Here's what we mean. Just a week after Hutchinson recommended Germany, the European keystone reported much stronger-than-expected GDP. He recommended Chile back in December, and three of the stocks he highlighted have posted strong, double-digit returns - and one is up nearly 25%. He again recommended Korea - which analysts were downgrading - only to have the traditionally conservative International Monetary Fund (IMF) come out with an upgraded forecast that projects solid growth for that Asian Tiger for this year and next.

A longtime international merchant banker, Hutchinson has a nose for profits instincts - as evidenced by his unerring ability to paint a picture of what's to come. He's able to show investors the big profit opportunities that are still over the horizon - while also warning us about the potentially ruinous pitfalls hidden just around the corner.

With his "Alpha Bulldog" investing strategy - the crux of his Permanent Wealth Investor advisory service - Hutchinson puts those global-investing instincts to good use. He's managed to combine dividends, gold and growth into a winning, but low-risk formula that has developed eye-popping returns for subscribers.

Take a moment to find out more about "Alpha-Bulldog" stocks and The Permanent Wealth Investor by just clicking here. You'll the time well spent.]

Source : http://moneymorning.com/2010/07/28/municipal-bonds/

Money Morning/The Money Map Report

©2010 Monument Street Publishing. All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Monument Street Publishing. 105 West Monument Street, Baltimore MD 21201, Email: customerservice@moneymorning.com

Disclaimer: Nothing published by Money Morning should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investent advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication, or 72 hours after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Money Morning should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

Money Morning Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in