Best of the Week
Most Popular
1. Stock Markets and the History Chart of the End of the World (With Presidential Cycles) - 28th Aug 20
2.Google, Apple, Amazon, Facebook... AI Tech Stocks Buying Levels and Valuations Q3 2020 - 31st Aug 20
3.The Inflation Mega-trend is Going Hyper! - 11th Sep 20
4.Is this the End of Capitalism? - 13th Sep 20
5.What's Driving Gold, Silver and What's Next? - 3rd Sep 20
6.QE4EVER! - 9th Sep 20
7.Gold Price Trend Forecast Analysis - Part1 - 7th Sep 20
8.The Fed May “Cause” The Next Stock Market Crash - 3rd Sep 20
9.Bitcoin Price Crash - You Will be Suprised What Happens Next - 7th Sep 20
10.NVIDIA Stock Price Soars on RTX 3000 Cornering the GPU Market for next 2 years! - 3rd Sep 20
Last 7 days
Boris Johnson Hits Coronavirus Panic Button Again, UK Accelertoing Covid-19 Second Wave - 25th Sep 20
Precious Metals Trading Range Doing It’s Job to Confound Bulls and Bears Alike - 25th Sep 20
Gold and Silver Are Still Locked and Loaded… Don't be Out of Ammo - 25th Sep 20
Throwing the golden baby out with the covid bath water - Gold Wins - 25th Sep 20
A Look at the Perilous Psychology of Financial Market Bubbles - 25th Sep 20
Corona Strikes Back In Europe. Will It Boost Gold? - 25th Sep 20
How to Boost the Value of Your Home - 25th Sep 20
Key Time For Stock Markets: Bears Step Up or V-Shaped Bounce - 24th Sep 20
Five ways to recover the day after a good workout - 24th Sep 20
Global Stock Markets Break Hard To The Downside – Watch Support Levels - 23rd Sep 20
Beware of These Faulty “Inflation Protected” Investments - 23rd Sep 20
What’s Behind Dollar USDX Breakout? - 23rd Sep 20
Still More Room To Stock Market Downside In The Coming Weeks - 23rd Sep 20
Platinum And Palladium Set To Surge As Gold Breaks Higher - 23rd Sep 20
Key Gold Ratios to Other Markets - 23rd Sep 20
Watch Before Upgrading / Buying RTX 3000, RDNA2 - CPU vs GPU Bottlenecks - 23rd Sep 20
Online Elliott Wave Markets Trading Course Worth $129 for FREE! - 22nd Sep 20
Gold Price Overboughtness Risk - 22nd Sep 20
Central Banking Cartel Promises ZIRP Until at Least 2023 - 22nd Sep 20
Stock Market Correction Approaching Initial Objective - 22nd Sep 20
Silver Bulls Will Be Handsomely Rewarded - 21st Sep 20
Fed Will Not Hike Rates For Years. Gold Should Like It - 21st Sep 20
US Financial Market Forecasts and Elliott Wave Analysis Resources - 21st Sep 20
How to Avoid Currency Exchange Risk during COVID - 21st Sep 20
Crude Oil – A Slight Move Higher Has Not Reversed The Bearish Trend - 20th Sep 20
Do This Instead Of Trying To Find The “Next Amazon” - 20th Sep 20
5 Significant Benefits of the MT4 Trading Platform for Forex Traders - 20th Sep 20
A Warning of Economic Collapse - 20th Sep 20
The Connection Between Stocks and the Economy is not What Most Investors Think - 19th Sep 20
A Virus So Deadly, The Government Has to Test You to See If You Have It - 19th Sep 20
Will Lagarde and Mnuchin Push Gold Higher? - 19th Sep 20
RTX 3080 Mania, Ebay Scalpers Crazy Prices £62,000 Trollers Insane Bids for a £649 GPU! - 19th Sep 20
A Greater Economic Depression For The 21st Century - 19th Sep 20
The United Floor in Stocks - 19th Sep 20
Mobile Gaming Market Trends And The Expected Future Developments - 19th Sep 20
The S&P 500 appears ready to correct, and that is a good thing - 18th Sep 20
It’s Go Time for Gold Price! Next Stop $2,250 - 18th Sep 20
Forget AMD RDNA2 and Buy Nvidia RTX 3080 FE GPU's NOW Before Price - 18th Sep 20
Best Back to School / University Black Face Masks Quick and Easy from Amazon - 18th Sep 20
3 Types of Loans to Buy an Existing Business - 18th Sep 20
How to tell Budgie Gender, Male or Female Sex for Young and Mature Parakeets - 18th Sep 20
Fasten Your Seatbelts Stock Market Make Or Break – Big Trends Ahead - 17th Sep 20
Peak Financialism And Post-Capitalist Economics - 17th Sep 20
Challenges of Working from Home - 17th Sep 20
Sheffield Heading for Coronavirus Lockdown as Covid Deaths Pass 432 - 17th Sep 20
What Does this Valuable Gold Miners Indicator Say Now? - 16th Sep 20
President Trump and Crimes Against Humanity - 16th Sep 20
Slow Economic Recovery from CoronaVirus Unlikely to Impede Strong Demand for Metals - 16th Sep 20
Why the Knives Are Out for Trump’s Fed Critic Judy Shelton - 16th Sep 20
Operation Moonshot: Get Ready for Millions of New COVAIDS Positives in the UK! - 16th Sep 20
Stock Market Approaching Correction Objective - 15th Sep 20
Look at This Big Reminder of Stock Market Mania - 15th Sep 20
Three Key Principles for Successful Disruption Investors - 15th Sep 20
Billionaire Hedge Fund Manager Warns of 10% Inflation - 15th Sep 20
Gold Price Reaches $2,000 Amid Dollar Depreciation - 15th Sep 20
GLD, IAU Big Gold ETF Buying MIA - 14th Sep 20
Why Bill Gates Is Betting Millions on Synthetic Biology - 14th Sep 20
Stock Market SPY Expectations For The Rest Of September - 14th Sep 20
Gold Price Gann Angle Update - 14th Sep 20
Stock Market Recovery from the Sharp Correction Goes On - 14th Sep 20
Is this the End of Capitalism? - 13th Sep 20
The Silver Big Prize - 13th Sep 20
U.S. Shares Plunged. Is Gold Next? - 13th Sep 20
Why Are 7,500 Oil Barrels Floating on this London Lake? - 13th Sep 20
Sheffield 432 Covid-19 Deaths, Last City Centre Shop Before Next Lockdown - 13th Sep 20
Biden or Trump Will Keep The Money Spigots Open - 13th Sep 20
Gold And Silver Up, Down, Sideways, Up - 13th Sep 20

Market Oracle FREE Newsletter

How to Get Rich Investing in Stocks by Riding the Electron Wave

Municipal Bond Market Score Card

Interest-Rates / US Debt Feb 23, 2011 - 11:43 AM GMT

By: Fred_Sheehan


Best Financial Markets Analysis ArticleMeredith Whitney has kicked up a storm with her 600-page, municipal-bond report. She was one of the first analysts on Wall Street who warned the banks were going to topple well before they toppled. (Standard & Poor's downgraded Bear Stearns three notches - to BBB - on March 14, 2008, two days before J.P. Morgan acquired Bear's carcass.) Whitney told 60 Minutes on December 19, 2010: "You could see...50 to 100 sizable [municipal] defaults.... This will amount to hundreds of billions of dollars' worth of defaults." The municipal bond CABAL (issuers, fund managers, analysts, the municipalities) denounced Whitney and her predictions.

In concert with the times, the debate is superficial. It is not even a debate but a tryout for the Society of Mind-Numbing Auctioneers. The drift on Bubble TV goes something like this:

Bubblehead announcer: "You there - at the other end of the camera! Wha' da' you think of Whitney's hundred defaults?"

Muni Expert #1: (everyone on Bubble is an Expert): "No. That's extreme. Municipalities are having their problems, but they know it and are taking action..."

Bubblehead Announcer: "So - how many - 10?

Muni Expert #1: "It is hard to put a number on it, but I estimate [pause] none."

Bubblehead Announcer: "Yo! Number two! - Zero or 10?

Muni Expert #2: "Between zero and 20."

Bubblehead Announcer: "I have 20 defaults, 20 defaults, 20 defaults, He-e-e-re! Hey, producer! [Offstage] Will you give me 30? No? [Turning to the camera] There you have it folks. Whitney is a scaremonger who is trying to make money off your fears!"

These discussions do not enlighten. The typical municipal bond investor - and that is to whom the following is addressed - is older, may or may not still be working (the following will be directed more towards the retiree), has accumulated a pool of assets, and that pool is heavily weighted towards municipal bonds. This investor depends upon coupon income as a major source for spending. Municipal bonds are often preferred by this cohort because the stream of income is usually not taxed at the federal, state, or local level. Also, it is a top choice because investment advisers tell old people this is the safest investment. That statement is probably correct, historically, but then, "House prices have never gone down across the U.S." was the pitch line into 2007. (The demise of the house market is intertwined with the drum beat to destiny in the municipal bond market, for obvious reasons. But members of the CABAL ignore this.)

Newspapers are filled with stories of towns running out of money, municipal employee layoffs, reduced services, and taxes being raised. The resolution to these disputes will be as varied as the municipalities engaged in such struggles.

There are helpless cases, probably those identified by Whitney. She is an excellent analyst. Whether her forecast for the size and timing of defaults is accurate does not matter other than to a municipal bond insurer and credit-rating agency. It is whether the retiree receives the expected coupon payment from a specific bond or portfolio of bonds that is of first consequence.

There are four competitors in this struggle for municipal funds; the battle among them will potentially deny the bondholder full payment. It would be convenient if the parties could be split into four pieces of a pie, the pie being of a fixed size. There are two means, however, by which the pie may inflate, meaning new cash inflows that could delay the immediate prospect of defaults. These will be discussed next, after which the fixed pie will lie center stage.

First of the two is the bond market. Municipalities will continue to issue bonds until they cannot. Currently they can, notwithstanding some recent problems of specific issuers.

Today, many bonds are issued to meet not only current expenses (vs. capital expenditures), but also projected expenses in future years. This evolution is presumably not stated in bond offerings, but is known sotto voce. (Friendly city hall clerks are good sources for such information.) Municipal bonds were traditionally floated for capital requirements: construction, for instance. It was considered reckless, if not illegal, to sell bonds to pay this month's salaries. Today, it should be assumed that a cash-poor city will use bond proceeds for immediate needs - if it can get away with it. This is fraud. See the Miami Herald from February 17, 2011 "Audit: Miami Misused Millions in Public Works Funds."

Second, is the federal government. There has been talk of federal bailouts for states and cities. If the federal government is to pick up expenses for Illinois; California; New York City; Harrisburg, Pennsylvania; and a hundred others, the cost will be enormous. The federal government has plugged non-federal gaps at an increasing pace since the $787 billion stimulus bill was passed in 2009. It has also established avenues to keep paying state and city bills after the $787 billion is depleted.

This will not be sufficient though, so let us assume a Big Bailout Bill is proposed. This may or may not pass. If it passes, the pie (flows to the mendicants) will grow. This should help boost the municipal bond market, but it should be remembered that we will live to see the moment when yields of 10-year, U.S. Treasury bonds double, possibly precipitated by such a reckless Bill as this. When yields double (this is not a question of "if"), municipal bondholders may satisfy themselves that coupon income will still be paid, but that will only be of momentary consolation given the chaos of a broken bond market.

If such a Bill does not pass, Federal Reserve Chairman Ben Bernanke may buy a trillion dollars worth of municipal bonds before Congress acts. Some congressional committee would then interrogate this unaccountable public servant, doubting the legal authority for his purchases. Bernanke; in his vague, impenetrable mien; will claim he had authorization and cannot reveal which securities the Fed bought since disclosure would endanger the solvency of the parties involved. ("Parties" - including the balance sheet of the Federal Reserve.) The New York Federal Reserve Bank will publish 12 papers, simultaneously, with both historical and legal justification for the Fed's purchase of municipal bonds. That will be that.

Assuming the bond market shuts down (it will, at some unknowable point) and the Feds, as well as the Fed, do not inflate the pie, the fixed pie with the four parties can be viewed as follows. (Eventually, the deleverging U.S. economy will shrink this fixed pie. Tendencies during the time when America is miniaturizing will probably resemble those discussed below.)

#1 - Bondholders - want to be paid interest and principal. (General Obligation bonds are addressed here. The distinction from Revenue bonds is explained on page 20, footnote 20 of The Coming Collapse of the Municipal Bond Market.) Aside from not being paid, most bondholders do not want to be scared. ("Most" - because some thrive on these fears.) Fears can be precipitated by potential default. Prices are likely to fall when default threatens. For example, see six-month charts of California and New York State municipal bond funds. Very few bonds in California have defaulted, possibly none in the funds. Therefore, all interest and principal payments may be current. There are many investors who will not be reassured (and, already, in California and New York are dismayed) should the market value of their investments fall 20%.

The fact that many municipal bond investors are not sophisticated, and look to these assets as their source of retirement income, means this market could be particularly subject to panic. On the other hand, the highly vulnerable investors may be too petrified to act.

Default may mean no more than a few missed payments that will be paid later. (A technical default means no missed payments at all, but it would be surprising if the Bubble media is able to explain this material distinction to its viewers and readers, who may be deaf to legal talk when their remaining assets are plunging in value.) The holder of a bond in default may not listen to promises that missed payments will be paid in the future, no matter how likely. The sales pitch is often that "municipal bonds are the safest of all investments." These investors have heard this before (stocks, houses), so may have lost heart.

Therefore, the bondholders are not interested in grievances of public employees, the loss of municipal services, or, a tripling of tax rates to avoid default. The municipal investor being discussed needs this money.

#2 - Municipality - the state, town, county, or other administrative district does not want to change its mode of operation. It would like to continue building monuments to folly, hiring campaign workers in permanent jobs, awarding higher benefits to employees, and selling bonds since tax receipts do not meet this largesse. See: Illinois is not Peter Pan.

Some, of course, know better and are cutting expenses and attempting to corral employee benefits. Some were always managed well. But those in the headlines pretend to address current circumstances with no intention of balancing their budgets. They have more to lose by doing the right thing - such as, laying off workers, or, halting the construction of a new $100 million high school that is intended to provide 3,000 union construction jobs. Often, this is the reason schools, stadiums, museums, and other white elephants have been built.

The ostriches with their heads in the sand can not conceive of a time when the bond market will shut down. They have little motivation to close funding gaps. The ostriches are also very American; specifically, the vintage of Americans who have been swept into the post-modern guise that everything will work out well. In this case, the federal government will fill the gaps. They may be right, but for how long?

Municipalities hold a trump card that has not received much attention. Many state and city expenses are mandated by the federal government. Congress imposes new regulations that include more school administrators, demand access ramps, the expansion of health benefits, and on it goes, but the Feds do not fund these declarations of magnanimity. In 1970, Medicare cost the states $2 billion. The estimate for 2008 was $158 billion. Some state or city is bound to tell the Feds "you pay for it, or we're stopping it." From a spectator's point-of-view, the scuffle that follows will be engaging.

#3 - Employees - want to keep what they have and many want more. The United States is a large country so it is hard to generalize about the stubbornness on either side. Recent histrionics in Wisconsin, including the juvenile comments by President Obama, represent the aggressive union position. The unions will not budge. In such situations, when the negotiation of benefits and pay fails, court decisions will intercede. Bondholders are the least of the unions' concerns. In such circumstances it is prudent for bondholders to expect the sort of vilification heaped on the owners of General Motors' debt.

As a reminder, the Obama administration and the unions accused hedge funds of forestalling justice. The greedy Greenwichites claimed General Motors' bonds were a contractual arrangement (a bond being a contract). This would not do and a ukase was imposed on hedge fund managers that satisfied the President, a graduate of Harvard Law School.

Crucial to the propaganda campaign was the false representation that hedge funds owned most of the bonds. In fact, a large contingent of GM bondholders fit the profile of the municipal investor. General Motors' bondholders wanted their day in court.

The Family and Dissident Bondholders group was denied official status to represent bondholders by the bankruptcy court. [In re General Motors Corp., 09-50026, U.S. Bankruptcy Court, Southern District of New York (Manhattan).]

The group was overwhelmed by the machinery of the state. A spokesman for the Unofficial Committee of Family & Dissident GM Bondholders said: "The committee members today simply lack the resources needed to mount an effective appeals process on the accelerated basis that would be required here." The "accelerated basis" indicates the Dissident Bondholders were denied Due Process, a potential hazard to municipal bondholders.

Peter Kaufman, president of the Gordian Group LLC, an adviser to the Family and Dissident Bondholders, stated: "It's a tragedy. Twenty-seven billion dollars of bonds, many if not the majority of which are owned by mom and pop, have been essentially wiped out."

Not many municipal bond managers and brokerage firms have considered such a reoccurrence when municipal workers tread the same path. The mom-and-pop holder of a Wisconsin general obligation bond should be prepared to sell in a hurry. In fact, mom and pop should not own Wisconsin general obligation bonds today. Wisconsin sold 10-year bonds in January, 2011, with a yield-to-maturity of 3.75%. Given our state of affairs, which includes Ben Bernanke's campaign to ruin the dollar, the entire structure of interest rates will double at some point. Consumer inflation is at least double the 10-year yield today - 7.5%. Mom, pop, grandma, and grandpa are not being paid an adequate yield given the risks, and given that these securities only repay a fixed amount of dollars. Bonds do not go Verticalnet.

The militant public employee and compromised court scenario is the worst case. There are many municipalities where pay and benefits remained within reason. There are other states and cities with more important troubles. There are some with no problems.

#4 - Taxpayers - are not happy. Homeowners are often paying more in property taxes now than before house prices fell 10% - 50%. States have also raised sales taxes and imposed fees on the most basic services. The citizenry is awakening to the mismanagement and criminal racketeering that created the fiscal abyss Meredith Whitney so ably quantified.

Taxpayers grit their collective teeth as they are learning of outrageous pension and health benefits awarded to their neighbors, the contractual skullduggery between city officials and parking-garage managers, and the fleecing of the taxpayers through incompetence that is barely conceivable to any bystander with an IQ above 70. To all appearances, the taxpayer is facing an infinite tax bill since general obligation bonds are sold with the promise that the issuing authority will "in good faith use its taxing power as may be required for the full and prompt payment of debt service."

This belief is another reason legislators are slow to act and that some public-sector unions are unwilling to negotiate pay and benefits. This is in contradiction to the workers best interests, but they will be the last to accept the Deleveraging of America. Taxpayer resentment is building, a pustule with the ulceric properties that may corrode this mountain of municipal malpractice.

By Frederick Sheehan

See his blog at

Frederick Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, November 2009).

© 2011 Copyright Frederick Sheehan - 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.

© 2005-2019 - 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

6 Critical Money Making Rules