PUTTING THE MUNI BOND PANIC INTO PERSPECTIVE
Investors are increasingly fearful of a crisis in the municipal bond market. Meredith Whitney’s call for defaults has created quite a stir. But many notable investors have come out calling Whitney’s claims over the top. David Rosenberg says it has created a “huge long-term buying opportunity” and Bill Gross says “I don’t subscribe to the theory that there will be lots of [defaults]“.
I tend to agree with Gross on the matter though Rosenberg’s long-term buy call is likely too broad for my comfort. Jeff Margolin of First Trust wrote an excellent piece earlier this week putting the muni bond panic into the proper perspective and helps to resolve a few of the current myths that are circulating:
“One trigger to the bond market weakness came on December 19, 2010 when an analyst went on a popular prime time news program suggesting that this year there could be “50-100 sizeable defaults worth hundreds of billions of dollars.” The problem with this assertion is that according to a December 21, 2010 Citigroup report, the top 50-100 municipalities in this country do not even have “hundreds of billions of dollars” of debt outstanding. By the way, according to Marketwatch.com, there has only been one municipal bond default since the week of December 19th, which was valued at only $6 million.
It has been argued that budget issues confronting states are as bad as budget issues confronting countries such as Greece or Ireland. According to the International Monetary Fund, Greece’s debt as a percent of its gross domestic product (GDP) is estimated at over 100%, while Ireland’s is around 55%. To put that in perspective, the median for all 50 states is only 2.2%, according to MarketWatch.
According to Bloomberg, municipal bond defaults hit a record of $8.15 billion in 2008. That same year, $157.7 billion worth of corporate bonds defaulted, according to Forbes. Municipal bond defaults have since declined to just $2.52 billion in 2010. Part of the reason defaults have been declining is because revenues have been increasing for many states and municipalities the past year. Rockefeller Institute data shows that for the most recent quarter where data is available (3Q 2010), local and state revenue has increased for the third straight quarter. Additionally, many states, cities and towns have raised taxes significantly, cut services and cut budgets in order to get their
balance sheets healthier.The muni market is enormous with a size of over $2.9 trillion and over 55,000 different issuers, according to the Municipal Securities Rulemaking Board.
In a Moody’s study that covered 1970-2009, only 54 of the 18,400 municipal bonds they rated had defaulted. Of those, only 5 involved general obligation debt.
In a Fitch study covering the period from 1999-2009, only 10 entities defaulted, which equates to an average annual default rate of 0.04% over those 10 years.
Even during the Great Depression the default rate for municipal bonds only reached 1.7%.”
I am not attempting to downplay the very serious budget issues that many states and localities are currently suffering, however, it is important to keep things in perspective and not blow this problem well out of proportion. This is not to say that we won’t see localities default, but I think fears of a state ever being allowed to fail or even widespread local defaults are beyond stretched.
First of all, if the USA is willing to save banks and let states fail then the purpose of this country has failed and we should just fold up shop and thank everyone for being a citizen for all these years. Second, we have the mechanism in place to avoid a Euro style crisis. Unlike the Europeans, who lack the proper tools to deal with their own crisis, the USA is fully united and established a central treasury long ago. The funding mechanism for crises is ready to roll should it ever be needed. If ever there was a need for a “Geithner Put” I have little doubt that this administration would utilize it. After all, no one fails in this “capitalist” world anymore. Third, we’re far more likely to see increased austerity measures (such as the tax increases in Illinois) as opposed to defaults. The credit crisis is still causing ripples across the world, but one thing it is not doing is turning the USA into Europe.
Buy muni’s now???
MG
Yea this is definitely a buy the dip opportunity for sure…
I’m a little leary of wading in though with Rosenburg being bullish on it…
Rosenberg has been pretty decent on his bond calls. They’re a little more related to macro, which he’s good at. His equity calls, not so much.
Well, according to the figures of the excetpt ( munis worth 2.9 trillion and 55.000 issuers ) the average issuerer has a debt of approx. 0.5 billion dollar, so 100 average issuers have a debt of 50 billion dollars. Therfore it sounds very plausible that the top 100 issuers have several ( e.g. 3, 4, 5 ) 100 billions of debt
.
Nevertheless I agree with the view that the current Fed and treasury can and will not allow a huge crash of the muni market. However if performing …ehem… vertical or exogeneous money creation too easily, the acceptance of the dollar currency will depreciate world wide. Remember the talks of chinese officials.
It might turn out in 10 years that this year was a huge buying opportunity for muni bonds. The downside risk is the fact, that Mrs Yellen said that the US is on an unsustainable budget path.
When you bring the currency into it you’re inadvertently bring hyperinflation into the mix. As regulars should know, the only true risk to the USA is a hyperinflationary collapse. There is no solvency crisis here. And I am sorry, but I just don’t buy that thesis. The evidence for it is poor at best. The USA can afford a $100B or $500 backstop (similar to the EFSF) if it becomes necessary. I don’t think it will, but if push comes to shove we would spend the money. And we likely still wouldn’t have high inflation in the USA….
“The USA can afford a $100B or $500 backstop (similar to the EFSF) if it becomes necessary. ”
Agreed! Moreover I have no strong opinions on the future.
Anyway, although I sometimes disagree in some points, your perspectives are frequently an interesting read.
Predictions, particularly about the future, are hard!
This is a hedge my Merideth. She has a small percentage of being right, but if she is, her consulting agency shoots to the moon. Personally, I think MW is a chicken head with hardly a clue. I don’t listen to a word she says.
I’m just thinking about classic “loan shark-victim” relationship:
you increase interest (panic sell off in munis)- tax hikes, spending cuts, budget balancing follows (more interest revenue is comming)- bounce back sucking pension funds, life insurance, maybe some mum and dads along the way (“relief rally”)…then another sell off, higher yields, more belt tightening, more interest revenue and…the show goes on.
the same cycle is in play in Europe as well: rising yields- austerity- relief rally…and again rising yields.
from investor perspective- it is like swimming upstream, unless you can navigate fast. But it just happens that muni’s are tax extempt, with “buy and hold” label attached, not “hot speculative”.
if you think belt tightening will balance budgets once and for all, think again
The same “notable investors” who are benefiting from the entire financial fiasco to begin with no doubt. In any situation there are some who benefit at the expense of others. The uber wealthy are sacking the US and leaving the ruins for the American citizens. They could care less about the default of Cities and States because they are the same people who will buy public assets and infrastructure and then charge the public to use them.
It is time for revolution.
During MW’s 60 minute piece she mentioned that when she did her research, there was almost no data available from the states prior to 2008 (before credit collapse).
Also, keep in mind that when a small number of analysts came out in 2006 and 2007 and said the subprime market was an accident waitng to happen, dozens of analysts came out and defended it as being contained, or too small to cause a problem.
While the government and fed can bail them out it will not be without severe implications. There is a limit to how much the Fed can expand its balance sheet.
When QE1 started oil was at $40, QE2 oil was at 75. Can the fed start QE3 to support more bailouts with oil pushing over $100 and other commodities rising exponetially? Inflation or not how long can food/energy rises be ignored?
Keep in mind that the subprime mess started off very slowly with the 2 bear stearn hedge funds having problems and it was completly ignored by the market and dismised by all but a few.
Yes, but you must be realistic. We write checks to the states every year. In August Congress passed a special 26B bill for emergency loans to the states. It’s a fact of life. They receive Federal funding. EVERY YEAR. The same is not true in Europe so when people make the comparisons it’s apples and oranges.
States will continue to tighten their belts. They will raise taxes, cut spending and likely receive more federal aid. But what will not happen is what we’re seeing in Europe. The fact is, the rescue package is permanently in place already. Most of the people who make the comparison are taking things out of perspective or just trying to scare you to make headlines.
And every time a State accepts Federal funding it comes at a price. The price for bailing out States in financial trouble will be more Federal control over the States and less freedom for the citizens of that State.
That’s a very broad conclusion. I would argue that the USA is better off when the govt provides funding to a locality so that it doesn’t have to fire teachers. Now, if Federal aid is just allowing state workers to continue receiving excessive pay as opposed to making very real fixes in their budgets and their communities then we’re on the same page. But it’s not as black and white as your comment implies. Govt spending is not always bad.
I’m no apologist for these states and their reckless spending, but I am also not a glutton for punishment. I do not think that we should allow our states to go into turmoil just because a recession wrecked their income streams. The USA can afford to provide aid that eliminates broad default fears. If temporary funding can be provided to stave off BK then it should be done. It’s not unlike the Fed’s role as lender of last resort. It serves a good purpose by avoiding mass panic.
The states are suffering. They are making cuts. It’s not easy. But the people who want to just let them crash and burn are not clearly thinking through the ramifications.
How do you difine excessive pay? The government has to employ professionals like Doctors, Engineers, and lawyers. These people make half of what their private sector counterparts do in the states at least. I am sick of being attacked because i decided to forfeit high pay for the security of a pension. i wish i hadnt now, but i dont deserve to have my life and my childs life wrecked. A contract was entered into by me and the state govt. they decided to defund the pension fund and spend it on corruption. i am tired of taking the hit and the blame. i am not overpaid! i am a chemical engineer with a business degree and 28 years of experience. Do you think $61,000 is too much?
Depends. I am not attacking you personally and I have been a bigger defender of public employees than most other people. But there is no doubt that many people in the govt are overpaid. I obviously wouldn’t include you in that group.
Best,
Cullen
“States will continue to tighten their belts. They will raise taxes, cut spending and likely receive more federal aid. But what will not happen is what we’re seeing in Europe. The fact is, the rescue package is permanently in place already. Most of the people who make the comparison are taking things out of perspective or just trying to scare you to make headlines.”
So what will this do to all of the talking heads forecast of a sustained growth in GDP? The states are are going to raise taxes..lay off workers and the consumer will continue to fall by the waste side as the spx 1500 and above talking heads are saying our economy is growing slowly but nicely.
Persoanlly, I believe the only thing growing is our deficit and it is doing very little for our economy. The consumer is the economy..not the government..so with more people about to hit the unemployment lines..taxes being raised for the ones working…real inflation taking even more from the consumer..I think the believers in the economic growth and gdp above 4% are smoking something crazy.. smoke amnd mirrors..make everyone believe everything is alright and the economy will prosper..only problem..they are selling that to the 9.6% unemployed and the highest food stamp numbers seen since the depression..Oh no..I said depression..my computer may get shut down
Austerity will certainly put pressure on the pvt sector. It’s not becoming a prevalent problem (yet), but it’s certainly a risk to growth.
“There is a limit to how much the Fed can expand its balance sheet.”
pjf,
What is that limit exactly and how is such a limit enforced?
Thanks
The limit is all USD denominated assets.
Thanks.
That would be one big balance sheet!
It sure would. The point of course, is that there is no real limit to what the Fed could buy. Of course, it would cause all sorts of problems, but that’s more theoretical. I think the Fed’s purchases cause massive problems in the markets, but that’s for another discussion….
I should add that there are technically legal constraints as to what the Fed can and can’t buy, but as we’ve seen over time those laws can be changed overnight to accomplish whatever goal it is they have….
I meant to say there was no data after 2008…so it did no reflect the credit collpase and its effect. So her research was based on figures 2008 and prior
Thank you. The perspective offered here is vital and compelling.
Watch all the people trash Meridth. The people trashing her have a huge vested interest in the Muni market. They are paniced.
Why are they paniced?
1) No more BAB program so municipalities can borrow more to service their existing liabilites;
2) Massive pension underfunding hidded with public accounting trickery called “smoothed returns”;
3) Little economic growth to fuel revenue increases;
4) Municipal financial statments are leveraged like an LBO.
Watch out.
I happen to agree with the author and certainly not Meredith Whitney. I also can’t take someone that seriously who can’t spell the word “panicked” or Meredith’s name. You might be best off on the Yahoo boards.
We are in the worst recession since the GD and a prediction of 50 out of 50,000+ (one TENTH of one percent) is unreasonable? If the GD default rate was 1.7%, then 0.1% doesn’t look too outrageous a prediction to me, in comparison.
As she pointed out in her recent CNBC appearance, many municipalities are restructuring their debt, which in her mind is a default by another name, yet not counted as such. Perhaps munis don’t outright “default” in a technical sense, but if plenty “restructure”, and you aren’t get payments in the timeframe you’d planned on, it’s still a notable cashflow alteration that must be considered.
As for the total monetary amount, I don’t know. I think it’s a case of one or two munis doing it, and then others seeing it as a possibility from that point forward. If this were to snowball, it could hit a serious dollar amount. I agree with others, however, that the Fed / powers-that-be won’t let it get to that point.
Finally, I find this “it can’t happen” defense awfully similar to the “house prices can’t fall” theme of yesteryear, stated by many in the same sorts of people in the same sorts of positions. Have munis defaulted in any significant amounts since the GD? No. Has the country been in a financial contraction like this since the GD? Also no.
It might not happen, or it might be prevented from happening if the process begins, but it’s not an outrageous call. Prechter and Celente make some outrageous calls. This is not so outrageous.
Argh, grammar mistakes …
As your resident economic ignoramus, allow me to disagree with this article’s soft tenor:
MW hasn’t changed her tune in over 6 months. What HAS changed is the volume of opposition to her thinkings; and it seems to be coming from the financial sector (such as Jeff Margolin). And what does JM offer up to dispute MW? – 7 paragraphs of ideas.
5 and one-half paragraphs deal with past, out-dated support for munis.
1 deals with using American’s fear of a Greece-style default as a”red herring”
1 deals with a fact that respondant Dr. Oliver Streibel shows destroys JM’s
assertions in paragraph 1 (50-100 municipalites….).
Being the ignoramus that I am, it makes me wonder if the financial sector would be massively hurt by a large default in munis. Could that be a reason for JM’s sorrily-supported article?
It’s not just Wall Street that would be hurt….And let’s not forget. These massive crises hurt Main St much more than they hurt Wall Street. Just look at what the great recession did. Main St is still in the dumps and Wall St is pretty much recovered.
Of course Wall St has a vested interested in avoiding mass panic in the muni market, but then again so do the rest of us.
I think that the real challenge facing a large percentage of States and Municipalities are their shortfalls in their pension obligations. I’m not sure if these shortfalls are even lumped into the numbers being reported?? If they are not then Whitney may not be off by much.
the real question is whether pensions get paid out before or after the bondholders. If they get paid AFTER bondholders than by the time states default there will be blood on the streets. Do people know the seniority structure in the muni market? I am a commodity guy so I have no clue about munies, sorry.
I think that the point of Rosenberg’s call is not that the states are not in bad shape but there will be a substantial decimation to real incomes and structure of the state sector BEFORE bondholders take a haircut. Again I don’t know if it is correct. Please enlighten me
I fully agree MW overstates the problem. And when push comes to shove, budgets and taxes will be adjusted to prevent a significant number ($ volume) of defaults.
The money required to alleviate muni problems – weather it comes from increased taxes or budget cuts – make sno difference. Raise taxes, cut municipal spending, re-structure bond payments – none of these contributes to economic growth.
At the end of the day all of that money is redirected from consumers and employees, out of PCE.
And the total amount of adjustments needed to balance is going to be significant to the economy.
I don’t think there will be bailouts, but I also don’t think any states will default (there will be muni defaults, of course, but not state level). Default is very bad politics, for one thing. And there are always ways to avoid it (cut, raise taxes).
U.S. Mayors Say City Bond Defaults Likely Amid Budget Strains
The mayors of Los Angeles and Chicago said the financial strains still weighing on local governments in the wake of the recession may cause cities to default on their bonds.
Los Angeles Mayor Antonio Villaraigosa, a Democrat, said municipalities are being squeezed as states move to balance their own budgets, a step that can involve taking more funds that would otherwise be sent to towns and cities.
“There’s no question you’ll see some cities in default,” Villaraigosa told reporters today at a press conference in Washington, where the U.S. Conference of Mayors is meeting. “The difference between us and the federal government is they can print money. The states balance their budget oftentimes on the backs of cities, counties and school districts. We actually have to balance a budget.”
I agree with the comment that Meredith Whitney has very little too loose. It is a good binary trade for her. If she happens to be right because of the stars aligning, she looks like a genius. I believe there may be an opportunity, the move down has been tremendous. Interesting is also is that some of the ETFs were trading at a discount to NAV, that has been uncommon. MUB, at one point was at a 2.4% discount, it is less today, but the overall price is cheaper.
Don’t mean to over comment here, but Jeff Gundlach of Doubleline Capital, one of the better bond traders out there, has some interesting comments on the muni bond market …
here
Can’t comment enough with stuff like that Oroboros. Thanks for posting. I hadn’t seen that.
Vallejo’s exit plan: cuts, more cuts and haircuts
“The city would pay general unsecured creditors about 5 percent to 20 percent of their claims, according to court papers filed in U.S. Bankruptcy Court in Sacramento, California’s capital. The creditors, who include retirees and former employees, will be paid $6 million over two years, according to the filing.”
“securities issued by restricted funds such as water revenue bonds are unaffected.”
http://ftalphaville.ft.com/blog/2011/01/19/463371/vallejos-exit-plan-cuts-more-cuts-and-haircuts/
All the debt reduction methods described are affecting purchasing power and forecast a continuing decline in the US standard of living. Unemployment will not be reduced until the cost of labor continues its decline enough to compete internationally. This would raise US exports to a meaningful level so as to approach the German model. But the history of workers response to greatly reduced income brings rising dangerous political agitation.
Simply put Margolin needs to get his facts stright before writing such an article. There is past history of states going through default in the US. Also Whitney did not say there would be defaults of 50-100 billion ,but that there could be and no one should be disputing that fact. The states alone are up to 150-200 billion in debt on their budgets this year. Cullen, I know that you are in the group that thinks we can just keep backstopping everything until eventually the economy turns around. I tend to side more with the group that believes that we can’t keep bailing out every bank,city,county,state,and country in the world. Somewhere either we draw the line and allow those that are insolvent to go through restructuring, or nature and the market will choose that time and place for us.
I just think we have the ability to back stop things. That doesn’t mean we always should. If localities go bust then so be it. Who cares. But if CA is on the brink I believe the Federal govt should step in and provide aid.
Should we have saved the banks in 2008? Certainly not. Spending money at the Federal level is not as black and white as an austrian econ textbook might have us all believe. I am generally against govt involvement in the markets, but I also understand that govt can be utilized for good purposes and in fact MUST be used some times.
Do you think it would be a good thing if CA or Illinois went bankrupt? Would it “teach us a lesson”? Or would it just be an unnecessary burden for us all?
How long before someone notices “the emperor is naked”
No, I don’t think Meredith Whitney’s call is over the top. I think Rosenberg’s thoughts are over the top. We saw the muni bond markets turn when the Treasury markets turned. Coincidence ? No way !!! We saw the bond markets top in late august/early september.
Newsflash,scare tactics are a waste of time…..Thanks cullen for being level headed and seeing through the crap.
Illinois has BALANCED their budget without any help from the feds…..Even with the extra borrowing to pay backlogs and lack of federal support they did it with just a 2% tax increase.
just out…A BALANCED BUDGET FOR ILLINOIS GOING FORWARD.
http://www.state.il.us/budget/Three%20Year%20Projection%201.20.11.pdf
http://www.bloomberg.com/news/2011-01-21/u-s-state-bankruptcy-weighed-by-house-republicans-blocking-aid.html
Republicans on a fresh high of a 2.8 tril cut to stimulus programs and playing chicken with states. As more repubs are elected, there will be more austerity which will further hurt state’s balance sheets. I agree that the muni panic is a great buying opportunity; however, we might not see the bottom until we actually see some defaults brought on by boneheaded austerity measures.
Yes, these sorts of proposals have the potential to really cause some serious problems….