Archive for December, 2010

Cleaning Up: Thoughts on Muni Bond Market

Friday, December 10th, 2010

Thoughts on this:

Thanks for the fearmongering, but I don’t think it’s quite so bad.

Four points:

(1) The pension problem has been festering for a long time, and I just don’t see a kill-the-market catalyst or crisis other than the banking system having another liquidity crisis (like 2008).  But Bernanke has made it clear liquidity will be unlimited (for at least the next 3 years, eh) and the banks still own Congress behind-the-scenes and will not vote their own suicides. So unlike 2008, the market is unlikely to crash this time.

(2) The ongoing budget problems can and will (eventually) be met with rational cuts to “fluff” services, plus tax increases on those willing to put up with them.  Not to mention the monetary inflation that Bernanke is pumping into the system on a weekly basis!

(3) The ongoing, happening-right-now solution to the pension underfunding issue — once people wake up to the problem — has been (1) stop the bleeding – cease enrolling new employees in the troubled pension system and (2) make the workers pay for the pension – force current members of the plan to contribute to the pension out of salary (e.g. “your 2% COLA raise is now your pension contribution”).  This wave hasn’t reached all shores yet, but it’s visible — even in California (e.g. the University retirement system).  And retiree medical is just gone, at least until this nation gets serious about having a first-world medical system.  The public unions are still kicking, but the writing is on the wall… even in California.

(4) You claimed “My best guess is that two states go down — Illinois and California…” and then “If you have to own munis, own the better-quality states – in fact, own bonds that have first claim on revenues rather than general obligation debt.”  But you neglected to mention that in many states, including California, debt service payments are protected in the state’s Constitution.  Therefore a CA general-obligation bond is in fact quite like a revenue bond, protected by the tax revenues of the entire state.  That doesn’t make them risk-free, but they could well be lower-risk bonds than those issued (at currently lower rates!) by states which currently appear “better-quality” (short-term)!  Because those other states may have a more vulnerable (less diversified) economic base and lack the constitutional default protection…

In short, it might be quite profitable to do your own due diligence here, and wait for these fearful guys to bid up your preferred market after the crisis passes.