Buyers Beware: Municipal Bond Prices Don’t Reflect Financial Stress

Muni investors are acting as if there is no default risk in the municipal bond market based on yields.  It’s a bit like the conditions in the eurozone before the sovereign debt crisis. The Wall Street Journal reports:

Investors are ignoring warning signs in the $2.8 trillion municipal-bond market, raising the risk of a reckoning, according to some market specialists.

Numerous municipalities are struggling financially. A Rhode Island city recently said it faces insolvency. Harrisburg, the capital of Pennsylvania, is considering a municipal-bankruptcy filing. And famed investor Warren Buffett recently warned of a "terrible problem" ahead for municipal bonds.

But municipal-bond prices aren’t reflecting much concern. Yields on municipal bonds maturing in 2020 stood at 3.15% Friday, up slightly for the week but down from 3.3% in April. As prices and yields move inversely, this indicates lessening concern among muni investors, even as the cost of insuring against defaults has been rising…

Mr. Buffett’s Berkshire Hathaway Inc. has trimmed its municipal-bond investments to less than $4 billion as of the first quarter of 2010 from about $4.7 billion at the end of 2008.

"I don’t know how I would rate them myself," Mr. Buffett testified. "It’s a bet on how the federal government will act over time."

Increasingly, municipalities are showing signs of deep financial stress. Harrisburg said it might file for Chapter 9 bankruptcy proceedings. And Central Falls, R.I., whose motto is "City with a Bright Future," handed control of its finances to a receiver, unable to pay its debt.

I asked Are munis the next shoe to drop? in April and I am still wondering given the funding difficulties states and municipalities are having. Look at the shell game New York state is playing with its pension funds. Not every municipal bond is a lemon, of course. But, there will be contagion. Moreover, given the credit ratings agencies lapses, you can’t rely on ratings to see you through. It does pay to do your homework. But how many individual investors do this? When the next downturn hits, revenue shortfalls will make this crisis real. Until then, it’s buyer beware.

Source: Investors Looking Past Red Flags in Muni Market – WSJ

  1. Blahblah says

    Most people don’t know or care… but the municipal bond insurers are broke. Look it up. Municipalities pay bond insurers a fee so the bonds are insured. The insurance provides a higher bond rating which translates to cheaper cost to borrow. Unfortunately all it would take is for a couple large bonds to default pushing the bond insurers bankrupt thereby making all other bonds realistically much riskier because they would no longer be insured… Just something to chew on. The reality is ugly, and a lot of what is put out there serves as nothing more than distractions from the truth… Keep up the info.

    1. Edward Harrison says

      Good points on the insurers, something we used to talk a lot about during 2008. Buffett has stepped in to some degree. However, the WSJ article points out that he has pulled back.

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