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The Collapse Of The Muni Bond Market

Tyler Durden's picture




 

With most investors' eyes glued to equities and corporate bonds, and to a much greater extent, US Treasurys, many are ignoring the storm clouds gathering over the traditionally much more boring, income oriented municipal bond market. A recent research piece by welling@weeden covers most of the question marks vis-a-vis the muni market, although with proclamations such as "the municipal market will probably repeat the pattern of the sub-prime collapse. Although it is plain to see, the usual experts do not notice. This was true of all of our recent financial bubbles, including subprime mortgages" the paper's message may not be too welcome to the $3 trillion+ muni market. For all readers who enjoyed Sprott's recent outlook on the inevitable US debt repudiation, this is a must read report.

 

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Wed, 10/28/2009 - 14:41 | 113181 curbyourrisk
curbyourrisk's picture

thanks for PDF format!

 

Wed, 10/28/2009 - 14:43 | 113188 credittrader
credittrader's picture

MCDX13 +11bps to 105bps today!!! tightest to IG in weeks...should Munis trade through the high quality corporates of IG13?

Wed, 10/28/2009 - 14:46 | 113193 Yankee
Yankee's picture

Just pay your taxes, not to worry.  Short some NYC bonds, we've been around these blocks for 30 years or more now.  Who gives a shit, they have been told, they have seen so many times, there is always money under the municipal rug.  Big pensions in some shit hole in CA, who cares.  NYC nonsense who cares.

Wed, 10/28/2009 - 14:48 | 113197 Mad Max
Mad Max's picture

Bought a muni bond fund in early 2008 to get 2.5% returns when that was difficult... sold it in December 2008 on the expectation that municipal bankruptcies would be starting shortly.  Obviously I sold earlier than necessary, but this analysis suggests my idea was right.  (Yes, timing is everything, yes yes.)

I should have become a town supervisor for some stupid wealthy suburb that didn't realize it was massively overpaying its employees!

Don't miss Mish's post today on Houston being bankrupt.

So when exactly does the wave of municipal bankruptcies start, and what ugly politics will be revealed in that wave?

Wed, 10/28/2009 - 14:59 | 113212 Miyagi_san
Miyagi_san's picture

around here there shutting off the street lights...OT.. pelosi will announce heathcare bill tommorrow,  I think that GDP # is a setup for a beat 

Wed, 10/28/2009 - 14:53 | 113203 chunkylover42
chunkylover42's picture

Wait, I'm confused.  Moody's and S&P both said my muni bonds are AAA-rated. 

Wed, 10/28/2009 - 15:48 | 113253 Stuart
Stuart's picture

Given what we now know about Moody's and S&P's complicity in the MBS fraud, why would anyone ever again listen to these two corrupt organizations.  

Wed, 10/28/2009 - 14:55 | 113205 lizzy36
lizzy36's picture

Ravitch Says States Face Total Deficits of $500 Billion in 2011

I believe that the states across the United States will face deficits a year after stimulus ends of $300 billion to $500 billion a year,” Ravitch told about 200 people gathered at New York University’s Robert F. Wagner Graduate School of Public Service. “You’re going to begin to see cracks in the municipal bond market well before then, because that’s an inexorable casualty of unfundable state deficits.”

http://www.bloomberg.com/apps/news?pid=20601087&sid=aUGZAP9hYc4k

Wed, 10/28/2009 - 14:58 | 113211 Anonymous
Anonymous's picture

Munis are very funky, you have to look at the details really carefully. Some are general obligation bonds, pretty safe. Others are backed up by things like airport or convention center revenue. Forget the ratings, you have to look under the covers yourself

Wed, 10/28/2009 - 15:04 | 113217 mule65
mule65's picture

Is WOPR down?

Wed, 10/28/2009 - 15:22 | 113236 I need more cowbell
I need more cowbell's picture

WOPR only works on low/no volume days. He be lazy.

Tomorrow will be sehr interessant, meine fruende. The GDP leak was:

a) to lower expectations, so we grind lower today rather than swoosh manana and scare the children

b) lower expectations, to set a bear trap, when anything north of 2.7 is bally-hooed like your first son being born with two dicks

c) the boyz are already short, and wanted to jump start the festivities

d or, an infinity of other shit

Wed, 10/28/2009 - 19:23 | 113516 Cognitive Dissonance
Cognitive Dissonance's picture

WOPR called in sick and spent the entire day on Zero Hedge chat making eyes at Marla and dissing Cheeky.

Or was it the other way around?

Wed, 10/28/2009 - 15:22 | 113237 Edna R. Rider
Edna R. Rider's picture

The most hilarious thing I read all day (the part about the Fed):  Contrary to opinion, the stock market will embrace a tightening monetary policy, says Jeffries & Co. chief strategist Art Hogan. Rather than seeing higher corporate borrowing costs, he says, investors will know the moves are coming because of positive economic signals: "The Fed has a pretty good picture of the economy, and can usually see around the corner."

Wed, 10/28/2009 - 16:24 | 113324 Takingbets
Takingbets's picture

ROTFLMAO! Just like they were able to see and contain subprime.

Wed, 10/28/2009 - 16:35 | 113346 bonddude
bonddude's picture

Hogan's thinking with his "bottom."

Wed, 10/28/2009 - 15:44 | 113239 Careless Whisper
Careless Whisper's picture

Munis collapsing, CRE collapsing, home prices tanking more, dollar... gonzo.

And now the violence begins.

Not happy with your loan mod? HIRE SOME MUSCLE and go after your banksta:

http://rocktrueblood.blogspot.com/2009/10/not-happy-with-your-home-loan-re.html

 

 

Wed, 10/28/2009 - 15:30 | 113242 Bam_Man
Bam_Man's picture

But, but, but those Muni bonds that are not AAA-rated are INSURED though.

What's there to worry about?

Wed, 10/28/2009 - 16:48 | 113361 agrotera
agrotera's picture

hahaha

Wed, 10/28/2009 - 19:25 | 113518 Cognitive Dissonance
Cognitive Dissonance's picture

If they keep up with these lies, I might just have to hold my breath until I turn blue. That will straighten them out good.

Wed, 10/28/2009 - 15:41 | 113245 zarrmax
zarrmax's picture

It really depends on the bond deal but to say that the muni market as a whole is going to collapse is wrong. Of course if inflation comes & interest rates rise, bond prises will fall but that's a normal function of the security.

 Most investors wrongly assumed the stability and integrity of the investment and ran away from CA munis last year. Each bond is different and you need to read the documents but CA G.O.s are second in line for payment (behind education). Arnold & Co. are fighting over line itmes 350-400... I'm number 2... no credit risk there.

On the other hand, a G.O. for a dirt district that never got off the ground is a shoe in for BK.... but then again, anyone who knows muni's knows this and won't touch these bonds. HY junkers rule that space....

I can see the states are in trouble but munis have one BIG advantage over others... they can raise taxes.

Wed, 10/28/2009 - 15:56 | 113261 Mad Max
Mad Max's picture

Legally, they can raise taxes.  As a political and practical matter, I am more skeptical.  The Iowa issues noted in the article came from a conservative farm state in a time of civility.  Look at how Congresscritters freaked out over extremely mild protest at town hall meetings and anticipate how local politicians may react when faced with their own neighbors and past supporters yelling scary things at them in a local meeting.

Municipalities and most other public issuers (other than states) can declare bankruptcy.  This may be increasingly attractive when the alternative is viewed as scary by the local politicians.  Imagine the reaction of most people if told that their property taxes were being raised to 42.5%, as apparently once happened (article).  Concerns over reelection would be replaced with concerns over fleeing to safety, I suspect.

Wed, 10/28/2009 - 16:26 | 113328 zarrmax
zarrmax's picture

As a disclaimer, I have not read the article ( I'm going to read it tonight).

You make good points and while I agree that local issuers can file BK and this might be a route, the likelihood is small that they actually do file. Ad Hocs and creditors will pow-wow and work an alternative, sustainability is the name of the game and completely different from a distressed corp. (See Icahn/ CIT). There's no corp raiders in muni land (in the traditional sense). Although I admit that in order to get to this point, the muni in question is in trouble the real question is if the bonds will still pay.

Case in point: Vallejo, CA filed in 2008
The bonds never missed a payment. The reason they filed was to get out from their civil contracts with police,firemen etc. (Like I orginally said, line items #350). I think the real problem is the excess gov. spending. Vallejo was paying firemen $150k per year which sounds ridiculous but I can tell you when your house is on fire you don't want the guy who was the lowest bidder going in to get your child. If states did away with "special interests" programs, aka. friends of friends, most municipalities and states would be ok.

Wed, 10/28/2009 - 16:37 | 113347 Mad Max
Mad Max's picture

Zarrmax, you sound like you know this area and I look forward to a more detailed post after you read the article.  I only deal peripherally with muni bonds and never with distressed bonds, so I'm no expert.  My main point is that between the visceral impact of local tax increases and the abrogation of centuries of law in the GM and Chrysler "bankruptcies," I no longer assume that laws are going to be applied in the way written or intended.

Wed, 10/28/2009 - 16:58 | 113360 zarrmax
zarrmax's picture

Agreed... what a cluster fuck GM & Chrysler were... thank god I didn't trade those names regularly. I did invest with play money in GM but only after the BK. My cost basis for GM is in the low teen's which should work out....:)

Wed, 10/28/2009 - 16:40 | 113350 bonddude
bonddude's picture

Additionally, Vallejo school GOs which are reported to be in tech. default will continue to pay. the issue was something about the routing of funds through state accounts or some such.

Wed, 10/28/2009 - 16:48 | 113364 bonddude
bonddude's picture

When that first bad selloff hit last year and people were dumping their bonds to meet margin calls and funds were dumping to meet selling there were STUPID good deals 7-9% on money good Cal Smaller district paper. God that was fun. Could happen again. Got to understand the nature of the taxes or revenue streams behind them.

Wed, 10/28/2009 - 17:09 | 113396 zarrmax
zarrmax's picture

It could happen again but the likelyhood is low. The real crash in muni's happened not because of individual margin calls or fund redemptions but because Lehman dumped their muni book on the market. This drove prices down to the point of "crash" alone, the margin calls and redemptions where part of the velocity. There was a point where I said no bid on everything passing up G.O.'s yielding 10% + for quality credits.

Wed, 10/28/2009 - 18:09 | 113445 bonddude
bonddude's picture

Not to be disagreeable but it couldn't have just been that. There were hundreds of millions in odd lot bid lists (pieces under 250M/even 10-50m indicates piecemeal institutional and retail) and lehman just wasn't a player in the sizes and credits I was seeing. I would say that while you might be right about Lehman as they were dumping all assets, so was anyone else trying to raise cash. Remember it was a domino effect. It lasted about 1 1/2 months at the bottom.

Thu, 10/29/2009 - 08:45 | 113881 zarrmax
zarrmax's picture

I don't dispute there were hundreds of millions of odd lot bid wanteds. As we all know, retail does not move markets, institutions do. The big liquidations came first, moving the market way outside the normal trading range. This one-off, "six-sigma event" is what caused the market to initially crash. Retail literally woke up a week later to find their "super safe, super steady" munis that they used as margin collateral for their day trading accounts were down 20 points and they couldn't cover the call. This is what I meant by velocity. They were forced to sell everything into an already down market. I aggree this was a domino effect, I just think the big domino fell first.

Thu, 10/29/2009 - 09:02 | 113906 bonddude
bonddude's picture

Just think if they let the bigger dominos go...gs, ms etc. . Things would have gotten crazy cheap.

cheers

Wed, 10/28/2009 - 21:16 | 113597 Anonymous
Anonymous's picture

As a muni buyer, I'll take your dirt bonds all day long. If you own non-performing dirt bonds, you likely work for Nuveen and haven't ever cracked a cover of an OS. I own several where the development went bust and I have yet to miss a payment.

Thu, 10/29/2009 - 08:51 | 113889 zarrmax
zarrmax's picture

I'm not here to give investment advice.... just be careful.

Wed, 10/28/2009 - 15:50 | 113255 Anonymous
Anonymous's picture

New York City's average compensation has "exploded". An annualized rate of 5.6% (2000 to 2009)? Hard to see that as irresponsible - unless its irresponsible to not match the increase in Wall Street salaries during the same period. The people sweeping the streets provide more value than the brokers ever did.

Great history in the document. Apparently one of the three founders of Lehman Brothers was New York governor in 1933, when NYC was close to declaring bankruptcy. Lehman called a special session to eliminate mandatory wage laws in NYC.

Now, with 20 million people working for states and municipal governments, they are threatened with collapse unless they cut and cut hard.

I guess reducing everyone's income is going to help get us out this crisis as soon as possible - or at least allow the banks to grab as much distressed sale and foreclosed property as they can squeeze out of us.

Thu, 10/29/2009 - 11:39 | 114080 Anonymous
Anonymous's picture

You don't see the raw stupidity in linking compensation of employees of the Water and Sewer department to stock prices (a proxy for Wall Street boom times)?

Municipal employees across the board are egregiously overcompensated. In every single solitary instance I could find a brighter, harder working person to do their job for half to three quarters of a muni employee's pay.

Municipal compensation has hijacked this country. (It is not even the absurd salaries, it's the comically off the charts guaranteed lifetime benefits.).

Wed, 10/28/2009 - 15:53 | 113257 chet
chet's picture

Time for a jubilee across the board.  Mark it ALL zero.

Wed, 10/28/2009 - 16:22 | 113319 Chumly
Chumly's picture

I second that motion.

Ahem, Mr. Chairman, we move to bring this vote before the full committee.

Wed, 10/28/2009 - 18:03 | 113440 Green Sharts
Green Sharts's picture

Wipe out the savers and let the borrowers off the hook.  Sounds like the ultimate destination of government policy since Alan Greenspan became Fed chairman.

Wed, 10/28/2009 - 15:56 | 113259 chunkylover42
chunkylover42's picture

welcome everyone to the next great bailout.  a lot of federal money is about to go to the states, further usurping their power at the expense of washington.  play nice or else, they'll be told.

he who controls the purse strings has the power.

Wed, 10/28/2009 - 16:08 | 113284 Miyagi_san
Miyagi_san's picture

Stimulus 2 ... save the teachers union...The kids will be bright but wont have a future.

Wed, 10/28/2009 - 16:33 | 113338 Mad Max
Mad Max's picture

I've been told, privately, by a former economist for my state's government that there is an inverse correlation between teacher pay and student outcomes.  I can also tell you that Detroit Public Schools have high pay by any measure and their quality is below abysmal.  I personally went to one of the best funded districts in my state and still got mediocre teachers.  I would have been better off at a Catholic school where teacher pay is 20-40% less but teachers care and students pay attention.

Wed, 10/28/2009 - 16:03 | 113272 BetterOffDead
BetterOffDead's picture

Nothing a little ink and paper won't fix.  States will bail out cities and towns with BB paper received from the government.  Lookout for the Term Municipal Securities Lending Facility, coming to a town near you.

Wed, 10/28/2009 - 16:09 | 113288 Anonymous
Anonymous's picture

Washington couldn't dump Medicaid liabilities on the states forever....so to "relieve them of this burden" they are going to take over the entire healthcare system! Before long there won't be "states" as the whole game will be owned by Federal Bankers. Looks like my Dad was right about Socialism working its way into power.

Wed, 10/28/2009 - 16:10 | 113292 Anonymous
Anonymous's picture

Here is why I am not worried about municipals (nominally that is although when it's done, a hamburger will be $40)

Anything that is fair in terms of capitalism, the feds will fo the opposite..trade on this and you will win.

Here is the fact..if the fed lets states go bust and muni bankruptcies yet they bailed themselves out, individual states will secede (sp?) from the union and start their own vibrant economies built on production. This will be completely fair, new currency will not be fiat, lower taxes to attract capital etc etc..this would be great but the fed will never let this happen..so, they will bail out muni bonds. (They are pretending to care about the dollar cuz it was collapsing and maybe a lip service .25% hike and then dump more quantitative easing and counterfeiting into dollar strength) This crap is so obvious once you realized how rigged it is and their desired endgame.

Wed, 10/28/2009 - 16:35 | 113345 Mad Max
Mad Max's picture

This is so crazy and asinine that it's probably dead-on.  We're far down the rabbit hole and still digging.

Wed, 10/28/2009 - 16:12 | 113299 Dixie Normous
Dixie Normous's picture

Anyone have a cheap way to short this mess.  Appears most of the ETFs have no options

 

Wed, 10/28/2009 - 18:04 | 113441 Anonymous
Anonymous's picture

Short Moodys - Read the speech by David Einhorn!!!

Wed, 10/28/2009 - 16:18 | 113309 Gordon_Gekko
Gordon_Gekko's picture

"Today, no matter what one's reason for owning municipal bonds, these are speculative investments."

So is holding cash today...what a sorry state of affairs.

Wed, 10/28/2009 - 16:23 | 113321 HarrisonBergeron
HarrisonBergeron's picture

I think I am going to be sick.

Wed, 10/28/2009 - 16:48 | 113363 bugs_
bugs_'s picture

Houston we have a problem!

Wed, 10/28/2009 - 16:51 | 113370 Anonymous
Anonymous's picture

The big risk for muni bonds is inflation. When interest rates climb to 18%, today's bonds are done for. Also, it only takes a few random defaults to make the overall risk picture much worse, so the value of existing bonds could plummet. On the other hand, federal and state taxes must go up in the next decade, so muni's would be good for that...

Thu, 10/29/2009 - 11:35 | 114070 jm
jm's picture

Real interest rates are the real risk.

When CPI really caves, the interest burden on these poor bastards is going to cause many defaults, repudiations, and interest reductions.

With gov't as involved as it is now, courts will cave to political pressure.  Game over creditors.

 

Wed, 10/28/2009 - 17:09 | 113395 gookempucky
gookempucky's picture

Break out the cat urine--I feel a heavy metal trip coming..

Wed, 10/28/2009 - 17:31 | 113407 dza
dza's picture

And, for bonus points, what's the notional value of the Oracle of Omaha's (mr "weapons of financial mass destruction") credit default obligations on the municipal bond market? 16 billion. with a "B" billion. Sixteen of them.

Wed, 10/28/2009 - 17:39 | 113416 Gunther
Gunther's picture

If I remember the last two years correctly, the story goes like this:

A market that nobody ever talked about made headlines. The headlines were bad. The market froze up.  All efforts to get the market going again failed. 

Repeat with the next less-risky market...

Wed, 10/28/2009 - 19:10 | 113501 Anonymous
Anonymous's picture

http://blog.nj.com/njv_mark_diionno/2009....

Director of Finance of New Jersey say public pensions will not be paid, that there will be a tax revolt.

PBGC has a max pension of $60K a year, I think. Maybe that will be the bailout max pension.

In the short term munibondholders and pensioners are united in desiring increased local taxes, but they will be fighting over the carcass at the end.

I hold California munis, mostly GOs, on the theory that I gotta have some income, and I hope thta the tax free income will be greater than the capital loss (so far so good.) I'd rather hold munis than real estate, good luck to us all!

Wed, 10/28/2009 - 19:46 | 113544 johngaltfla
johngaltfla's picture

I do remember writing and commenting on this in my usual sarcastic manner in February of 2008 in a piece titled "Municide" and boy did the muni pumpers hammer me over that one. I'll simply repeat one part of it:

 

Pension plans, conservative investors, and many millions of other souls have piled billions of dollars into supposedly safe, insured and low-yielding municipal bond funds. The idea that the valuations of these instruments changing in a drastic manner never even crossed the minds of anyone (well exclude myself and a few others), as there seemed to be a huge gap in the River of Denial where the disconnect between the “subprime crisis” and the solvency of the cities involved was huge. Well, the connection was finally made when the Auction Rate Security markets went off the scale recently. With failed auctions resulting in some communities seeing back breaking 18 to 20% yields, the idea of issuing new paper or starting new projects will fade quickly. And that reduces employment opportunities in those cities. As well as impacting the investors, be they pension plans or just a bankster in the Caymans, to shun this market and fly for safety in tangible assets. That is why the stories about declining home sales, falling building permit applications and small to medium sized business bankruptcies are starting to scare the dickens out of the investors domestically and overseas. What happens if the monolines have to start paying out on defaulting municipal bonds? What happens if the “good bank” becomes as insolvent as the bad one, reducing the capitalization of the “bad bank” with it’s devalued shares? And what happens when the Municide kills the insurers causing a massive write down of actually worthless assets by the largest banks in the United States? These questions are ones that they do not want to have answers to, but the Federal Reserve has to be aware of this pending implosion.



Unfortunately for all of us, the failure to project future revenues and growth does impact everyone in the U.S. The decline in sales tax receipts, property tax receipts, and other fees originally projected from an expanding economic base as well as healthy real estate market, will eventually lead us to city after city, county after county, defaulting on various securities once thought or perceived to be the safest in the nation. As the resets continue this year and next, even more over-valued real estate which will force property tax revaluations and appraisals to be evaluated lower and lower, feeding the vicious cycle downward even more so. Asset devaluations with accelerating commodity inflation will eventually destroy the average American citizen’s standard of living. Add in the starting wave of HELOC and second or third home equity defaults and you have a formula for a banking crisis on top of the municipal bond crisis to come. The result of this economic contraction along with the forced decline in government spending on the state and local level will leave huge revenue gaps that will result in either default or increased federal intervention.

 

Yes, this will end with another government bail out. It has to our we will see unemployment top the 20% mark in very short order (their headline number, not reality).

 

Thu, 10/29/2009 - 02:06 | 113786 Anonymous
Anonymous's picture

Holy crap...johngaltfla? Could this be the John Galt of the always entertaining, and now sadly defunct "Shenandoah" blog?

What happened to you man! Your dancing banana's and rapist wit are sorely missed.

Wed, 10/28/2009 - 20:55 | 113588 Anonymous
Anonymous's picture

Personally I think the Muni Market is as safe as the Treasury Market. With Feds bailing out Citibank/GM/Fannie and Freddie who really believes that the Feds won't bail out the states and cities if things get harsh? We already have too many moral hazards built into the system already. I think it's highly unlikely that the Feds would let the muni market fail.

Of course the whole country could fail with the Feds become the "lender of last resort" but that's another story.

Thu, 10/29/2009 - 11:31 | 114061 Anonymous
Anonymous's picture

Re-read the article and focus on the parts where it talks about renogiation of bond contracts. In other words, they will tear up that O.S. if it suits them. We already know what the new administration thinks of bond contracts.

In theory it's safe; that's the author's whole point. You've been anesthestized into thinking nothing could ever go wrong here...but it CAN. They will tear up your O.S. under conditions in the fine print.

Thu, 10/29/2009 - 09:23 | 113945 jswede
jswede's picture

brutal reading...  just brutal.  I was thinking about the parallels to the auto unions throughout reading this, and, sure enough, Lowenstein's "While America Aged" is referenced in the last section.  and we know how that one ends....

Wed, 12/16/2009 - 16:26 | 166397 Anonymous
Anonymous's picture

Big Brother is comming, 1984 is more like 2024 of before becafull what u say on blogs also carfull what u think even in your sleep big brother is watching , one worl curancy is how it will start, one world government is next thrfew very ritch others drows or pleabeens or slaves or surfs

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