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Fear and Trembling In Muni Land
Wolf Richter www.testosteronepit.com www.amazon.com/author/wolfrichter
Municipal bond investors, a conservative bunch who want to avoid rollercoaster rides and cliffhangers, are getting frazzled. And they’re bailing out of muni bond funds at record rate, while they still can without losing their shirts. So far this year, they have yanked out $52.8 billion. In the third quarter alone, as yields were soaring on the Fed’s taper cacophony and as bond values were swooning, net outflows from muni funds reached $32 billion, which according to Thomson Reuters, was more than during any whole year.
Muni investors have a lot to be frazzled about. Municipal bonds used to be considered a safe investment – though that may have been propaganda more than anything else. Munis are exempt from federal income taxes, hence their attractiveness to conservative investors in high tax brackets. Munis packaged into bond funds appealed to those looking for a convenient way to spread the risk over numerous municipalities and states. While the Fed was repressing rates, muni bond funds were great deals.
Then came the bankruptcies.
The precursor was Vallejo, CA, a Bay Area city of 115,000 that filed for Chapter 9 bankruptcy protection in 2008 and emerged two years ago. But it’s already struggling again with soaring pension costs that had been left untouched. Jefferson County, which includes Alabama’s largest city, Birmingham, filed in 2011 when it defaulted on $3.1 billion in sewer bonds, the largest municipal bankruptcy at the time [but it’s already issuing new bonds; read..... Municipal Bankruptcy? Why Not! And so The Floodgates Open].
Stockton, CA, filed in June 2012. Mammoth Lakes, CA, filed in July 2012. San Bernardino, CA, filed in August 2012. They were dropping like flies in the “Golden State.” Detroit filed in July this year, crushing all prior records with its debt of up to $20 billion. That’s $28,000 per person for its population of 700,000.
But Detroit is just a fraction of what is skittering toward muni investors: the Commonwealth of Puerto Rico. The poverty rate is 45.6%. Unemployment is 14.7%. The economy has been in recession since 2006. The labor force has shrunk 16% from 1.42 million in 2007 to 1.19 million in October. The number of working people, over the same period, has plunged from 1.8 million to 1.1 million, a breathtaking 39%.
Puerto Rico had a good run for decades as federal tax breaks lured Corporate America to set up shop there. But when these tax breaks were phased out by 2005, the companies went in search for the greener grass elsewhere. To keep splurging, the government embarked on a borrowing binge that left the now lovingly named “Greece of the Caribbean” with nearly $70 billion in debt.
That’s 70% of GDP, and for its population of 3.67 million, about $19,000 per capita, or about $64,000 per working person. And then there is the underfunded pension system. But unlike Detroit, Puerto Rico is struggling to address its problems with unpopular measures, raising all manner of taxes and cutting outlays. Not even the bloated government payrolls have been spared. Too little, too late? Given the enormous poverty rate and long-term shrinking employment, what are the chances that this debt will blow up?
Pretty good, according to Moody’s Investors Service. Last week, it put $52 billion of Puerto Rico’s debt under review for a downgrade – to junk. Moody’s litany of factors: “Failure to access the public debt market with a long-term borrowing, declines in liquidity, financial underperformance in coming months, economic indicators in coming months that point to a further downturn in the economy, inability of government to achieve needed reform of the Teachers’ Retirement System.” This followed a similar move by Fitch Ratings in November.
Alas, Puerto Rico has swaps and debt covenants with collateral and acceleration provisions that kick in when one of the three major credit ratings agencies issues the threatened downgrade. Which “could result in liquidity demands of up to $1 billion,” explained Moody’s analyst Lisa Heller. It would “significantly narrow remaining net liquid assets.”
Now Puerto Rico is under pressure to show that over the next three months or so it can still access the bond markets at a reasonable rate. If not....
Puerto Rico’s debt was a muni bond fund favorite because it’s exempt from state and federal taxes. Now fears of a default on $52 billion or more in debt are cascading through the $3.7 trillion muni market. But Puerto Rico isn’t alone. Numerous municipalities and some states have ventured out on thinner and thinner ice.
Default risks are dark clouds on the distant horizon or remain unimaginable beyond the horizon. And hopes that disaster can be averted by a miracle still rule the day. However, the Fed’s taper cacophony is here and now, and though the Fed is still printing money and buying paper at full speed, the possibility that it might not always do so hangs like a malodorous emanation in the air.
Taper talk and bankruptcies are a toxic mix for munis. Now add the lure of stocks that have become the official risk-free investment vehicle with guaranteed double-digit rates of return for all years to come. So muni-fund investors, tired of losing money, are seeking refuge in stocks. This has pressured munis further. The Bank of America Merrill Lynch master municipal index has dropped 2.8% and, unless a miracle happens, will end the year in the red. A first since 2008. Its index of bonds with maturities of at least 22 years has skidded almost 6% – though the Fed hasn’t even begun to taper.
The Fed’s easy money policies over the decades encouraged borrowing binges by municipalities and states. When the hot air hissed out of history’s greatest credit bubble in 2008, the Fed’s remedy, its ingenious QE and zero-interest-rate policies, blew an even greater credit bubble – kudos! As that credit bubble transitions from full bloom to whatever comes afterwards, the plight of muni bond funds is just the beginning.
The Fed’s policies of dollar destruction took on a sudden virulent form in 1970 – clearly visible against the Swiss Franc. And it’s still going on. When even the Swiss couldn’t handle it anymore, they too jumped into the currency war. Read.... Mother Of All Currency Wars in One Chart: Dollar Vs. Swiss Franc
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Not all states and muncipalities are going broke. There are many good investments out there you just have to examine their books as best you can. I still invest in several. Most of the large metropolitan areas scare me and I do not invest there. I am not brave enough to invest in the stock market although I do own some stocks but I do have time to investigate city bonds and have done well with them.
The lady that called the bankruptcies was spot on just early. But that is mostly the big cities where the public unions run the place.
Well, obviously, the answer is to securitize the muni market.
and rehypothecate and use the funds from one rehypothecation to feed the other end of the munibonds.
One happy moebius circlejerk of fraud.
Enjoy Christmas 2013 - is maybe probably last Christmas before total collapse. Eat much food and drink much libation and brace for 2014 when USD and Euro is complete utter fail with Yen and Yuan. Next year is eat scrap for Christmas.
I'll take the other side of that bet.
Collapse will come from the periphery, not the center. USD, at the center, will see inflows from every bankrupt nation on earth as they try to lock down whatever remaining private wealth they can via capital controls or outright confiscation. You're already seeing it, if you look closely. Right now it's a trickle, but when TS really HTF, that trickle will become a flood as everyone with even a smidgen of wealth to preserve heads straight for the deepest market on earth: the US dollar. Stocks will go up, real estate, even muni bonds and definitely treasuries. It will be the counter-intuitive "nobody saw it coming" move of the decade, if not century. Everyone will be caught on the wrong side, which will just add fuel to the fire.
In a true global collapse, do you think ANYWHERE will be in better shape than the USA?
Gentlemen, place your bets.
Ya, I'm taking the opposite bet to you.
Stocks crash, dollar has severe problems relative to actual goods & services, no bet on other particular fiat currencies as they could print/retract at will, gold up, silver up, oil way up.
Munis hit bankruptcy crashes so just as with many euro bonds last year having a given yield but only theoretically with no bid in actuality, many muni bonds will face the same.
In a true global collapse, do you think ANYWHERE will be in better shape than the USA?
that is exactly why we are still sitting here...in the USA...we looked all around the world and realized that there really is no where to go that would be any better than where we are with our family/friend contacts, our knowledge of the culture and language and our ability to simply blend in. it's very important to not be noticed...
What about gold? Seems like that would have more appeal than $s.
Paper gold would no doubt rise in that scenario, but physical would go into hiding and be hard to get at any price. The gold market is too small to absorb the kinds of flows we're talking about, besides, once you've bought it, you still have to get it (and yourself) out of harm's way.
I know it seems counter-intuitive that dollars would be the go-to trade in a crisis, but it's really a case of the lesser of two evils. Go to any rat-hole nation on the planet, including the big ones, and you'll find a black market in dollars. Most people in the USA have no knowledge of how totally fucked the US dollar system really is, so how many people OUTSIDE the USA would know any better? You go with what you know (and with what's available) and, for better or worse, dollars have always played that role.