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David Kotok | Policy Madness in Muniland
Here is the latest from David Kotok at Cumberland Advisors. -- Chris
Policy Madness in Muniland
Cumberland Advisors
September 14, 2011
Policy Madness (inconsistency) in Muniland. Some bullets.
1. President Obama proposes jobs creation by raising infrastructure spending. This is the purview of state and local governments. They finance their share with municipal bonds.
2. Obama adds a reinstatement of the Build America Bonds program, which had a 35% federal subsidy of the taxable interest. The concept was to use the top federal income tax bracket as an equalizer. The BABs program was successful for the two years of its existence but failed to gain extension in the year-end political fight of the last lame-duck session. BABs was a nearly unique federal fiscal initiative. There was no monetary (Federal Reserve) component. It was used throughout the country. It financed infrastructure and met the needs of state and local government units. Its impact was equally divided among red states and blue states.
3. Obama also proposes a reduction of the tax-free bond benefit for high-income Americans (over $250,000 annually for joint return filers, $200,000 for singles). The net effect is to reduce the value of tax-free income and thereby raise the cost of municipal finance. Poor people do not buy tax-free bonds. Wealthy American taxpayers buy them when they are advantageous due to the tax arbitrage. Narrow the arbitrage and reduce the demand for tax-free bonds. Reduce the demand and lower their use. Lower their use and raise the cost of finance for very toll road, school board, and sewer plant in the United States.
4. Let’s examine this policy hodgepodge against some real-time, live market pricing. We will choose the NY State Thruway, since it is an infrastructure project and a toll road that nearly everyone can identify. They recently sold a tax-free issue and they have an existing BABs issue. Therefore, we are able to compare an apple with an apple. This is the same issuer with the same revenue securing the bonds. The maturity is nearly identical. The difference is that one is BABs and the other is tax-free. One gets 35% of the interest rebated by the federal government. The other gets no rebate, but the bondholder pays no federal income tax on the interest.
5. Here is the market pricing. NYS THRUWAY 5.449s of 4/1/25 traded at 4.52% on 8/9/11 (most recent recorded trade). The CUSIP is 650014TF0. This is BABs. Compare it with NYS THRUWAY 5s of 3/15/26 priced at 3.28% on 9/9/11. The CUSIP is 650028TF0. This is federally tax-free.
6. Let’s do an exercise. We will assume that the NYS Thruway is going to finance today and could obtain this yield on a traditional new issue. We will assume the federal income tax top rate remains at 35%. In addition, we will assume that the BABs legislation passes and the program goes back into effect. Okay, 65% of a 4.52% yield is 2.94%. That is the rate the NY Thruway would actually pay (after federal rebate) if it were to sell new BABs bonds today and if the new BABs included a 35% rebate. Clearly, the BABs program would offer the NYS Thruway the lowest cost of financing for its infrastructure project.
7. The existing market-based price of the tax-free bond has a yield of 3.28%. That is a very recent market-based new-issue price. If Obama reduces the value of the tax arbitrage on this bond, the yield in the market place will rise. That means the NYS Thruway will end up paying a higher yield to borrow with a tax-free bond.
Possible policy outcomes from Obama’s initiative are: (1) Nothing changes and the political impasse in Washington prevails. Alternatively, (2) Obama reduces the value of tax-free bonds by raising the effective tax rate – the result is a higher cost of finance for the issuers. On the other hand, (3) if the Congress authorizes the BABs program to resume, then the cost of infrastructure finance declines.
Now, Congress: you decide the best way to create infrastructure jobs. The worst way is to continue to bicker and fight among yourselves and do nothing.
A final, unrelated note about another form of Muniland Madness. We have been a harsh critic of the Meredith Whitney scare, which predicted “hundreds of billions of dollars” of municipal defaults. She said it on 60 Minutes on December 19. So far, there has been less than $1 billion in Muni defaults in the first 8 months of this year according to Distressed Debt Securities Newsletter. She still has four months to go and needs $99 billion in defaults to be correct.
We stand by our original and often-repeated position. High-grade Muni credits are available and the notion of mass defaults is exaggerated. Whitney triggered months of Muni bond fund redemptions. Billions were lost by investors who panicked and liquidated.
At Cumberland, we maintained that well-researched Munis were cheap. Meredith sent many Muni investors to the edge of the ledge. Fortunately for them we were able to talk them off. As you can see by the NYS Thruway example above, compared with their taxable counterparts, Munis still are cheap.
Hat tip to Cumberland’s Michael Comes, who helped research the bond details.
David R. Kotok, Chairman and Chief Investment Officer
Resources:
To sign-up for Market Commentaries from Cumberland Advisors: http://www.cumber.com/signup.aspx
For Cumberland Advisors Investment Portfolio Styles: http://www.cumber.com/styles.aspx?file=styles_index.asp
For personal correspondence: david.kotok@cumber.com
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Doesn't matter WHAT the interest rate is - or the tax exempt status. You're STILL going to lose money to inflation with anything less than double digit interest rates.
Bonds of any kind have returned less purchasing power over time than the initial amount used to purchase them.
Forget all the deflation nonsense. You may be seeing prices tank on stuff you don't need or can't afford to buy anyway but prices are going UP on the things you NEED - like FOOD. The government CPI stats are bogus and have been for some time.
As far as municiopal defaults go... just wait. Even here in affluent suburbia you've got record tax delinquicies - and a record number of houses that SHOULD be in foreclosure (but the banks are holding off because they don't want to recognize the losses or kill the remaining market). Unemployment is still going up. If people aren't working they're not paying their taxes. Even revenue backed bonds are at risk - less traffciic, fewer tolls colleccted. You've got communities around here that have borrowed and borrowed for years - because taxes are already too high to pay as you go - and those interest costs are mounting. You WILL be seeing defaults. Whitney was just early. They can kick the can down the road for an amazingly long time but the day of reckoning is coming.
You don't see who is behind this?
Increase borrowing costs for local & state so the money can be shifted to the Feds. Then the Feds send the money back to the local & state gov. at the discretion of a new Czar.
NEVER EVER would this new Czar feel compelled to favor unions. NEVER would they confiscate more wealth and distribute it to the Unions.
The actions of the Longshoremen in Washington State coincided with comments from Trumka to set the stage for what has unfolded since. A "Jobs" bill to favor "teachers, police and firefighters" (i.e Unions) and a Muni Tax to give the Feds the power to spend for local & state entities...i.e. public sector unions.
The Mafia is running the show. Goodnight America.
everyone is broke. have they already started selling muni's to pay the inerest on the older ones. if not, they will soon
who is this nutjob
I've noticed advertisements airing on CNBC for muni-bonds. Every financial adviser can steer a client to a muni if it fits the client. Why would someone be advertising munis on television?? Are they having difficulty finding buyers? If they are a good deal why advertise??
Reminds me of the "Reminiscences" story of the railroads advertising the sale of shares on the installment plan....
gh
“”California is limited in raising taxes, but a prop 13 revolt is brewing across the country.””
An anti-13 revolt is in Sacramento led by Gov. Brown. Commercial is the first target in the cross hairs. Calpers the Government retirement system is up side down for around ½ Billion. California will raise taxes and drive more and more of the productive from the state. The progressives seem to become more radicalized as things go worse, and increase the anti-business attitude. The “other peoples money” is leaving.
As the treasurer of Orange County California, munis are extremely high risk instruments. Munis are real estate and capital gains bonds. Califoria is limited in raising taxes, but a prop 13 revolt is brewing across the country. Raising tax rates in the future is call ex-politician.
The federal govt. is broke and social security accounting that has allowed politicians to treat net contibution funding above payments as surplus to the deficit. Next year SS will have net negative funding and this will increase dramatically over the next years.
They used to be called european nations, now they are called PIIGS. The muni yields above taxables scream default.
I've traditionally been a Meredith fan, but I think she missed the boat on this call - or at least her timing is way too early.
Not all muni's are created equal. We all know about OC's legendary blowup, but some counties and municipalities (yes, even in California) are fiscally prudent and have their financial houses in order. A little research will lead you to those that are less risky. I agree that long term, Whitney will likely be proven correct; but I think that's at least a few years down the road.
btw, a 3% tax-free yield for someone in the top state (California) and federal brackets is equivalent to a nearly 6% taxable yield. Given that Hussman's forward projections for S&P growth is south of 5%, that's not small potatoes...
Whitney was right to make that call.
1. Bankers are SUPPOSED to ERR ON THE SIDE OF CAUTION, especially when it comes to managing OTHER PEOPLE'S MONEY.
2. The interest rate swaps/CDS these entitites have with Wall Street aided by subjective rating agencies put these entities at risk for higher paying yields, etc. Had TARP not passed, these swaps would've been cancelled like they were with Lehman Brothers at no cost to the taxpayers. Now they're expensive to cancel.
3. Because of these silly swaps, state workers have become not servants of the taxpayers- but instead a fascist,revenue collecting Stassi. You don't think the bills paid themselves, did you? There has been an obnoxious climb in people pulled over in California and fined heavily for MINOR infractions. For example, rolling right on a red light will cost $460 in California. I've seen people pulled over for the dumbest things in Santa Barbara and the San Francisco Bay Area.
The prey seems to be younger, non-rich adults who are not wealthy, the most vulnerable in a boomer dominated society. I've seen a cop hold up a college student for 45 minutes in Santa Barbara, literally inventing things to ticket him for (he bought a used car and went through some processes, then got dinged when it wasn't up to standard). The fines were heavy, especially for something that he wasn't made clear about. Mind you, the kid was a college student-not a dot com billionaire. I've known people who got DUIs simply by smelling alcohol. The cops go after easy targets and they raise the fines. They don't care if you need that money for rent or a lien.
4. Along with #3, 414 companies (EMPLOYERS) left California since the subprime collapse. 159 companies left California this year alone. When people are not working, who do you tax?
5. On top of #4, please reference the Delta Smelta bs. issue caused by the EPA (who are really domestic terrorists in sheeps' clothing). Somebody "discovered" the delta smelta in the Colorado river so they shut off irrigation panels to Central California costing them their livelihoods. The EPA has also assisted the CA government in ruining lives with total disregard for Eminent Domain. There are many other cases.
6. Looking at #3, 4, 5 and 6; where do Californians come up with money for rent/mortgages? The property values still has ways to drop as a result of the aforementioned scenarios. How do you get taxes from income or properties anymore?
7. Has anyone noticed what illegal immigration and amnesty costs this state?
There is so many HUGE things that happens under the surface of what these shills are telling us. Whitney might have the wrong outcome predicted, but she gets whats' going on. Therefore, I'm more likely to trust her opinion than Cramer's.
Time will vindicate Meredith. Geting a few percent for this kind of risk is fucking beyond stupid. I'm guessing it's where retirees are putting their cash to get SOMETHING for a yield.
I'm with Whitney on this one. The collapse of this ponzi scheme/fiat money exercise will encompass everyone, including Munis.
Whitney may be a tad off on the timing or maybe not, but you'd be a fool to assume the risk for what they're paying. The potential for major movements is real and you want to risk your capital for 3%? 3%???
there are very few choices left...and Munis ain't one of them. The real bad stuff hasn't happened yet, but it will.
Know anyone with a mountain of cash/reserves who isn't worried about the tax hit anyway because their lawyers are better than your lawyers?
Hint: some of them have access to the discount window and a guaranteed two-year nitrous oxide filled happy fun zone.
Look closely; they're pushing people into BAB land, because they know dey gwine issue a "Whitney-Load" of them soon,
and they can "shield" the interest income (especially with credits for possibly-do-nothing, election #winning job creation).
Ron Paul should start taking election contributions in 1/10oz gold and silver dimes only.
http://www.youtube.com/watch?v=KS6yKMYTF5M
when you don't have a realistic solution that is politically "sellable" be brazen and propose the moon and six pence!
+1 for your use of "pence" in common vernacular.
If I were one of the "less than 1bn" screwed, I wouldn't be very happy. You are so cavalier with OPHEM.