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Generational Dynamics Web Log for 18-Jan-2011
18-Jan-11 News -- Municipal bonds appear to be in free fall

Web Log - January, 2011

18-Jan-11 News -- Municipal bonds appear to be in free fall

China to station troops in North Korea

Municipal bonds appear to be in free fall

MUB - Muncipal bond fund corresponding to the S&P Muncipal Bond Index (Bloomberg)

MUB - Muncipal bond fund corresponding to the S&P Muncipal Bond Index (Bloomberg)

As shown by the adjoining municipal bond index graph from Bloomberg, muncipal bonds have been crashing since November, and appear to be in free fall.

Municipal bonds are a popular investment since, in most cases, any money earned is free of federal and state income taxes. They're issued by muncipalities as a way of borrowing money for such things as roads, schools, sewage treatment plants, and so forth.

The fall in the value of municipal bonds indicates that investors are increasingly afraid that many municipalities are going to go bankrupt, and the bonds will go into default.

Normally, few people pay attention to the municipal bond market, but this time there's a lot of interest because analyst Meredith Whitney appeared on the CBS show 60 minutes a month ago, where she said:

"There's not a doubt in my mind that you will see a spate of municipal bond defaults ...
You could see 50 sizeable defaults. Fifty to 100 sizeable defaults. More. This will amount to hundreds of billions of dollars' worth of defaults."

I saw Whitney on CNBC last week, and she was talking about how much anger is directed at her because she makes predictions that people don't want to hear. (I know the feeling very well.)

Whitney is famous for having predicting the failures of CitiBank and other large banks in 2007, at a time when analysts on CNBC were saying that the idea that these banks would fail was utter nonsense. Since Whitney turned out to be right, she's now taken more seriously.

Whitney was ridiculed for her prediction about CitiBank, and now she's being similarly ridiculed for her predictions about municipal bonds.

Her biggest critic is Bill Gross of PIMCO, the largest bond fund in the world, who disagreed with Whitney, according to Bloomberg:

"Ultimately, municipal bankruptcies will be at a lower level. I don’t subscribe to the theory that there will be lots of them."

Despite the fact that municipal bonds appear to be crashing, some analysts are still recommending that investors buy municipal bonds, calling the current crash a "buying opportunity."

For example, Deborah Levine, an analyst for MarketWatch, says that "History is on investors’ side when it comes to municipal-bond defaults. From 1999 to 2009, only 10 rated entities failed to make debt-service payments, resulting in an average annual default rate of 0.04%, according to Fitch Ratings."

Home price index versus long-term trend (WSJ)

Home price index versus long-term trend (WSJ)

People who say such things aren't paying attention. We reported recently on a study of the Case-Shiller home price index by Peter Schiff in the Wall Street Journal (Access), which indicates that home prices have been increasing much faster than the historical trend during the last ten years, and that home prices are still going to fall sharply, by as much as 30%.

Since muncipalities depend on housing values for most of their revenue, the fall in housing values will cause Whitney's prediction to come true. In fact, her prediction will probably turn out to be optimistic.

From the point of view of Generational Dynamics, the global financial crisis has only begun, and the collapse of the municipal bond market will be just one part of it. Stocks today are still overpriced by over 150%, as described in "Updating the 'real value' of the stock market." Thus, as bad as it's been, far worse is to come. It's impossible to predict what will trigger this crisis, but a municipal bond crash is one possibility.

Additional links

Violence in Tunisia seems to have simmered down on Monday. The country's interim prime minister announced a national unity government, and promised to hold elections within six months. LA Times

China is in talks to station Chinese troops in North Korea, nominally to protect Chinese port facilities. But the location would give access to the Sea of Japan, and would allow intervention in North Korea in case of instability. AFP

The Palestinian Authority is expected to submit to the United Nations Security Council its long awaited resolution to declare Israeli settlements illegal and demand a halt to their construction. Associated Press

(Comments: For reader comments, questions and discussion, see the 18-Jan-11 News -- Municipal bonds appear to be in free fall thread of the Generational Dynamics forum. Comments may be posted anonymously.) (18-Jan-2011) Permanent Link
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Generational Dynamics Web Log for 18-Jan-2011 18-Jan-11 News -- Municipal bonds appear to be in free fall

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Generational Dynamics Web Log for 18-Jan-2011
18-Jan-11 News -- Municipal bonds appear to be in free fall