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Great Depression Online Archive Issue:

Stepping In Front of a Stampeding Herd

Great Depression Online
Long Beach, CA
January 25, 2011

Inside This Issue You Will Discover…

*** Where the Government Debt Buck Finally Stops
*** What Counts
*** Stepping In Front of a Stampeding Herd
*** And More

Where the Government Debt Buck Finally Stops

When the Federal Government is bankrupt what does it do?  It prints more money.

When state governments are bankrupts what do they do?  They balance their budget by holding money normally allocated for cities and local municipalities.  In other words, they pass the buck.  Bloomberg reports…

“Los Angeles Mayor Antonio Villaraigosa, a Democrat, said municipalities are being squeezed as states move to balance their own budgets, a step that can involve taking more funds that would otherwise be sent to towns and cities.

~~~~~~The Muni Bond Crisis is Here~~~~~~

Last November, the whole world tuned in as the greater part of the U.S.A.’s 50 states turned red -- and no, I don’t mean the political shift to a republican majority during the November 2 mid-term elections.  I mean “in the red” -- as in, financially fercockt, overdrawn, up to their eyeballs in debt.

Here are the latest stats: California, Florida, Illinois, and New Jersey now suffer “Greek-like deficits,” alongside draconian budget cuts, job furloughs, suspensions of city services, and the growing "rent-a-cop" trend of firing city workers and then hiring outside contractors to fill those positions.

The Muni Bond Crisis is Here

~~~~~~~~~~~~~~~~~~~~~~~~~

‘“There’s no question you’ll see some cities in default,’ Villaraigosa told reporters today [January 21] at a press conference in Washington, where the U.S. Conference of Mayors is meeting.  ‘The difference between us and the federal government is they can print money.  The states balance their budget oftentimes on the backs of cities, counties, and school districts.  We actually have to balance a budget.’”

Now there’s a concept…actually having to balance a budget.  It seems so quaint these days.  But shouldn’t all levels of government have to balance a budget?

What Counts

If all levels of government balanced their budget, we wouldn’t have nearly the debt problems we have today…problems that will only get worse.  Let’s consider municipalities a bit more…

Back in December, financial analyst Meredith Whitney told the world on 60-Minutes that the municipal bond market was the “next shoe to drop” in the ongoing financial crisis.  Whitney even suggested there could be 50 to 100 sizable municipal bond defaults reaching hundreds of billions of dollars this year.

Obviously, other municipal bond analysts didn’t welcome Whitney’s prediction of yet another major financial collapse.  But what analysts think and what investors think are two different things.  Ultimately, what counts, is what the market thinks.

“Speculation about local governments defaulting has weighed on the $2.9 trillion municipal market, where returns tumbled during the last quarter of 2010 by the most since 1994.  Last week, yields, which move inversely to prices, hit the highest since the depths of the financial crisis in December 2008.”

As you can see, municipal bond investors have been exiting the market and pushing up yields.  Has this set the stage for a shrewd buying opportunity?

Stepping In Front of a Stampeding Herd

“Muni yields are now looking sweet compared to taxable bonds,” explains Jim Gallagher at the St. Louis Post-Dispatch. “For instance, the yield was 3.3 percent Wednesday on the Vanguard Intermediate Term Tax Exempt fund, which owns investment-grade munis.  That’s the equivalent of 4.4 percent on a taxable bond if you’re in the middle-class 25 percent tax bracket.  It equals 4.9 percent for affluent lucky duckies in the 33 percent bracket.

“Compare that to the 3.6 percent yield on Vanguard’s Intermediate-Term Investment Grade fund, which invests mainly in corporate bonds, and the 2.2 percent yield on Vanguard Total Bond Market index fund, which tracks both corporates and government bonds.”

Naturally, opportunities are found in crisis.  No doubt, as Gallagher notes, there certainly appears to be some value in the municipal bond market at the moment.  Just know that buying municipal bonds at the moment will be like trying to catch a falling knife.  What we mean is from our vantage point we appear to be closer to the beginning of the municipal bond default crisis than the middle or the end.

Perhaps a municipal bond crisis will be averted.  But risking your savings for a 3.3 percent non-taxable return doesn’t seem like a business proposition worth taking.  Being too smart or too clever often results in poor investment decisions. 

The fact is, since November 11, 2010, investors have pulled $17.6 billion out of U.S. municipal bond funds.  Betting against this is like stepping in front of a stampeding herd.  It’s probably best to stay out of the way, let the herd pass, and then reevaluate the opportunities at that time.

Sincerely,

M.N. Gordon
Great Depression Online

P.S.  The municipal bond market has been melting like a snow cone in the Sahara desert.  According to recent data, 35 muni bond issues totaling $1.5 billion have defaulted since January 2010, three times the average annualized rate going back to 1983.  Also, in the week ending January 19, investors withdrew a record $4 billion from municipal bond funds, setting a new record.  In the words of a recent LA Times article “It’s a cold, cold world in the municipal bond market right now.”

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