Dark Vision for Muni Bond Holders

Sometimes I feel like all I do is find reasons to worry, (it's not usually that tough to do), and as I'm often reminded, "that's what I'm paid to do." Anyway, the following article is an excellent piece on the totally dire outlook for many municipalities. With shrinking revenue streams, and ballooning expenditures, we are in for a rather stressful period as bond holders of Municipal debt. I know it caused me to take a harder look at my personal holdings and start to think about potential exit strategies if the proverbial (you-know-what) hits the fan.
Read it and think.


Dark Vision
The Coming Collapse of the Municipal Bond Market
PDF  

By Frederick J. Sheehan

Municipal bondholder can weave a case supporting a personal municipal portfolio or municipal bond fund today. At what gain? At what risk?

The gains are well known. Municipal bonds pay a steady, known income. It is known because municipal bonds are presumed never to default. Municipal bonds pay out yields that may exceed the inflation rate.  Even if the yield is short of inflation, it is better than 1-2%, about what one can expect to receive on the most popular safe, fixed-income investment: a money-market fund. There is very little gain by an income-conscious bondholder: Betting against the odds and being right does not pay.

The central risk is the assumption of safety. Top rated municipal bonds offer little chance for a capital gain. (The most plausible possibility for gains today is if taxes are raised. The value of a tax-exempt security would rise.) Therefore, the best case is no negative developments.  If municipal bonds default, stop paying coupon obligations or simply delay payments, the premises upon which they are owned are shattered.

Today, the balance between gain and risk is tilted towards risk. The probabilities weigh against the bondholder. Municipal bondholders should satisfy themselves with answers to the following questions:

Will revenues - assessed house values, incomes, personal spending (sales tax) - recover quickly to previous levels?

Will municipalities refuse to pay for federally mandated programs? (There is hope here. Several towns in California have announced they will stop funding federal mandates.)

Will police, teachers, etc., accept lower retirement benefits without going to court?

Will courts force municipalities to "levy taxes sufficient to pay debt." 

For a municipality that has no other means to acquire revenue, will the federal government offer a blank check?

If the federal government lends money, will bondholders be paid in full?