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Friday, February 18, 2011

Muni bonds may be junkier than you think

So suspects the SEC. And if those slow dogs wake up and start sniffing around, you know something's up.

Comments (4)

The Congress will, at some time in the next five years, provide a procedure for States to file for bankruptcy. The reasons for this are

1. States (and local government units) have committed to Defined Benefit Pension Plans and Post Retirement Health Care Benefits which are so generous that they cannot be funded with existing tax revenues while still providing basic public services.

2. Bankruptcy will allow state and local governments to abrogate union contracts (see Wisconsin)and in the extreme eliminate public employee unions as a political and ecnomic force in the economy.

This means that at some point in the next 5 to 20 years there will be signficant bankruptcy filings by State and Local governmental units. Choose your investments wisely.

Agreed, the public pensioners will be left hanging. And the retirees utilizing public retiree health care benefits will probably be put into the same pool as the rest of us, which is now known as Medicare, albeit with a sweeter payment arrangement. But mess with the muni debt holders? No way. Remember, there are a lot of wealthy people holding this debt because it confers a double tax advantages to the holder in return for lower rates of return. And the only guy to date that's been hung out for his role in the recent financial swindle is Bernie Medoff - because he crossed a lot of wealthy people.

There will be a bailout of the debt holders.

This SEC investigation has nothing to do with GO bonds, which are what a state bankruptcy would address. The investigation is over pricing bonds that trade so infrequently that their last trade price overstates what their fair market value is. Not unusual for small bonds issues to go a year or two without one trade.

There are some parallels between this high risk municipal bond situation and what happened in the securitized mortgage market leading up to the September 2008 meltdown. The first financial market fissures leading to the meltdown were manifested in the Spring of 2007 by banks and hedge funds becoming unable to unload or sell the higher risk portion of their mortgage portfolios. These high-risk securities were held on the books at inflated values, with the Lehmans, Bear Stearns and AIGs hoping and praying that markets would recover before they had to sell these depreciating assets (or cover the losses in the case of AIG) -- didn't work out that way and the meltdown ensued. Would not be fun if the orderly selloff of munis that seems to have started turns into a panic.

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