Municipal Bonds are not a safe haven in a serious recession

It is a given that we are in a serious recession. It is a given too that a number of municipalities will fail as the recession deepens and tax revenues decline. Those with capital preservation high on their list of priorities, will see the writing on the wall and reduce if not eliminate their exposure to municipal bonds before it is too late.

Muni bonds have looked good recently, especially high quality ones, against comparable treasuries.  The spread has enticed many to buy municipals with good underlying value, even after the major insurers like MBIA no longer offered the kind of security muni buyers had long become accustomed to.  But things are beginning to change, and the change will be rapid.

 

Few people argue that we are in a serious recession.  The signs are everywhere – inflation, energy costs, credit crises, housing, etc.  But the real signs are in the behavior of the consumer who is cutting back on everything, from driving, to buying, to traveling, etc.  And, as the consumer cuts back and companies experience worse and worse results, tax revenues decline.  And, as unemployment increases – as it is now and will continue to do so, tax revenues decline even more dramatically.  All this creates the perfect storm, not only for bank failures but for municipal bankruptcies.  We are about to see a large spate of municipalities and their agencies go down, and with them will go their bonds.  Significant reductions in tax revenues – and there is no way to avoid these shortfalls – will lead to a major collapse across the board in municipal bonds.   The general obligation bonds will be the least likely to fail, but even some of these will fail.

 

A Standard and Poor’s report of defaults during the 1990’s indicated that failures appeared in all bond areas.  The greatest failures during this period occurred in healthcare, housing, and construction.  But the report also made clear that no bonds were exempt, even highly rated ones.

 

It is a given that we are in a serious recession.   It is a given too that a number of municipalities will fail as the recession deepens and tax revenues decline.  Those with capital preservation high on their list of priorities, will see the writing on the wall and reduce if not eliminate their exposure to municipal bonds before it is too late.

Ari Socolow
Ari Socolow: Ari Socolow is the Chief Economist and Editor-in-Chief at BestCashCow. He is particularly interested in issues relating to financial literacy and bank transparency. Since co-founding this website in 2005, Ari has been frequently cited in the media as an expert on local and national savings accounts, CD products, mortgage and loan products and credit card rewards products.

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Comments

  • Tom

    July 22, 2008

    "Few people argue that we are in a serious recession."

    Actually, lots of people are disputing this. It's not even a definite we are in a recession but if we are it looks pretty shallow. GDP has yet to show negative growth.

  • Sam Cass

    July 22, 2008

    Similar sentiment reported here.

    http://www.bestcashcow.com/bonds/article/bestcash_admin/is-now-a-good-time-to-invest-in-municipal-bonds

    So far the muni market hasn't blown up - except for auction rate securities. There are several municipalities struggling. Muni market is also divided into several different categories and some are safer than others.

  • JRodgers

    July 25, 2008

    Good article on the challenges faced by states and municipalities in today's WSJ.

    http://online.wsj.com/article/SB121682740001077489.html?mod=todays_us_nonsub_page_one

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