Municipal Bonds are not a safe haven in a serious recession

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.