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Thread: Individual Investors Fly Into Muni Bonds like Moths to a Flame

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    Default Individual Investors Fly Into Muni Bonds like Moths to a Flame

    (snip)"Summer of Municipal Discontent

    With fiscal years for states beginning on July 1, this summer could very well bring a host of unwelcome headlines for financial markets. Miraculously, Illinois has managed to surpass California in terms of fiscal distress.

    Fine, we all know that fiscal woes are coming. But here's the nut of the thing: Who owns this muni debt?

    Well, consider this round two for American households.

    According to page 91 of the Federal Reserve Flow of Funds report, there is $2.8 trillion in muni debt outstanding. Here's the order of ownership:


    •Households $1 trillion
    •Banks $220 billion
    •Insurance companies $350 billion
    •Mutual funds $500 billion
    •Money markets $370 billion
    •Broker/dealers own just $40 billion.

    My friend Conor observes that, "for the cynical folks who think bailouts only happen if Goldman Sachs (GS) stands to benefit..." Well, that belief will likely be put ot the test.

    Even worse, consider the fact that households make up a significant portion of holders of muni debt indirectly though the banks, insurance companies, mutual funds and money markets above. The $1 trillion ownership figure is actually much higher.

    And still worse than that, over the last three quarters the household sector has bought 80% of all flows into munis."(snip)

    (snip)"CMA data shows Illinois and California are in the top ten list of sovereign default risks, with Illinois leapfrogging California in terms of increasing risk.

    Please consider CMA Market Data as of Wednesday, 23 June 2010.



    Illinois is ranked as a better risk than Iraq, but riskier than Portugal and California. Is that supposed to be comforting?

    The countries (or states) are ranked by their cumulative probability of default (CPD), which gives the market's assessment of an issuer's likelihood of default over the life of a CDS contract.

    Regardless of whether or not states and municipalities default on municipal bonds, I am quite sure of two things:

    1. The risk of default is well above zero
    2. Municipal bondholders are not being compensated for the risks they are taking.

    Mike "Mish" Shedlock "(snip) from


    The basis of this surprising statistic can only be that many high earning Americans are in the process of shifting their investments out of stocks, out of corporate bonds, out of money markets etc. and INTO municipal bonds ... which happen to be exempt from federal, state and local income taxes. The obvious assumption is that they are being prompted to do so by already announced increases in federal and state income tax rates that are slated to take effect at the end of 2010.

    There also appear to be two less obvious take-aways. First is that allowing state or local governments to 'use' their capital instead of private companies or banks will lower private sector liquidity and increase private sector interest rates ( with the associated rising costs of doing business putting a damper on any economic expansion / recovery / job creation ). Second is that the potential for principal losses on many muni bonds actually ranks right up there with the PIIGS ... but it is highly doubtful that state and local gov'ts or bond brokers disclosed this risk to the individual muni bond buyers.

    ~
    Last edited by Melonie; 06-23-2010 at 04:22 PM.

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