Friday, August 13, 2010

Municipal Bond Distress

The Next Sovereign Debt Crisis

Of the $2.8 trillion, perhaps 25 percent effectively consists of short-term obligations, much of which was purchased based on questionable ratings resting on doubtful guarantees. Even if only a few financially stressed municipal debt issuers default, anxious short-term debt holders could suddenly demand cash and trigger a liquidity crunch.

Here's a chart of 20-Year Treasuries and 20-Year Municipal Bonds.



Here's a chart of their difference.



Note that the bottom fell out in late 2008 and that there is a substantial risk that it will happen again. Here's what Suze Orman had to say in March 2007 though.

Suze Orman vs. Warren Buffett Revisited

What does Orman do with the rest of her money? Solomon asked, and was told: "Save it and build it in municipal bonds. I buy zero-coupon municipal bonds, and all the bonds I buy are triple-A-rated and insured so that even if the city goes under, I get my money. I take a little lower interest rate to make sure my bonds are 100 percent safe and sound."

She was convinced that she could get more reward without taking on any more risk. So much for that theory.

Suze Orman vs. Warren Buffett

When I first started as a stockbroker, I had been a waitress for seven years in Berkeley, California. And -- how much money do you think I had? Nothing, absolutely nothing. But people would come to me, and I had to pretend that I knew what I was talking about and convince you what to do with your money... - Suze Orman, April 2000

Perhaps she is still pretending.

Source Data:
FRB: Selected Interest Rates

2 comments:

  1. Doesn't she want Munis as they are tax-exempt? Isn't that how the super-rich avoid paying any taxes?

    If the muni market implodes, we should get rid of that tax exemption. It only helps the rich, and it also lets municipalities borrow more than they otherwise could.

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  2. In theory, if the muni market implodes then she won't be getting all her principal back. State and local governments can and have gone bankrupt. She is sticking to the insured munis, but if the muni market implodes then the muni insurers might too.

    In practice, the government may do a bailout and make her whole. I'm not in favor of that though. She should know the risks. She says that if a city goes under she'll still get her money back. What if many cities go under?

    The article says, "purchased based on questionable ratings resting on doubtful guarantees." I believe that. She says, "100 percent safe and sound." I don't believe that.

    As a side note, maybe I should get into the muni insurance business. I'd love to earn fat premiums. If the muni market implodes and overwhelmed my ability to pay then I could just say it was a black swan event that nobody could see coming. I'd fit right in!

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