Wednesday, September 8, 2010

Graham Summers - The Muni Bond Crisis is Officially Here

Graham Summers on Municipal bonds...

The Muni Bond Crisis is Officially Here: Harrisburg, PA Drops $3.3 Million in Muni Bond Payments
Back in January, I outlined a general 2010 forecast for the financial markets to subscribers of my paid newsletter Private Wealth Advisory. All in all, I outlined ten specific items I thought would come true.


They were:
1) MASSIVE increases in volatility in the markets

    (CHECK)


    2) The Fed to continue its bailout efforts but in a more subtle “behind the scenes” manner (less public bailouts, more non-public lending windows/ purchases of Mortgage Backed Securities/ etc.)

      (CHECK)


      3) The market potentially struggle to a new high (potentially 1,200 on the S&P 500) sometime before March 2010 (this is negated by any major negative catalyst e.g. a sovereign debt default, major bank going under, etc.)

        (CHECK though I was off by a month+ on the top, which occurred in April).


        4) Once the market peaks, a serious, VIOLENT reversal followed by a volatile roller coaster ride downward for the first half of 2010 culminating in a Crash

          (CHECK on the first part and we’re getting there on the Second: the Crash).

          5) Several sovereign defaults and credit rating downgrades

            (Sort of CHECK on the first part, DEFINITE CHECK on the second)


            6) Multiple states to beg for bailouts or default on their debt.

              (Getting there but not yet)


              7) A municipal bond Crisis

                (Check: Harrisburg last week)


                8) Interest rates to rise or inflation to break loose

                  (Half CHECK: Negative on interest rates, but food inflation and cost of living is breaking loose)


                  9) China’s credit bubble to pop

                    (Getting there but not yet)


                    10) Civil unrest in the US
                    (Getting there but not yet: see Atlanta riots at section 8 housing)


                    All in all, every single one of these predictions has either come true or is in the process of coming true as I write this. I take great pride in my work, so I’m pleased to have provided such an accurate forecast to my subscribers. However, I get no pleasure from the fact the financial world is heading to “you know where” in a hand-basket.

                    Indeed, just last week my prediction #7, a municipal bond Crisis began in earnest when the capital of Pennsylvania, Harrisburg, dropped $3.3 million worth of municipal bond payments for the month of September.

                    This is just the beginning. Collectively US states continue to face massive budget short-falls in spite of massive Federal Aid. According to the Center on Budget and Policy Priorities, US states are expected to run deficits of $144 billion and $119 billion in FYs 2011 and 2012 respectively, unless they can cut spending further or raise taxes dramatically to close these gaps.



                    States can cut spending and raise taxes all they like, but the stark reality is that most of them have debt problems. And a growing number will be forced to choose between social programs and debt payments to make ends meet. Social programs buy votes, debt payments buy credit ratings.


                    Which do you think politicians are going to sacrifice?


                    I believe we that Harrisburg, Pennsylvania’s actions represent the very tip of the iceberg municipal bond missed payments and/or defaults.

                    Remember, the muni bond market is $2-3 trillion in size, so we’re not talking about a minor issue here.
                    Worst of all, individual investors are the ones most likely to end up getting creamed.


                    Indeed, ever since the 2008 Crash, investors have been generally pulling money from stocks and putting them into bond funds. All in all they’ve put $480 billion into bond funds since June 2008. Of this, some $88 billion or 18% has gone into municipal bond funds according to the Investment Company Institute.
                    These folks are in for a very rude surprise when they find out that munis, which historically have maintained extremely low default rates, are not nearly as risky as once thought.


                    I strongly urge you to review any muni bond holdings you might have in your portfolio. Below is a list of the states with the largest projected fiscal deficits for FY 12.


                    State


                    Projected FY12 Shortfall


                    Shortfall as % of FY 11 Budget


                    California


                    $21.3 billion


                    25%


                    Connecticut


                    $3.8 billion


                    21%


                    Illinois


                    $17.0 billion


                    52%


                    Louisiana


                    $1.7 billion


                    21%


                    Minnesota


                    $3.8 billion


                    25%


                    Mississippi


                    $1.2 billion


                    27%


                    Nevada


                    $1.3 billion


                    36%


                    New York


                    $14.6 billion


                    27%


                    South Carolina


                    $1.3 billion


                    26%

                    Source: http://www.cbpp.org/cms/index.cfm?fa=view&id=711

                    However, as the case of Harrisburg, Pennsylvania proves, the muni bond crisis is going to be a state, city, and town affair, so examine EVERY muni bond you own, regardless of where it is located.

                    Good Investing!

                    Graham Summers