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Municipal Bond Yields are “Breaking Out”

by Brett on July 6, 2010

Municipal bond yields continue to “break out” as investors are (finally) coming to the realization that local governments, which lack their own printing presses, may have problems making good on their outstanding debt.  The Financial Times reports:

The sharpest swings in the muni market have been seen in the $100bn so-called “Build America bonds” – or Babs – a type of US muni debt that has characteristics similar to corporate bonds. This sector has attracted a fresh investor base, which is now demanding greater compensation for risk.

Risk premiums, or spreads on Babs relative to Treasuries, have risen to 228 basis points, according to an index from Barclays Capital. The spreads have climbed from a low of 161bp in early May to their highest level since Barclays started compiling the index last October.

Absolute yields have risen to 6.03 per cent from 5.97 per cent.“The problems in the eurozone have driven up fixed-income yields overseas – on banks, utilities and sovereigns,” said Matt Fabian, a managing director at Municipal Market Advisors. “Babs compete directly against those issuers for buyers.”

As I was discussing with our friend and regular reader JL earlier today, the muni trap is really a Catch 22 for high income earners.  On the one hand, they are about to get bent over with higher tax rates coming from Uncle Sam, as they are asked to “pay their fair share.”  So given a high tax environment, getting only higher, tax-free options like munis make sense.

But, they are certainly a gamble – you are gambling that in the event of a default, they get bailed out.  Who would buy California muni bonds today?  Only someone who was betting on a bailout.


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  • Mike

    Largely that is what is prices into these bonds is that they are implicitly backed by the US Government similar to Freddie and Fannie securities.

    Just like Greece and Dubai the local and state governments will have their time in the spotlight.

    I wish MBIA was not so low priced or else I’d short it. I have not gotten a chance but I’m sure a lot of the big banks have them in their balance sheets as well. Assured Guaranty may be another option.

    At any rate the Government will have to bailout many of the states in the future. With the economic slowdown Illinois and California in particular are just ticking away waiting to burst.

  • Brett

    Yep totally agree on all counts. MBIA would have been a beautiful short during that last leg down – it’s collapse was breathtaking!

  • Mike

    Brett-

    California has not passed a budget yet have they ? I saw the potential canidate that was talking on CNBC about how he will go through each item and gather appropriate parties and see if they can do without that service, or something to that extent.

    The Government is ungodly inefficient, so that is probably at least a 100 year task, lol…..

  • Brett

    No sir, they have not – and state workers are making minimum wage until it’s passed. With the legislature on summer vacation right now (LOL!), that will probably be at least another month or two.

    Ha yeah exactly – really their only hope is to cut almost everything, and just let the private sector pick up the pieces! It’d be a painful initial transition, but ultimately would be a healthier, more sustainable situation.

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