What Municipal Bond Crisis?

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If there's an unfolding crisis within the $2.9 trillion municipal bond market , bond investors certainly aren't acting like it.

Just last week, 128 gutsy gunslinging lenders pieced together $6.1 billion in bids for a $3.7 billion taxable pension bond offering from the financially troubled state of Illinois. Bonds with a maturity of 2014 had a 280 basis point spread (2.80% higher) versus comparable U.S. Treasuries. Sure, bond investors got a juicy yield from the Illinois deal, but was it enough to compensate them for the financial risks still ahead?

The aftermath of the Great Recession has caused the steepest decline in state tax receipts on record. And while the need for money to support state funded services hasn't dwindled, combined state tax collections are 12% lower compared to pre-recession levels. Despite making severe spending cuts, most states still face large budgetary shortfalls.

Other heavily populated states like California and New York show similar signs of financial stress.


For 2011, California has a budget shortfall of $17.9 billion which represents 20.7% of the state's budget. Additionally, a $8.2 billion shortfall remains open for FY2011. The SPDR Nuveen Barclays Capital California Municipal Bond ETF (NYSEArca: CXA) has shrugged off these problems by rising 3.48% year-to-date. CXA carries a tax free yield of 3.89%.

New York has a budget shortfall of $8.5 billion for 2011, which is 15.9% of its budget. The SPDR Nuveen Barclays Capital New York Municipal Bond ETF (NYSEArca: INY) is 1.49% lower year-to-date and carries a yield of 3.44%.

Nouriel Roubini, best known for his calls on the 2008 financial crisis, sees $100 billion in possible munibond defaults spread across the next five years, according to the Wall Street Journal. While that's a higher default rate by historical standards, it's hardly crisis levels. One could say that 'Dr. Doom,' as he's been called, is slightly more optimistic these days. 

The national municipal bond market (NYSEArca: MUB) has gently risen 1.63% since the beginning of the year. 

What about the hotly contested subject of guaranteed pensions to state workers that critics say are sinking states into fiscal chaos?

'Even after the worst market crash in decades, state and local plans do not face an immediateliquidity crisis; most plans will be able to cover benefit payments for the next 15-20 years,' said Alicia Munnell, at the Center for Retirement Research at Boston College. Office party anyone?

Put another way, states, cities and municipalities still have another 15-20 years to pretend they aren't in financial trouble. Of course, the unforgiving moment when interest rates start rocketing higher, things will change. They always do.    



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , ETFs

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