AMERICA’S $2.7 trillion municipal-bond market is usually a sleepy corner of the fixed-income world. Muni bonds, which are issued by local-government borrowers, have usually yielded slightly less than Treasury debt, thanks to a tax exemption on interest income and a reputation for safety. But things changed last year as investors fled risk and there was an implosion of the bond insurers, which used to rent their ratings to roughly half of the market (see chart).......
For many municipalities, however, the future looks unsettling. What was a homogenous lump of a market, with lower-quality issuers lifted to the same level as highly rated ones by bond insurance, is fragmenting. For the first time in decades, investors have had to start doing their own homework on borrowers’ underlying credit risk. Most do not have the wit or will to analyse the thousands of smaller issuers, such as hospitals and school districts. These are having to offer much higher rates than big-name borrowers. “It is the smaller and lower-rated issuers that are most impacted by the loss of bond insurance,” says Jerry Rizzieri of Barclays Capital..
It may have gotten better, especially with Obama's payoff to the banks:
The recently passed economic-stimulus package should help, too. Some $220 billion of it should flow to states and cities, easing fears of municipal defaults and downgrades. The plan also offers new tax incentives to buyers of muni bonds. There are longer-term reasons to like them, too. Tax rates are rising and likely to stay high, making tax-exempt debt more attractive. The population is ageing, and older people tend to favour fixed-income securities, as will many of those whose faith in equities has been shaken by the stockmarket crash.
How bad could it get? We are still waiting on the collapse of Jefferson County Alabama, and that could be multiplied by hundreds of cities.
A partial list of cities and states burnt by Bad Deals
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