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Tuesday, January 13, 2009

Bailout or Not; Avoid Muni Bonds!

Tuesday, January 13, 2008 From the A-Letter, Vol. 11, No. 1

With yields as high on municipal debt as they've been in years and the President-elect's office all abuzz with news of stimulus for state and municipal governments, the cunning investor is paying attention. The bailout of the financial system is already leading to some serious opportunities in commercial debt, so should you get ahead of the curve and dive into municipal debt?

In a word; no. At least not yet.

After all, big government curing our economic woes with "stimulus" projects is almost like a drug dealer curing withdrawal symptoms with more just can't help but wonder whether his medicine is exactly what got you there in the first place. Regardless, we'll indulge popular thinking and acknowledge the fact that the government is now prepared to throw piles of free money at this sector of the economy.

But hold on just a second...what's that percolating in D.C.? US$1trillion won't do the trick, they say. Everyone from Bernanke to Riksbank-prize-winning economist Paul Krugman say that we'll need more...possibly US$2trillion, or even more than that. And Obama has certainly indicated that he'd be open to that kind of discussion.

Now, let's glaze over the fact that I could personally put another man on the moon - and probably Jupiter - with that kind of loot. And while we're at it, we'll glaze over the potential US$3trillion in government spending in 2009 (more than any government has spent in a single year since humans started governing).

No, let's be professional about this, and in the words of Ricky Roma from Glengarry Glen Ross, "You never open your mouth until you know what the shot is." So let's figure out the shot...

Bloated State & Local Governments...
In the period between 1960 and 2000, the Federal Government went from two million total employees to three million. This difference didn't even track the total growth in population over that period. But in that same period, state and municipal governments went from six million total employees all the way up to 20 million.

And since then, the situation hasn't really improved. When the "War on Terror" terrified us into giving up a greater portion of our personal liberties for the promise of "security," these payrolls ballooned again.

Think about it in practical terms; when was the last time you went to the DMV or the county courthouse? There were at least a handful of TSA-style security guards to frisk and scan you...since everyone's a terrorist until proven innocent these days...who do you suppose pays their bills?

Why you do! And you also pay for another 20 million more state & local employees who rely on over US$74 billion in your annual taxes to keep a roof over their heads. But you have to remember; these outfits aren't run with the trademark efficiency of business titans like IBM or Microsoft.

Instead - as you can see from the chart at the right - they constantly waffle back and forth from periods of excess savings to periods of excess debt (note that the Census data for this chart ended in 2007...when our crisis was just beginning and state & local governments held a collective savings rate of -10%!)

Sovereign Society Investment Director Eric Roseman chimes in, "The growing funding concerns facing municipalities has already spread to several states, including California, which requires cash to finance a massive budget gap in 2009. California, with a long string of budget deficits has declared a State of Emergency in December as the state runs out of cash. California is the largest issuer of muni debt."

"What's truly alarming about December's scrapped Port Authority offering was the short duration of the fixed-income term of only three years. Investors would typically embrace a short-term note that pays a tax-free yield. But these are not normal times."

"The rating agencies have also confused investors since the market has lost confidence in their ability to accurately rate and rank credit offerings."

"As the U.S. economic recession deepens into 2009 it would be advisable to avoid tax-exempt municipal bonds, despite their attractive yields. The risk is too high. You've got to believe that many more cities, towns and states will suffer from a credit squeeze coupled by a lack of buyers as revenues continue to decline in a deteriorating economy. Avoid muni bonds."


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