From Moral Obligation to Moral Hazard
Before we get to
the current situation at hand, it’s important that we
have a historical understanding of municipal bonds.
The
first
officially recorded municipal bond was issued by the City of New York for a
canal in 1812. It was a general obligation bond, meaning the city pledged every
available resource – most notably, tax revenue – to repay the debt. So, in
theory, unless the city lost its legal ability to levy taxes, which it never
would, investors would be repaid. That’s
key because every single general obligation muni bond
issued since that time has carried the same level of implied safety.
If Kevyn Orr succeeds
Just like we witnessed during the real
estate collapse when homeowners started walking away from their mortgage
obligations without any recourse, other cash-strapped municipalities are
destined to follow Detroit’s lead and try to renege, too.
Three More Reasons to Be Wary of Muni Bonds
•Muni Bond
Threat #1: Misguided political proposals
•Muni Bond
Threat #2: Market forces
•Muni Bond
Threat #3: A less-than-robust recovery
TOXIC
MARKETS
In terms of specific cities, I’d be most concerned about
Chicago and Cincinnati. Much like Detroit, they’ve suffered a mass exodus of citizens.
Based on the last census,
Chicago’s population checks in at 2,695,598 people, down 25% from its peak of
3,620,962 people in 1950. Meanwhile, Cincinnati’s population of 296,223 people
has dropped 41% from its peak population of 503,998.
And overcoming financial
obstacles becomes increasingly difficult when your tax base contracts.
What is the Intuition?
All it takes
is a crisis of confidence to undermine a supposedly “safe” muni bond
investment. And there are definitely enough headwinds in the market to bring
one about.
SOURCES
Recent News
08/08/2013
08/09/2103
08/16/2013
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