Storm Clouds Gathering Over the Municipal Markets?


Revenue shortfalls of states and cities and a growing backlog of new bonds for sale overwhelmed the market recently, leading some to question whether the day of reckoning has arrived for municipal bonds, according to a New Times article by Mary Williams Walsh, “Municipal Bond Market Shudders.” Municipal bonds took their biggest hit since the financial collapse of 2008.

The Build America Bonds program, in which the federal government pays 35 percent of the interest costs on the taxable bonds, is scheduled to expire at the end of this year. States and cities have been rushing to take advantage of it. As a result, the supply of tax-exempt municipal bonds has decreased. Under normal demand, reduced supply would lead to a price increase. Despite the reduced supply, however, prices of tax-exempt municipal bonds fell because of poor investor demand, according to the article.

California is on shaky ground and a few prominent defaults have made the market jittery.

Observers have warned that a crisis similar to the one that provoked riots in Greece could be in store for insolvent U.S. states and cities. Many face huge unfunded pension and health care liabilities.

Fitch, the credit ratings agency, recently reported that ratings downgrades for municipal bonds outnumbered upgrades for the seventh consecutive quarter, according to the article.

“This is what happens with our market now, with these fears of a systemic credit crisis,” Matt Fabian, managing director at Municipal Market Advisors, was quoted as saying, adding: “Any weakness is related to fears of default.”

According to the article, much of the decline was in longer-maturity bonds and bonds with lower credit ratings, as the Federal Reserve bought hundreds of billions of dollars of Treasury bonds and investors concluded the Fed’s move will be inflationary over the longer term.

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