Tuesday, November 16, 2010

PIIG Syndrome Comes To The U.S.: Time To Dump Your Munis

It was only a matter of time.  The PIIG disease has come to this country, infecting the States and municipalities with huge budget defiicts and impossible public employee benefit and pension plans.  Check this out - this is Pimpco's general Municipal Income Fund, with the top 5 State positions noted:

This thing has lost 15.3% since its peak in early September - less than 2 months.  I'd say that fund has trichinosis. If you happen to have a decent portion of your wealth tied up in muni paper, lose sleep assurred that many individual munical issues have lost a lot more, given that the above atrocity is a highly diversified fund, which "shelters" the fund from the ravages of any one individual municipal issuer's disaster.

I got the idea for this post from an article in Saturday's NY Times, which I happened to peruse during my long weekend in La Cittá.  Some imbecile from McDonnell Investment Management tried to explain away the performance of the muni market by "explaining" that the cliff-dive was concentrated among bonds with longer maturities and lower credit ratings.  You can read the NY Times article HERE.

To be sure, longer-dated issues in the muni market have fared worse than their shorter-duration brethren.  But that's a function of duration and correlation with the overall bond market - NOT with credit risk.  As the graph above of a highly divesified muni surrogate illustrates, the PIIG disease is one largely of credit risk, not reinvestment risk. 

The fact of the matter is that wealthy investors - the ones typical of those who invest in munis - piled into the muni market in the insatiable quest of tax benefits.  In other words, a "bubble" developed in the muni market in which prices were driven inexorably higher (and tax-equivalent yields were driven lower) in a frenzy of too much cash chasing after-tax returns and income.  THAT is a bubble.

Please be advised that this is a catastrophe developing that you want to avoid.  At least when a sovereign entity loses its ability to make payments from revenues (i.e. the U.S. Government or an EU satellite country), the sovereign entity can print money to make sure bond payments can be fulfilled.  Not the same with municipal bond issuers.  At this stage in the game, many States are borrowing the money from other sources for now to make payments.  But, as the chart above shows, the perceived risk of default is starting to soar.  As States and municipalities face much higher yields in order to attract yield-hog investors, your existing muni bond portfolio will get crushed.

We all know - that is, "we" who are willingly looking at the reality of the situation - the variables which are strangling the cash flow and budgets of States and municipalities are only going to get worse - a lot worse - as the underlying factors which are squeezing States deteriorate.  And muni paper is typically secured only by the ability of the issuer to fund repayment out of revenues derived from some form of taxation.  As that source of revenue dissipates, so does the value of your muni bond.

If you truly believe that the economy is getting better, then have fun riding your muni bonds into the ground.  But just like the PIIGS, this situation is going to exacerbate. 

Fortunately, there is a solution.  Got gold?


  1. http://finance.yahoo.com/q/bc?s=NXP&t=3m&l=on&z=l&q=l&c=

    this is a graph of NXP, a nuveen tax-free muni ETF (with leverage). It has dropped 10% in 2 days! brutal.

    thanks for your interesting and witty posts. I enjoy following along daily.

  2. Speaking of PIGS would you believe it the Irish have found a way to jemmy open the ECB. One up for the Irish.

    "The Government of Ireland may have identified a legal loop-hole in the Euro support agreement put together for the occasion of the Greek Bailout back in May 2010.

    This loop-hole has allowed Ireland’s banks access billions of Euros of funding from the ECB over the past few weeks (Sept. 2010 to present), without the ECB having the power to force any of it’s structural change on to Ireland.

    Realising too late what is possible under the agreement, European’s financial leader are falling over themselves to pressure Ireland’s Government to cease subverting the support mechanism in such a manner and instead to row-in behind the spirit of the agreement. Hence the pressure over the past week-end for Ireland to access funding directly.

    The ECB, never intend itself to be a no-strings-attached clearing house for Irish banking obligations.

    The Government of Ireland has withdrawn from the bond market during this same time-frame. Budget figures have been announced for 2011 and Irish banks are availing of agreed support from the ECB.

    It is the European Central Bank that is in uncharted waters and feels suddenly that it has lost control. What it intended to be a stability pact has emerged as a de-stabalising pact where a country with 1% of the economy of Europe is eating 15% of the funding of Europe.

    Until Euopean leader have the opportunity to reform this recent agreement, the Euro seems to be the hostage of Ireland


  3. ( Pulls up chair, grabs a 12 pack and a nice cigar, oh and Popcorn...plenty of popcorn )



  4. Dave,

    Interesting phone tags today with broker.

    In India commodity exchange, MCX, trades mainly 2 Silver Futures, 1. 30Kg and 2. 5 Kg. I wanted to take delivery of some 5kg lots for 30/Nov/2010 Expiry. So I called broker to get first hand info on procedure as I am doing this for the first time.

    What I was told that there won't be any delivery for 5 Kg contracts. Further talking to them and I deduced that there is no one at broker is aware of the delivery procedures. Everyone is trading paper and finally settles with cash. Non delivery penalty is mere 4% of DDR (Due Date Rate).

    I am going to stand for delivery this time let's see what happens.

    I am not sure what are the default/penalty procedures are going to be at COMEX, I guess it is also going to be cash settled.

    Anything I should be aware of before going for delivery?

    From India

  5. India: thanks for your comment. I am going to pass that along to Midas and I may post it on the front today.

    As for the delivery situation, I think the only thing you can do is make sure your broker does not actually give the exchange your cash until you are certain you will be receiving your metal.

    If you can't arrange for that, then you will have to put faith that the process will result in your delivery. My guess is that you will be okay.

    Please keep me updated on how this unfolds.

  6. I guess my dollar call a few weeks ago was a little premature...I hate when I am ahead of myself. Note not a dollar long here...Just calling it as I see it. This maybe the last gasp if you will. In the meantime buying the Gold and Silver dip..


  7. Got USD's Chico?

    Yeah baby.

    Time to go to the silver store with my higher USD'S!