If Munis aren’t about to melt down, what’s all the fuss about? What’s special about right now?
To answer this, we have to go back. This market has been in disarray since the sub-prime crisis hit. It used to be an insured market. An assortment of AAA bond insurers assured investors that their principal would be safe, and the three major credit rating agencies could speak credibly on the risk of the underlying borrower. But the bond insurers got greedy and underwrote a bunch of crappy sub-prime loans, and the ratings agencies got lazy and said they were all AAA anyways. The Agencies lost their credibility and the insurers lost billions. Those two pillars of the muni market collapsed.
We’re left with the underlying credit quality of the public sector. And that’s looking worse right now because of the nature of the credit cycle. In any economy there are leading and lagging elements. Construction and manufacturing leads; public sector employment lags. This is so because government is reactionary. It takes a while for tax receipts to fall; it takes even longer for the governments to adjust. The downturn started in ’08, so muni governments are just now tightening their belts.
But the economy is recovering now. Employment has been rising and tax receipts are improving. While 2011 will be a tough year, it should be the bottom for municipal credit conditions.
The turmoil of ’08 is finishing its work in the public sector. What goes up comes down, and what goes down will come back up.
Douglas R. Tengdin, CFA
Chief Investment Officer
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