World
American municipal bonds: How stressed are they?

While the low interest rates have allowed many financially stressed municipalities to save money for new projects, they have created their own stresses in other ways. Many of them made generous retirement promises to civil servants, but what they never provided for were the actual funds to pay for the plans

In the fall of 2011 banking analyst Meredith Whitney caused quite a stir in the normally placid world of the US municipal bond market. These bonds or Munis as they are known are usually issued by local governments in the US. They can be issued by all sorts of lower political subdivisions including states, counties, and municipalities. They are also used for raising money for other infrastructure projects like sewers and roads. Some states also allow non-profit organizations like universities and hospitals to issue these bonds. The bonds are considered unusually safe. So when Ms Whitney predicted hundreds of billions of dollars of defaults in 2012, $19.1 billion funds flowed out of the $3.7 trillion market.

 

But then nothing happened. Instead of a massive meltdown, there were only $2.8 billion worth of defaults in 2011 and only another billion of defaults were added in 2012. Presently out of tens of thousands of projects only 204 deals are in default or about 0.55% of the total. So Ms Whitney’s prediction was way, way off. Or was it?

 

For several years now the Federal Reserve has suppressed interest rates. The result is that investors, especially institutional investors including pension fund managers have been searching the globe for any investment that pays a decent yield. The outflow of funds prompted by Ms Whitney’s prediction reversed with a vengeance. Over $50 billion flowed into mutual funds and ETFs specializing in Munis. The demand for the bonds was so high that yields for 20-year general obligation bonds were forced to a low of 3.29%, a yield not seen since 1967. The riskiest of these bonds were the most favoured. These high-yield bond funds account for only 11% of the funds but attracted 20% of the money.

 

It may be that Ms Whitney’s prediction may have been exaggerated and a little premature. In December ratings agency Fitch also warned about the safety of these bonds. Fitch expects to downgrade dozens or even hundreds of municipalities in 2013.

 

What is most interesting about the Muni market is that its problems are very similar to problems of bonds in other countries especially those in emerging markets. They are lightly regulated. They are subject to political influence and they lack transparency.

 

While most stocks and corporate bonds are subject to stringent listing and reporting requirements from the US investment watchdog, the Securities and Exchange Commission (SEC), the Muni market is exempt. Unlike stocks, Munis are not required to provide audited financial statements. Disclosures like a potential bankruptcy or a criminal investigation are immediately required for other investments, but are often delayed by issuers of Munis. Until recently rating agencies did not consider unfunded pension liabilities. A recent SEC report described the Muni market as illiquid and opaque.

 

While the low interest rates have allowed many financially stressed municipalities to save money for new projects, they have created their own stresses in other ways. Like their European counterparts, many municipalities made generous retirement promises to civil servants, especially to their politically powerful and connected unions. What they never provided for were the actual funds to pay for the plans.

 

Two examples stand out. Puerto Rico is part of the US but has a special status as a Commonwealth and has never asked for or received statehood status. It has problems that are similar to Greece—poor tax compliance, a shrinking population, political stalemate and a stagnant economy. Its main pension fund serving about 250,000 past and present government workers is only 6% funded and could run out of money as soon as next year. A fund for 80,000 teachers is only 20% funded. Nevertheless its bonds are widely held. They pay interest that is 2.5% higher than other issuers, because they are rated just one or two levels above junk. According to Standard & Poor’s there was a one in three chance of a downgrade in 2013. A downgrade could provoke widespread selling by institutions required to hold only investment grade bonds.

 

Puerto Rico’s case may be severe but it is hardly unique. The state of Illinois has an unfunded pension liability of $96 billion with problems that date back as long as 70 years. Rather than raise taxes it was simply easier to not fund the pension liabilities. Other states with similar problems include Connecticut, Hawaii, Illinois, Kentucky, Massachusetts, Mississippi, New Jersey and Rhode Island.

 

The irony of the pension mess and its effect on Munis is that it has been made worse by the actions of the Federal Reserve. By lowering interest rates it has made it all but impossible for pension fund managers to get decent returns. The Fed has always maintained that a recession would be worse. By manipulating the market they may well cause what they sought to avoid.

 

To access other articles of William Gamble, click here

 

(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and has spoken four languages.)

User

COMMENTS

bhagyasree

4 years ago

in 5500 salary how could i save money we live in joint family and am married i have a kid please suggest me in:[email protected]

Vinay Joshi

4 years ago

Mr. William Gamble,

Vigilance is the key to success!?

Why $1trn platinum coin idea killed to avert debt crisis?

How many states are cash surplus? The Fed will not prevent Munis defaults!

The nation is battling 'fiscal cliff'!

By the grace of Obama treasury minting is avoided!?

However neither the Fed nor the treasury believed in minting trillion $ coins to circumvent debt limit. Coins means one & the same.

Lets see if 16.4trn limit is raised or what happens then?

What if PRC [China] immediately liquidates at a discount its treasury holding? Say a $trn.

What if it forces OPEC to denominate in RMB?

Forget Munis, fiscal cliff inevitable!?

The slightest notion of default can cause havoc around the world economies.

Bye, t/c,

Regards,

Government postpones GAAR implementation by two years to 2016

The decision to postpone the implementation follows recommendations of the Shome Committee set up to look into investor concerns

 

New Delhi: Giving a big relief to overseas investors, the Indian government has postponed implementation of controversial General Anti Avoidance Rules (GAAR) provisions by two years to 1 April 2016, reports PTI.

 

“Having considered all the circumstances and relevant factors, the government has ...decided that provisions of Chapter 10A of the Income Tax Act (dealing with GAAR) will come into force from 1 April 2016 as against 1 April 2014,” Finance Minister P Chidambaram said on Monday.

 

The GAAR provisions, introduced by the then finance minister Pranab Mukherjee in the Budget 2012-13, were aimed at checking tax avoidance by overseas investors. The proposal, however, generated controversy, with investors expressing apprehensions that it would result in unnecessary harassment by tax authorities.

 

The decision to postpone the implementation, Chidambaram said, follows the recommendations of the Shome Committee which was set up by prime minister Manmohan Singh in July last year to look into investor concerns.

 

The government, Chidambaram further said, has accepted major recommendations of the panel with some modifications.

 

"The modifications that we have done are fair, non-discriminatory, just and strike a balance between interest of revenue and interest of investors. So, all apprehensions should now be set addressed," he said.

 

The GAAR provisions, the Minister also clarified, would override the double taxation avoidance agreement (DTAA) benefits if the arrangements were intended solely to evade taxes.

 

No investor, Chidambaram said, "should now have any apprehension about his investments in India. Only those arrangements, which have been made for the purpose of tax avoidance, will be brought under GAAR, he added.

 

He also clarified that investments made by non-resident Indians (NRIs) will not be covered by the provisions of GAAR.

 

About the applicability of the GAAR provisions, he said FII investments seeking benefits under Sec 90 and Sec 90 (A) of the I-T Act (dealing with DTAA) would be covered.

 

The Minister said only those arrangements which are aimed at only obtaining tax benefit would be considered as 'impermissible arrangement' and would attract GAAR.

 

As per the original GAAR provisions under Chapter 10 (A) of Finance Bill, 2012, the anti-tax avoidance provisions could be invoked "if one of the purposes" was to obtain tax benefit.

 

The Minister clarified that there would be a threshold limit of Rs3 crore of tax benefit for invocation of GAAR, as suggested by the Shome panel.

 

Moreover, Chidambaram said, that investments made before 30 August 2010, would not attract the provisions of GAAR.

 

On whether tax officials can look into cases between 30 August 2010, and the date for implementation of GAAR, he said: "They can go back is technically correct. But in order to go, you have to comply with a number of provisions in the I-T Act. If the assessment is completed, you can reopen the assessment only after very strict circumstances."

 

"This decisions (of GAAR rules modifications) have by and large addressed the concerns that were expressed by investors ... Most of the apprehensions I think have been removed now," Chidambaram said.

User

Retail inflation rises to 10.56% in December

The vegetables basket in December recorded the highest inflation of 25.71% among all the constituents that make the CPI

 

New Delhi: Rising for the third consecutive month, retail inflation breached the double-digit mark at 10.56% in December, driven by higher prices of vegetables, edible oil, pulses and cereal, reports PTI.

 

The retail inflation was 9.90% in November and 9.75% in October.

 

The vegetables basket in December recorded the highest inflation of 25.71% among all the constituents that make the Consumer Price Index (CPI), according to data released today.

 

Vegetables were followed by the oil and fats segment at 16.73%. Sugar turned more expensive by 13.55%. Pulses and cereals became dearer by 13.46% and 13.70% on an annual basis. Meat, fish and egg rose become 11.64% more expensive.

 

Clothing and footwear witnessed 10.74% increase in prices.

 New Delhi: Rising for the third consecutive month, retail inflation breached the double-digit mark at 10.56% in December, driven by higher prices of vegetables, edible oil, pulses and cereal, reports PTI.

 

The retail inflation was 9.90% in November and 9.75% in October.

 

The vegetables basket in December recorded the highest inflation of 25.71% among all the constituents that make the Consumer Price Index (CPI), according to data released today.

 

Vegetables were followed by the oil and fats segment at 16.73%. Sugar turned more expensive by 13.55%. Pulses and cereals became dearer by 13.46% and 13.70% on an annual basis. Meat, fish and egg rose become 11.64% more expensive.

 

Clothing and footwear witnessed 10.74% increase in prices.

 

In urban areas, retail inflation rose to 10.42% in December from 9.69% in the previous month. The CPI for rural population increased to 10.74% during the month from 9.97% in November.

 

All India provisional General (all groups) CPI numbers of December 2012, for rural, urban and combined are 126.8, 124 and 125.6, respectively.

 

The Reserve Bank of India (RBI) is expected to take into account the double-digit retail inflation when it comes out with its third-quarter policy review later this month.

 

Wholesale price based inflation for November was at 7.24%, much higher than the RBI comfort level of 5%-6%.

 

Concerned over the persistent inflation, the RBI has kept key interest rates unchanged since April 2012.

 

Industrial output growth rate had contracted by 0.1% in November, from a robust 8.3% in October.

User

We are listening!

Solve the equation and enter in the Captcha field.
  Loading...
Close

To continue


Please
Sign Up or Sign In
with

Email
Close

To continue


Please
Sign Up or Sign In
with

Email

BUY NOW

The Scam
24 Year Of The Scam: The Perennial Bestseller, reads like a Thriller!
Moneylife Magazine
Fiercely independent and pro-consumer information on personal finance
Stockletters in 3 Flavours
Outstanding research that beats mutual funds year after year
MAS: Complete Online Financial Advisory
(Includes Moneylife Magazine and Lion Stockletter)