How Safe Are Municipal Bonds?
by Annette Thau
Between November 2010 and the end of January 2011, municipal bond funds declined by an average of about 6%, although some declined by as much as 11%.
Declines in the price of municipal bonds (“munis”) are nothing new. Two significant declines occurred in 2008: the first in February 2008, and the second a virtual meltdown that took place as the financial panic of 2008 unfolded. Both declines were discussed in articles I wrote for the AAII Journal [past articles are available at AAII.com]. But one aspect of the most recent decline that distinguishes it from prior episodes is that it is generating heated and controversial discussions in the financial press and media. This is new. Unfortunately, much of this discussion is not well informed.
Much of the current discussion starts with a forecast made by Meredith Whitney, a highly regarded bank analyst, last December on “60 Minutes.” During that broadcast Whitney predicted that massive defaults were likely to occur in the municipal bond market. More specifically, she predicted 50 to 100 “sizeable defaults” generating “hundreds of billions of dollars” of losses. By now, that forecast has been repeated endlessly. Those who feel her forecast is justified cite two potential problem areas: first, general stress on the finances of issuers of municipal bonds such as states, counties and cities due to the continuing economic downturn; and, second, future problems due to significant unfunded liabilities for pension funds and the costs of healthcare to retirees.
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