Category

Municipal Bonds

Top News

This Could Shake Muni Bonds to the Core

Editor's Note: Detroit is more than a sideshow. What's at stake here is bigger than most investors realize. It could take a Supreme Court decision to determine the viability of many municipal bonds. Regardless of whether you are a muni bond investor or not, what happens in Detroit will affect you. Shah Gilani has the whole story.

Detroit went bankrupt, but so what?

Its own decades-long gross political mismanagement, corruption and incompetence pushed the city over the cliff into bankruptcy.

Why should we care?

It could change the way investors look at muni bonds. And not for the better.

The largest Chapter 9 filing in U.S. history will reverberate well beyond this once- bustling city and its creditors.

But w hat's most threatening to muni bond investors, and in fact all investors, is whether the city's general obligation bonds are secured or unsecured issues.

General obligation bonds, backed by a city's ability to levy taxes to pay interest and principal, are thought to be the safest of all munis.

Detroit is putting this to the test.

Top News

What the Detroit Bankruptcy Means for Municipal Bonds

You can't blame investors in municipal bonds for being worried about how the Detroit bankruptcy will affect the muni market – it's by a factor of four the largest municipal bankruptcy in U.S. history.

Last Thursday Detroit filed for Chapter 9 bankruptcy to seek relief for $18 billion in debt obligations, a debt driven primarily by years of soaring public pension obligations and shrinking tax revenue.

In the city's bankruptcy filing, Detroit emergency manager Kevyn Orr proposed cutting some of those retirement benefits and giving the city's municipal bondholders a haircut that could leave them with pennies on the dollar.

That prospect not only spooked investors in Detroit's municipal bonds, but triggered concern that other municipalities might soon decide to do the same thing.

Municipal bonds as an investment have already come under pressure this year. June was the fourth month in a row of negative net outflows. Over that time, $20 billion has exited the muni bond market.

"I think this will definitely help add to the stampede out of muni bonds," Theodore Feight, owner of Creative Financial Design, told Investment News.

Investing Tips

Municipal Bonds: While Others Bail, It Might Be a Good Time to Buy

Everything runs on liquidity. Unless you know something I don't, that dollar bill in your pocket is just as likely to buy a can of Pabst Blue Ribbon today as it was yesterday, and will be tomorrow.

Or you could sell 1,000 lbs. of gold – if you have that lying around – without fear of completely scuttling the global gold market. Your bank has to have cash, liquidity, lying around somewhere in the back if it wants to stay in business.

And in many cases, it's easy to see or verify this liquidity. It helps everyone feel better about doing anything.

But there are markets where this liquidity is kept off the open exchanges, where it can be used to juice up huge deals. Or it can prevent these huge deals from having the impact that they "should" have, keeping the hands of large traders hidden.

These are the sinister-sounding dark pools of liquidity.

Dark liquidity is generated and stored in a variety of ways, most of which are possible due to the huge variety of trading venues, electronic and traditional.

With dark pools, neither the size of the order nor the entity making that order can be known until the order is completed. Rosenberg Securities Inc. estimates that fully 15% – trillions of dollars – of all trades occurring on American exchanges, every day, utilize dark pools.

Not Playing Straight Poker

And the markets, like nearly everything else, operate on the wide availability and transparency of good, reliable information. A poker game gets its lurid thrills from the partial presence of that information, or the possibility that the information could be faulty. You wouldn't want to play with all your cards face-up. You just don't know, and that's why it's fun to play poker.

But the markets, despite some inkling to the contrary, can't function with true optimum efficiency if good information isn't available to the widest possible group of participants.

It's not that a player has to have the information, but it should be available to the player if things are going to work the way they should. One is a vying, gambling game, and the other is a free market. We should be able to tell the difference.

And there are nowadays big incentives and compelling reasons for large traders, for high-frequency traders, to maintain this half-plentiful supply of good information. Why? It's simple. They're making a killing off of arbitraging market inefficiency.

To continue reading, please click here...