Investor Warnings About the $3 Trillion Muni-Bond Market

The Chief Executive officer of JP Morgan Chase, Jamie Dimon, is one of many, along with analyst Meg Whitman and Money Morning’s Martin Hutchinson, who are issuing warnings for municipal bond investors. Dimon elaborates by saying that there have already been six or seven municipal bankruptcies, with more to come on the horizon. He notes that Detroit and Harrisburg, PA have just recently alluded to the possibility of bankruptcy, reflecting the somewhat dire financial situations facing various state governments that are dealing with deficits of approximately $140 billion over the next year, according to reports from the Center on Budgets and Policy Priorities. These rising debt levels rightfully cause concern to municipal bond holders who are coming to the realization that their seemingly safe investments are no longer guaranteed.

Recently, Vanguard Group backed off on three new muni-bonds due to the landscape of the sector. The New Jersey Economic Development Authority also failed to generate enough interest to refinance its variable rate debt and was forced to reduce its planned $1.8 billion offering to $1.1 billion, while paying a higher interest rate than expected. To emphasize the critical nature of the situation, the fourth quarter of 2010 was the worst quarterly performance for muni-bonds in sixteen years, with investors fleeing the market and pulling out some $22.7 billion, according to Thomson Reuters Municipal Market Data.

The CEO of Liberty Mutual Holdings, Ted Kelly, says that they have reduced their debt holdings in Connecticut, California and Illinois. He has told Bloomberg that he thinks that feeling the federal government will come in to bail out the states and local issuers has served to prop up the market. Unfortunately, the $160 million federal stimulus will be turned off in the first quarter of 2011 pulling away the life support that has kept many states alive. Last week marked the ninth consecutive session of declines sending yields up to 5.08%, with widening gaps between offers to buy and sell. Federal Reserve Bank of Richmond President Jeffrey Lacker told the Wall Street Journal that he sees “some potential for broader distress” in the municipal bond market.

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