Municipalities Bet Pension Funds, PIMCO and Bob Nelson Take us to School

Best of the Bond Market for March 27th, 2012

Top Story

Tweet by @Frank_McG (Cate_Long retweet) Article by Pension Pulse

Municipalities Betting on Pension Bonds? - Our Take: Instead of raising taxes to cover shortfalls in their public pension funds, some municipalities are issuing a form of taxable bond known as the pension obligation bond and using the money they generate to make other investments.  Their hope is that those investments will return more than the interest they are paying out on the bonds they have issued.  Sound crazy?  It is.

Here are some more of the highlights:

  • Congress made it illegal in 1986 to issue normal tax-exempt municipal bonds for this type of speculation, but municipalities found a loophole which allows them to do it with taxable bonds.
  • Oakland CA has already lost $240 million using this strategy and is apparently about to issue another $200 Million in Pension Obligation Bonds to try out this same strategy one more time.
  • Since 2008 the dollar amount of bonds issued has gone up each year, rising from $1.4 billion in 2009 to $3.6 billion in 2010 to $5.2 billion last year

Other Top Stories:

Tweet and Article by @PIMCO

The Great Escape: Delivering in a Delevering World - Our Take:  Another great piece from PIMCO Funds’ Bill Gross.  Most of the article is him outlining his view on where we are headed but the part I found most interesting was his take on where we have been and how we have gotten to the place where we are currently.    It all started a long, long time ago and this paragraph sum’s it up:

“The term delevering implies a period of prior leverage, and leverage there has been. Whether you date it from the beginning of fractional reserve and central banking in the early 20th century, the debasement of gold in the 1930s, or the initiation of Bretton Woods and the coordinated dollar and gold standard that followed for nearly three decades after WWII, the trend towards financial leverage has been ever upward. The abandonment of gold and embracement of dollar based credit by Nixon in the early 1970s was certainly a leveraging landmark as was the deregulation of Glass-Steagall by a Democratic Clinton administration in the late 1990s, and elsewhere globally.”

Where does gross recommend positioning your investments in the future?

  • For bond markets: favor higher quality, shorter duration and inflation protected assets.
  • For stocks: favor developing vs. developed. Favor shorter durations here too, which means consistent dividend paying as opposed to growth stocks.
  • For commodities: favor inflation sensitive, supply constrained products.
  • And for all asset categories, be wary of levered hedge strategies that promise double-digit returns that are difficult in a delevering world.
Tweets by @BNels22
trading ranges since beginning of year on MMD AAA: 10yr: 1.67%-2.33% (66bps), 30yr: 3.14-3.57% (43bps) – Our Take: The MMD AAA is an index put out by Reuters which is the benchmark for the AAA rated municipal market.  Bob gives us the ranges in the index since the beginning of the year which have been pretty large.  What we found interesting was that the range was so much wider in 10 year muni bonds than in 30 year bonds, so we asked Bob his thoughts he was kind enough to respond with the following: “lack of supply in 30yrs has been one factor. Less volatility without supply pressure.” Looks like it all comes down to supply and demand.
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