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Omaha, Nebraska, Warren Buffett’s hometown, has a problem. $850 million in unfunded retirement expenses for city workers. And this is not a problem unique to Omaha, Detroit and Chicago along with countless other cities across America have similar shortfalls.
The Rockefeller Institute of Government in Albany, New York, estimates that state pensions are underfunded by at least $1 trillion.
Buffett called attention to pension shortfalls in his annual report to shareholders of Omaha-based Berkshire, “Citizens and public officials typically under-appreciated the gigantic financial tapeworm that was born when promises were made.” He wrote.
Pension deficits have accumulated as the financial crisis drove down stocks, trimming the value of investments used to pay benefits. The problem has been exasperated by Governments failing to put aside enough money to cover the shortfall.
These deficits pose a long term risk to the $3.7 trillion municipal-bond market. Chicago, for instance, has a “massive and growing” pension-fund shortfall which could lead to insolvency, Moody’s Investors Service said in a report this month as it cut the municipality to three levels above junk grade.
What Can Be Done
Filling a $1 trillion hole isn’t going to be easy. Cities across the country are considering varied approaches to paying the bill. Philadelphia may sell a utility. Charleston, West Virginia, is weighing the closure of fire stations, while Bloomington, Illinois, is considering new levies on concert tickets, bowling and trips to the zoo.
But the fact is, the only way to solve this problem is to put more money into pensions or lessen benefits. Both of which mean more pain for citizens, who are already reeling as wages fail to keep up with inflation.
The pensions deficit is one of many problems facing the municipal market. Chief among them is the threat of rising interest rates. Munis benefit when interest rates fall, but many strategists don’t expect rates to continue to decline. The economy is improving slowly, recent hiccups related to bad weather notwithstanding, and that should put upward pressure on interest rates going forward.
And the nagging question of what to do about tax exemption continues to hang over the market. Congress is debating whether to strip away, or at least reduce, one of the big advantages of muni bonds: their tax-exempt income. If the proposals turn into law, it could drive down demand for municipal bonds.
So despite municipal bonds starting the year with a spring in their step, investors would be wise to weigh up the pros and cons before jumping in. While the sun may be shining now, there are clouds forming on the horizon.
Todays Other Top Stories
Benefits Pro: – Households, mutual funds turning away from U.S. munis. – Last year was a tumultuous one for the U.S. municipal bond market, with individual investors fleeing in droves, according to new data released by the Federal Reserve.
Bond Buyer: – Piwowar wants to improve muni price transparency. – Securities and Exchange Commission member Michael Piwowar has asked the staff of the Office of Municipal Securities to give him some proposals that he can push through the SEC to improve price transparency in the municipal market.
Bond Buyer: – Aggressive buyers ready to devour P.R. GOs. – Hedge funds and cross-over investors are expected to devour Puerto Rico’s junk-rated sale of general obligation bonds when the $3 billion deal thunders into the primary market on Tuesday.
Laissez Faire: – Is now the time to buy municipal bonds? – Municipal bonds were flying high until 2007–08, when the collapse of the property markets caused widespread worry. Munis depend on state tax revenue, and with the economy in recession, sales and income taxes were in jeopardy.
Milwaukee Journal: – Lower prices, higher yields make municipal bonds worth a look. – Each time the municipal bond market starts to pick up, it gets knocked down again. The result, says one Milwaukee investment manager, is lower prices and higher yields that make for some tempting opportunities.
Bloomberg: – Puerto Rico leads biggest wave of muni issuance in three months. – Puerto Rico is set to lead U.S. states and localities planning to sell $11 billion of long-term debt this week, the most this year, with yields near an eight-month low.
Reuters: – Bad fiscal reputation hikes rates on Illinois bonds-study. – Illinois is paying an extra premium in the U.S. municipal bond market because of its poor fiscal reputation, according to a study released on Monday.
LearnBonds: – Bonds and taxes – Three tax terms you need to understand. – I am a big fan of investing in individual bonds and think every fixed-income investor should spend some time learning about the benefits of an individual-bond allocation. As part of that learning process, it is important to understand some of the tax implications related to individual bonds. In this article, I would like to highlight three such intricacies.
Wall St Cheat Sheet: – The ABC of Investing in bonds. – Learn about investing in bonds. Which bonds to consider, constructing a portfolio, which bonds are best for you, determining your bond score and much more.
Miami Herald: – Should you consider U.S. Treasury’s new floating rate notes? – If you are looking for something new and exciting in the investment world, you may want to take a look at the U.S. Treasury’s latest offering: floating rate notes (FRNs).
Reuters – Safeway LBO puts spotlight on need for bond protection. – Investors have been put on high alert regarding the need for covenant protection in investment-grade corporate bonds, after being rattled by this week’s US$9.4bn LBO of Safeway and last month’s scare when Time Warner Cable was saved at the eleventh hour from a hostile bid.
WSJ: – Renewed embrace of bonds sparks boom. – Highly rated companies sold the most debt this past week since Verizon Communications Inc.’s record-setting $49 billion sale last September, in the latest upbeat sign from the bond market.
MoneyNews: – Corporations, many investors lose out on bond issues. – The way that corporate bonds are issued creates disadvantages for investors who don’t get in on the deal and corporations themselves.
Trading Floor: – Corporate bonds: Is that it? – If you’re investing in corporate bonds, you might be disappointed by the returns. The Morningstar Corporate Bond Index yields only about 3% and the company’s Dave Sekera says that may be as good as it gets all year. David points out that the current return is better than the 2.5% we got when the index bottomed out last May. However, the fifteen year average is around 5.25%.
WSJ: – Verizon in the market again with large bond sale. – Verizon Communications Inc. is back in the bond market Monday, shopping debt to investors in what will likely be its largest U.S. sale since its mammoth $49 billion bond deal in September.
Bond Vigilantes: – High yield: bullish or blinkered? – I recently attended JP Morgan’s annual US high yield conference. It’s one of the best conferences around: well attended, and with more than 150 companies, panel discussions and specialist presentations. As such, the topics covered give a good flavour of the market’s latest thinking.
Reuters: – High-yield bonds draw investors as emerging debt loses them. – Shove over, emerging markets – high-yield debt has taken your place. Emerging-market bonds, star performers just a year ago, are being replaced by high-yielding corporate debt from developed markets by investors searching for yield.
Income Investing: – U.S. junk-bond default rate drops to just 1.6% in February. – The only thing lower than junk-bond yields these days is the default rate among junk-rated U.S. companies, which fell further to just 1.6% in February from 1.9% in January, Moody’s reported today. The default rate is measured on a trailing 12-month basis. Globally, the default rate fell to 2.4% in February from January’s revised rate of 2.6%.
Artemis: – East Lane Re VI cat bond upsizes to $270m for Chubb, prices at low-end. – Catastrophe bond, sponsored by U.S. primary insurance group Chubb, has now completed at the increased size of $270m with pricing at the low-end of the previously reduced range.
Charles Schwab: – Emerging market bonds: Why now’s a good time to reassess the risks. – The calm in emerging market bonds was broken recently when Russian troops moved into Crimea. We think markets may be too complacent about the potential risks facing emerging market (EM) bonds in 2014.
Economic Times: – Emerging Markets top of the class despite Ukraine turmoil. – Emerging markets hard currency debt was the best performing fixed-income asset class in February in spite of growing political tensions in several countries, most notably Ukraine and Russia.
ETF Trends: – Some help for emerging markets bond ETFs. – Volatility in the developing economies pressured riskier assets at the start of the year, but investment money is slowly trickling back into emerging market debt country-specific exchange traded funds.
Morningstar: – What next for emerging market debt? – Fears about emerging markets don’t look like they’re going to go away anytime soon, so what is the prospect for emerging market debt?
Main St: – Surviving retirement by reading the bond market. – Which is it: Past is prologue, or past performance is no guarantee of future results? It’s a key question for fixed-income investors who must try to somehow forecast bond returns now that the basic rules of the game have changed, with yields more likely to rise than to fall.
FT Adviser: – ‘Crowded trade’ in BB bonds pushes managers to up risk. – Bond managers are moving to riskier areas of the high yield market in an effort to counteract the asset class’s increased sensitivity to interest rates.
FT: – Former Jefferies bond trader convicted. – A former Jefferies bond trader was convicted on Friday of lying about the price of mortgage bonds to defraud investors, including a US government programme set up to stabilize the financial system.
Bloomberg: – Gross stumbles in legacy test as El-Erian exit distracts. – Bill Gross, musing on his legacy in an April investment outlook, contended that the real test of his greatness as an investor would be his ability to adapt to a new era of shrinking bond market returns.
The Globe and Mail: – Rob carrick’s ETF buyer’s guide: Bond ETFs. – No matter what your interest rate outlook, there’s a bond ETF for you.But just try and find it. With its manic slicing and dicing of the bond market and its copycat products, the exchange-traded fund industry is overwhelming investors who just want to pick a nice bond ETF or two for their port.
ETF Daily News: – 2 rising ETFs with double-digit yields. – The market environment has been very challenging for the income investors. Traditional income assets currently produce miniscule yields and some even fail to deliver above-inflation returns. Search for higher yields sometimes lures investors to risky assets.
News Observer: – Andrew Silton: Things to look for in a mutual fund and its manager. – In the institutional world, banks carry out detailed analysis and an on-site visits with prospective fund managers. Obviously, you don’t have the time, and most mutual fund company wouldn’t take it kindly if you showed up for a visit. So what follows is a relatively quick way to kick the tires before you invest.
NJ.com: – All bonds are not ‘safe’ investment. – Investors who retreated from equities over the past few years into bonds should examine their bond holdings carefully. This is especially true for corporate bonds and bonds that have been paying relatively high yields. And, because of the way some of these bonds are listed on their statements, some investors might even be unaware that they are actually holding certain bonds and, consequently, may be unaware of inherent risks associated with some types of bonds.
Live Trading News: – Bond King trips, El-Erian ankles Pimco. – Last year in April Pimco’s Bill Gross, 69 anni, said that the test of his “greatness” as an investor will be his ability to adapt to a “new era” of shrinking bond market returns. And just about a year down that path Bond King is tripping.
Buying #PuertoRico GO? Tell the underwriters today. Orders being taken today, final pricing tomorrow. Like the corp deal it is.
— Muni Market Advisors (@Muni_Mkt_Advis) March 10, 2014
PUERTO RICO SAID TO OFFER BONDS WITH YIELDS RANGING FROM 8.625% TO 8.875%. SAID TO OFFER 8% COUPON ON 2035 BONDS.
— Brian Chappatta (@BChappatta) March 10, 2014
Bond contract allows for acceleration if debt crosses 60% of GDP threshold. Which may be case with loss of Crimea and unrest. Interesting.
— Bond Girl (@munilass) March 10, 2014