This is Fed week. In spite of the fact that we will receive a slew of economic data this week, all eyes and ears will be on the Federal Open Market Committee. This seems logical as the Fed has been the institution most responsible for economic growth for the past three decades. However, this is Municipal Monday. Let’s start of by discussing the fixed income market which arguably has the largest percentage of retail participation.
Bond Pigs (General Obligations gathered in their masses)
Although we are known for our prowess in taxable fixed income, we had our start in the fixed income business on the municipal side and as such have always had a soft spot for the tax-free space. However, having spent the majority of our career in the credit markets, we feel that we have a better understanding of how debt might fair in a bankruptcy than the typical municipal bond market participant or investor. This was reinforced by something Barron’s columnist, Michael Aneiro posted on his blog. He posted:
“A municipality’s full faith and credit tax pledge still doesn’t guarantee full recovery for bondholders. BofA notes that Detroit’s unlimited tax general obligation bondholders recovered just 74 cents on the dollar, roughly the rate at which the city was collecting its taxes, and it remains unknown whether those bondholders would have received more had they litigated further rather than settled.”
Following famous/infamous analyst, Meredith Whitney’s controversial call that there could be a flood of municipal defaults, we reminded readers that a general obligation bond was similar to a senior unsecured bond issued by a corporation. Readers and critics shot back that this was not so. The retort centered on tax revenues and the unlimited taxing power of municipalities essentially made municipal G.O.s secured debt. We disagreed then and disagree now.
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Saying that municipal G.O.s are “secured” by taxing power is like saying that unsecured corporate bonds are secured by revenues and unlimited pricing power. Although it has been mostly true in the past that municipalities could simply raise taxes on their captive tax base, municipalities such as Detroit have proved that municipal tax bases are less captive than in the past. This (at least) theoretically limits municipal taxing powers (in a real sense) just as business competition and economic conditions can limit pricing power among businesses. Thus, when viewing general obligation bonds below the state level, it is our belief that general obligation bonds should be analyzed and viewed similarly as unsecured corporate bonds. This is not to say that municipal G.O.s will have the same default probabilities as similarly rated corporate bonds. For one, municipal and corporate credit rating methodology is different. Municipal credit rating methodology tends to be more conservative. Thus A-rated municipal bonds tend to have better credit profiles than A-rated corporate bonds.
However, unless a bond issuer can print money (U.S. Treasuries) or is expected to receive the support of the Federal government in times of crisis; “general obligation” should not be assumed to offer any special protections for investors. General obligation bonds issued by U.S. states may be viewed differently because they cannot file for bankruptcy protection and would likely receive Federal aid if needed. One cannot make the same assumption regarding local level G.O.s (as Detroit has proven).
Given the pension and OPEB problems facing many cities and counties, we are not all that sanguine on local level G.O.s. One must understand the financial outlook for the city or county responsible for general obligation bonds one is considering. Therefore, other than state general obligation bonds, we prefer to focus on essential service revenue bonds. When it comes to local level G.O.s, Bond Squad takes that to mean “GO look elsewhere for opportunities.”
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We would like to clarify our aforementioned money printing statement. We do not mean one should invest in a bond issued by just any money printing entity. We want the ability to print U.S. dollars. At the present time we are domestically focused (a strategy an increasing number of firms are moving to, UBS being the latest). When we look around the world not only do we not see economic recovery, we do not see a desire among national electorates to approve reforms necessary to engender economic rebounds.
By Thomas Byrne – Director of Fixed Income – Investment Consultant
Thomas Byrne brings 26 years of financial services experience to Wealth Strategies & Management LLC. He spent the last 23 years as Director of Taxable Fixed Income for Citigroup, Inc. and predecessor firms in New York, NY. During the course of his long fixed income career, Mr. Byrne was responsible for trading preferred stock, corporate bonds, mortgage backed securities, government debt, international debt and convertible bonds. Mr. Byrne was also responsible for marketing, sales, strategy and market commentary within the taxable fixed income markets.
- November 2012 – Present, Wealth Strategies & Management LLC, Stroudsburg PA
- December 2011 – November 2012 – Bond Squad, Kunkletown, PA
- April 1988 – December 2011, Citigroup and predecessor firms, New York, NY
- June 1986 – March 1988 – E.F. Hutton, New York, NY
Director of Fixed Income
Wealth Strategies & Management LLC