As the sovereign debt crisis in Europe continues to unfold and illustrates the effects that massive debt can have on the global markets, four reasons suggest that municipal debt may be next.
First tax revenues are significantly down due to the Great Recession causing state and local governments to struggle to meet budget shortfalls. With unemployment rates still hovering around 10%, state and local income tax revenues continue to decline. Additionally, sales tax revenues have suffered as consumers have cut back on frivolous spending and purchases of big ticket items. The story behind property tax revenue is much the same. With foreclosures on the rise, property tax bills are being shunned away and home values continue to decline. To make it even worse, property reassessments done over the past 18 months are starting to kick in which is likely to suppress property tax revenues going forward.
Secondly, massive amounts of state and local debt generated via state funded pensions and other liability and long-term obligations are starting to accumulate and come due. In fact, numerous state agencies have implemented furloughs and forced non-paid vacations to cut spending.
Thirdly, there are no insurers to back municipal bonds. The credit crisis caused many bond insurers to shut their doors increasing the risk of municipal bonds. According to the Municipal Securities Rulemaking Board, currently less than 10% of newly issued municipal bond issues are insured. In 2008, more than 50% of all municipal bonds were insured.
Lastly, the trend of municipal bonds defaulting has already emerged. Since July of 2009, 207 municipal issuers defaulted on bonds valued at $6 billion, which included a major default in Las Vegas, backed by a Monorail project, and a Chapter 9 bankruptcy in Vallejo, California. As for the future, things don’t seem much more promising. The number of defaults in the $2.8 trillion is expected to continue to increase as local markets such as Harrisburg, Pennsylvania and Jefferson County, Alabama have openly mentioned bankruptcy and the likelihood that a major municipality, like Detroit of Los Angeles, will be unable to meet its debt obligations is relatively high.
Three ETFs that are likely to be influenced if the municipal bond market explodes include:
- SPDR Nuveen Barclays Capital Muni Bond (TFI)
- SPDR Nuveen S&P VRDO Municipal Bond (VRD)
- Market Vectors High-Yield Muni ETF (HYD)
If invested in these bond ETFs, the use of an exit strategy which identifies price points at which systemic risk may push values down could help mitigate the risk involved. Such a strategy can be found at www.SmartStops.net.
Disclosure: No Positions