According to the mainstream experts, all bonds are NOT created equal. There is debt, and then there is government-backed debt. And never the twain shall meet.
So, when all asset-backed forms of credit were pulled under by the financial tsunami, the general consensus was to keep moving to higher ground. And don't stop until you hit the Municipal Bond market.
Lo and behold, the "twain" met anyway. On April 9, 2009 Moody's assigned a negative outlook to the creditworthiness of every local government in the United States -- the first such downgrade of its kind EVER in the 100-year history of Moody's.
The basis of their demotion is two-fold: First, this insight from a recent Wall Street Journal: "In the next two fiscal years, 47 states are likely to face budget shortfalls of a combined $350 Billion" as tax-based revenue dries up.
And second, 58% of the total pool of muni bonds is covered by monoline insurers: i.e. Ambac and MBIA, both of which saw their shares plunge more than 90% in the past year.
In the words of one recent news source: "A Shock Warning On Municipal Bonds," leaves market reeling. (AP)
In reality, however, there is nothing "shocking" about it. History has shown time and again that government is not a separate entity from the rest of the economy, in a class of its own; but rather, the LAST entity to participate and/or succumb to the larger trend.
To our team of expert analysts, one scenario had always been a foregone conclusion: Muni's triple "A" status would tread the very same flood waters that sunk bonds backed by subprime mortgages, the real estate sector, corporate investments, hedge funds and stocks.
Here, Elliott Wave International president Bob Prechter first revealed the vulnerability of municipal bonds in his 2002 book Conquer The Crash. In Bob's own words:
"Today, millions of individuals and institutions own tax-exempt municipal bonds. While there are assuredly many exceptions, this class of bonds is the riskiest among popular government issues. In the United States, default could happen to municipal bonds at any time after times get difficult. Politicians in many jurisdictions have borrowed and spent way more money than is likely ever to be paid back. Merely paying the interest on that debt in tough economic times will become an acute problem for many issuers. In such cases, default for many cities and counties will be inevitable."
Also, when the downward tide had officially turned, and the usual suspects were extolling munis for their “resistance to the recession,” as early as a year ago, the April 2008 Elliott Wave Financial Forecast(EWFF) presented the following warning:
“One of the most vulnerable sectors of the debt markets is the municipal bond market. Instead of being a source of state and local funding, many residents will become a cost. Default could hit at any moment after times get difficult… Yields on tax-exempt municipal bonds are above yields on US Treasuries for the first time in as long as anyone can remember, another sign of how limited the supply of quality bonds will become.”
Following close behind, these EW Financial Forecast publications filled out the story:
May 2008 EWFF described a “Bear Hug for States & Cities.”
June 2008 EWFF reported on Vallejo’s filing for bankruptcy, the first California town to go insolvent since 2001.
February 2009 EWFF presented a special section titled “Out of the Frying Pan and into Munis.” The segment showed the continued rise in muni yields ABOVE Treasury yields, and cautioned against the idea that tax-exempt debt was a “safe bet.”
With the first downgrade in muni bonds EVER, this $2.7 trillion market is officially fighting to keep its head above water. All the while, local areas in many states from Florida to New York, Illinois to California teeter on the edge of bankruptcy.
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