Friday, July 26, 2013

Here Come Those Municipal Bond Defaults That Everyone Said Couldn’t Happen

Reggie Middleton
Last Wednesday Middleton wrote an article in which he ridiculed the notion of being able to withdraw economic financial aid while expecting rates not to spike. The fact of the matter, he writes, is that we are at the end of a 33-year-old bull market in credit. Or, more accurately, we are at the end of a 5-year synthetic extension of a 28-year-old credit market bull run, at the end of the largest global zero interest rate policy experiment ever.
And this final aspect is the kicker. We are likely witnessing the end of a 3-decade secular bull market in bonds. Why in the world would anyone want to buy debt now? Reference a chart of 10-year rates over time, and you will see that once you get this close to zero (and the applied end to excessive ZIRP), there's no way to go but up.
This applies to municipal investors as well. Not only are higher funding rates to be expected from a shifting market, but the actual fundamentals of municipalities are at rock bottom, putting an even larger premium on what is already a steep increase in funding costs.
In the multifamily housing segment, default rates increased significantly and were extremely high for the period from 1987 to 1990, the time of the S&L crisis when real estate lending was reckless because of declining lending standards by banks and other financial institutions. The default rate peaked in 1988 in the 11-year period reviewed to 4.31%, followed by 3.41% in 1989.
“Don't let me say I told you so,” writes Middleton. “Will those monolines start feeling part 2 of credit crunch?”
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