Institutions exit the muni market
Jenn Ablan takes a look at the muni market today, and although inflows have been strong this year, the smart money seems to be moving out of the market, positioning itself for a gruesome second half of the year.
The muni market is a curious beast. Most of it is highly illiquid, with small issuers, buy-and-hold retail investors, and tax-exemption rules which make enormous differences to the value of securities depending on where you live and what your tax rate is. At the same time, some big institutional players like to rotate in and out of the market on a speculative basis, with short time horizons, and when they do, they’re big enough to act as marginal price setters. If they’re moving on to the next thing, then prices are likely to fall a little — which is actually no big deal, for anybody but institutional investors who mark to market. Municipalities will pay a little more to borrow, but rates are still extremely low, and their investors, who are also their voters, will get slightly more attractive rates on their money.
The big danger in most markets when institutional investors leave it for dead is that it closes up entirely, and that borrowers have no market access at any price. That’s less of a worry when it comes to munis because they’re mainly reliant on individuals. At some point, if there’s lots of talk of default, then retail investors might stop buying municipal bonds, but that’s a little bit down the road. First you get the price decline (and CDS spreads widening out further still), then you get the default talk, and only then do you get the retail well drying up.
For institutions who mark to market, then, it makes sense to avoid munis for the time being: they have more downside than upside. But for buy-and-hold individuals, there’s no real reason to panic: you’re going to hold your bonds to maturity anyway, so it doesn’t really matter what happens to their value in the interim. And the chances are that they’re not going to default; what’s more, even if they do, you’ll probably end up getting your money back eventually in any case. And if you’ve lent to a big state-level borrower like California or New York or Illinois, you can be pretty sure that there will be some kind of government bailout too.
The real worry here is with the monoline insurers: municipalities are more likely to default if they know that their voters are still going to receive their coupon payments from an insurance company which provided a wrap for their bonds. But for the time being, at least, I’m not worried about a complete collapse of the muni market, where local governments in need of funds can’t raise the money at any price. That could yet happen, but I doubt it’s going to happen this year.