Court Case Is Lost in Cauldron of Muni Market Woes: Joe Mysak
Commentary by Joe Mysak
April 15 (Bloomberg) -- The U.S. Supreme Court will decide the fate of the tax-exempt municipal bond market today.
Or maybe it won't.
The court has been deliberating since November about whether states can tax the interest on each other's bonds.
The longer the court considers the matter, the more possibility there is of mischief. Sometimes the judges rule not only on the subject at hand, but on other things, too.
Perhaps the most famous example, at least in the municipal market, occurred in April 1988, when the court ruled that all municipal bonds must be sold in registered form, and that tax exemption wasn't guaranteed by the Constitution.
The court threw out the 1895 Pollock v. Farmers' Loan & Trust Co. case. Before the 1988 court ruling, all those who worked in this market learned that Pollock v. Farmers' Loan was why the government couldn't tax state and local bonds. Nobody mentions Pollock anymore.
You would think a Supreme Court ruling that has the potential to overturn the status quo and remake the mutual-fund business would have everyone in the market talking. It's a sign of the trouble brewing in this market that Kentucky v. Davis, the case before the court, is barely on the radar.
Single-State Funds
There's usually little news in the municipal market, and that's how investors like it. They buy munis for ``sleep assurance,'' as the one boring, totally trustworthy instrument they can invest in and be guaranteed a good night's slumber.
No more! As a money manager put it to me a couple of weeks ago, in a voice full of marvel, it's not one thing; it's every thing. This is why municipal bonds have offered 100 percent or more of comparable U.S. Treasury yields for so much of this year.
What's there to worry about?
Well, there's this Supreme Court case, of course. If the judges decide that states don't have the right to discriminate against out-of-state bonds, why would anyone want to keep their money in the almost 500 single-state bond funds? That's just for starters.
The longer the court deliberates, the knottier the ruling may be. I am waiting for one of those very special ``this, but also this'' rulings that keep bond lawyers guessing for weeks.
The court case is today's worry. Then there's Jefferson County, Alabama, which daily portends to be the new Orange County, California. Orange County, of course, declared Chapter 9 municipal bankruptcy in 1994.
`Hit the Iceberg'
How big an event was that? It occurred almost 15 years ago, and we're still talking about it. That's how big.
Jefferson County is in trouble for a combination of things, some its own doing -- too much floating-rate debt, too many interest-rate swaps -- and some not: downgrades to insurance companies, securities firms giving up on the auction market.
The question that people are asking is, ``Are there more Jefferson County-type disasters out there?''
Moody's Investors Service in February observed that it was unaware of other municipalities in the same boat. Chriss Street, Orange County's current treasurer and one of the earliest critics of that county's investment policies back in 1993, disagrees.
``Jefferson County is not the only government agency to be upside down in a swap,'' he said in an e-mail last week. ``Jefferson County is just the first ship that is admitting that they have hit the iceberg.''
Dirt Bonds
You don't have to concentrate on how municipalities engaged in swaps and derivatives and other things they didn't understand to be concerned about the health of the market overall.
Are we going to see a wave of so-called dirt-bond defaults? We typically do after a housing bust. Millions, and more likely billions, of dollars' worth of bonds were sold in recent years to build the infrastructure in places where nobody now wants to, or can afford to, live. The bonds are backed by taxes on the now non-existent residents. Guess what happens?
Let's not forget the bond insurers. Remember them? The industry was on the point of collapse a few months ago. The patient has stabilized, but hasn't left intensive care.
Then there's the auction-rate securities market. Thousands of individual investors still can't get the money they put in the preferred shares of tax-exempt closed-end funds. Redemption, for them, is coming at a glacial pace.
There's also the Securities and Exchange Commission's, and everyone else's, big investigation into the reinvestment-of- proceeds business. That's not going to have a good outcome.
It's not a surprise that municipal bonds yield 100 percent of Treasuries. The surprise is they don't yield 200 percent of Treasuries.
(Joe Mysak is a Bloomberg News columnist. The opinions expressed are his own.)
To contact the writer of this column: Joe Mysak in New York at jmysakjr@bloomberg.net
Last Updated: April 15, 2008 00:01 EDT |
