A wise and valued friend called my attention to an article on municipal bonds, Short Seller: Dump Munis.
James Chanos, noted for highlighting collapses including Enron, sees bad days ahead for municipalities. State and local governments already have fiscal pressure. They have defined benefit pension programs and "platinum" health care plans. He also raises the specter of the loss of the federal tax exemption if there is a bailout.
To balance this perspective, author Tom Sullivan also cites Gary Pollack, head of fixed-income trading at Deutsche Bank Private Wealth Management. Pollack sees "headline and downgrade risk" but notes the power of these governments to raise taxes.
Even if one hates the idea of tax increases, this is an article about the creditworthiness of bonds, not one about politics. It is easy and tempting to confuse the two.
Our Take
So often these questions are posed in black and white. Either one should buy municipal bonds -- or not.
The answer might be quite different. Suppose that both Chanos and Pollack are correct. Frankly, that is my vote! We should expect a higher than normal rate of failures by municipalities. There will probably also be tax increases.
The real investment question is not which of these experts is correct. It is the following:
Do current municipal bond prices reflect the acknowledged current risks?
The article invites us to choose one side or the other. The market presents a more nuanced challenge. Municipal bonds are not right for everyone. Tax considerations are an important issues. Having said this, there are two possibilities:
- An investor who has confidence in a given jurisdiction may find an attractive opportunity; and
- An investor who thinks the overall market is too pessimistic may find an attractive muni fund, avoiding the locality-specific risk.
A Further Conclusion
Too many market questions are posed in the form of one side being right and the other wrong. In fact, the market prices usually reflect the debate. You are only looking for an edge.
