Tuesday, September 11, 2007

Funny Thing Happened on the Way to Muni Bear Market: Joe Mysak

By Joe Mysak

Sept. 11 (Bloomberg) -- So much for the bear market in municipal bonds.

Back in August, a lot of investors were scratching their heads over just how much the net asset value of their municipal- bond funds had fallen -- more than 1 percent in some cases. What's going on, they asked.

What's going on was selling. Net asset value, or the dollar value of a share in a mutual fund, which is calculated daily, declined because the prices on the bonds in the fund fell. Those fell because some big institutional investors had to sell bonds to satisfy redemptions. And some hedge funds decided to get out of the tender-option bond business. In tender-option bond programs, institutional investors put muni bonds into a trust and sell floating-rate securities, pocketing the difference between short- and long-term yields.

So what you had was a whole bunch of bonds being put out for the bid. When everyone wants the same thing, the price goes up. If everybody wants to sell, the price goes down.

What a difference a few weeks makes.

Consider, for example, Vanguard's Long-Term Tax-Exempt Fund. The average net asset value of the fund this year has been $11.16. On July 31, the NAV was $11.06. After that, the NAV drifted lower, and by mid-August was in a sort of free-fall: $10.96 on Aug. 13, $10.92 on Aug. 15, $10.83 on Aug. 17 -- its low for the year.

On Friday, the NAV of the fund was calculated at $11.10.

Borrowing Costs

The Vanguard fund isn't alone. The NAV on most municipal- bond funds, even the high-yield funds that were hardest hit back in August, like those run by Eaton Vance and Oppenheimer, have rebounded in the same way.

Or consider borrowing costs for municipalities. They also increased during August, so much so that several issuers canceled or postponed their bond sales.

Let's take the oldest gauge of new-issue municipal bond yields, the Bond Buyer 20-General Obligation Bond Index, which measures how much it would cost 20 top-rated municipalities to borrow money for 20 years. The index is calculated weekly. It has averaged 4.38 percent this year, and reached a four-decade low of 4.03 percent on Dec. 7 of last year.

That spurred states and municipalities to sell more bonds, for both new purposes and to refinance outstanding debt, and this year looked like a lock to break the previous record of $408 billion set in 2005.

On Aug. 2, the index was 4.51 percent. It climbed to 4.59 percent on Aug. 9, to 4.74 percent on Aug. 16, and 4.81 percent on Aug. 23. The index is now 4.57 percent.

The Ratio

Of course everyone talked about the ratio between taxable and tax-exempt securities. Normally tax-exempts yield around 85 percent of taxable investments. In August, the tax-exemption went begging, and the ratio shot up to more than 100 percent on some maturities.

The bear market in municipal bonds lasted for about three weeks. By the third week of August, analysts were pointing out the weirdness. George Friedlander, municipal strategist at Citigroup Inc., headlined the firm's Municipal Market Comment on Aug. 20, ``An Important Buying Opportunity has Emerged in Municipals.''

And so it had. Mr. Municipal Market screamed ``Buy Me!'' for about, oh, two weeks. He's back to speaking in a normal tone of voice, and if history is a guide will soon return to his usual reserved whisper.

What's Ahead

Municipal bonds aren't subprime mortgages. They may have their problems. These include the ballooning costs of pension and other post-employment benefits, and a decline in real estate transfer and property taxes. Nobody's suggesting that these will affect states and localities' ability to pay debt service.

There's also a Supreme Court case on states' ability to tax out-of-state bonds. The court is slated to hear the case, Kentucky v. Davis, on Nov. 5, and the decision might throw the market into turmoil.

But right now, municipal bonds look pretty good, especially to those investors in cash or low-yielding money market funds.

Then there's the Fed, which meets next week to consider interest rates. At this point it seems unlikely that the Fed is going to raise rates. Most analysts are calling for a cut.

It looks like things are going to go back to normal in the municipal bond market.

To contact the writer of this column: Joe Mysak in New York at jmysakjr@bloomberg.net

Last Updated: September 11, 2007 00:02 EDT

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Lunch is for wimps

Lunch is for wimps
It's not a question of enough, pal. It's a zero sum game, somebody wins, somebody loses. Money itself isn't lost or made, it's simply transferred from one perception to another.