Muni Bond Market Wake up Call

Are muni  bond markets the next target for a bailout? the $2.7 trillion American local government bond market used to be considered a safe bet for investors. Typically, muni bonds yield less than Treasury bonds, and are exempted from state and federal taxes on interest income. But as The Economist reports, last year, bond insurers collapsed, creating a risk information vacuum,  and one-third of muni buyers fled from the market.  Though a recovery may be around the corner, the market is no longer a “homogenous mass” of local issuers (homogenous because  bond insurance equalized the risk between low and highly rated bonds).

The municipal bond market is fragmenting, “for the first time in decades, investors have had to start doing their homework on borrowers’ underlying credit risk.”

And that is a good thing – discriminating lenders can help discpline the market – but the article goes on to note, the federal government is not going to let an opportunity to intervene  go to waste, the House of Representatives’ financial services committee is working on a bill to provide a federal guarantee, and liquidity support to the municipal bond market.  A crisis brought on by easy money, fixed by easy money? The lessons of the bailout experiments of the last nine months should be sufficient proof to the contrary.