Muni Default Risk To Get Worse Before It Gets Better

Take a look at this WSJ video with Bob DiMella, manager of the Mainstay Tax Free Fund. In summary he says:

1) Muni Bond Demand Increasing – Demand for muni bonds is not going away any time soon because of coming higher taxes and taxable Build America Bonds (BABs) reducing the amount of new tax free bonds being issued. BABs are also finding their way into individuals 401k plans.

2) Muni Default Risk – The problem and solution are political meaning that problems have to be perceived as being so bad that politicians have the necessary cover to make difficult changes to balance the budget, such as reducing platinum pension and health plan benefits. Sounds like a GM bankruptcy coming to a town near you.

We believe Bob DiMella’s comments are largely on track. That said, there are clearly fundamental credit problems in poorly run municipalities (See Bondview BLOG on this) on Harrisburg, PA.

Plus there are larger recessionary forces at play that can break the camels back. The worst recession since the 1930s has caused the steepest decline in state tax receipts on record. As a result, even after making very deep cuts, states continue to face large budget gap according to the Center on Budget and Policy Priorities Jan 2010 report “Recession Continues to Batter State Budgets; State Responses Could Slow Recovery “