Will the Muni Market Collapse?

04/15/2011 11:17 am EST

Focus: BONDS

Richard Lehmann

Publisher, Forbes/Lehmann Income Securities Investor

Meredith Whitney, the analyst who predicted the crash of some of the major banks a couple of years ago, put out another provocative prediction late in 2010 when she said that 100 or more municipalities could default on their bonds. However, Richard Lehmann of Income Securities Advisor has tracked muni defaults for decades...and the math doesn’t add up, as he says in this exclusive interview with MoneyShow.com.

Now, you're an expert in municipal bonds. What do you think of her prediction or the prospects for the market?

I'm not an expert on municipal bonds, but what we've done since 1983 is track municipal defaults, and for this reason we've been consulted by numerous media outlets as to how valid that kind of a claim is.

What we've found, basically, is that even though 2008 and 2009 were record years for municipal defaults, the order of magnitude was something like $8 billion or $7 billion per year—which tapered off in 2010 to only about $2.5 billion.

Basically, the order of magnitude that Meredith Whitney is talking about is just inconceivable.


Yeah, because it's not realistic, for the reason that municipalities’ major burden is making the interest payments on an annual basis, not having to redeem the bonds.

Most of them have very long-term maturities out there and much of this debt is not coming due anytime soon. Also, in most municipalities, bond holders have a priority in getting paid before the employees of the municipalities.

Consequently, this gives the municipality some negotiating room with those union employees to force them to come to terms, because in a bankruptcy situation they would suffer more than bond holders would.

So, you don't think there's going to be a lot of defaults, but everyone agrees that the state of finances in state and local governments is just dreadful. I mean, how do you see the resolution to that coming?

No, their finances definitely are in difficulty, and basically a lot of the costs are going to have to be renegotiated.

But I think longer term that the remedy for all of these problems at the federal, state, and local level is going to be inflation. It's my belief that inflation is something that government is actively supporting and causing to come about. Even though they will deny that to anybody.

Well, I think even Ben Bernanke has said he's comfortable with a little bit of inflation. He says, I think, up to 2% or so, I mean up to the top.

Yeah, that's not what I'm really talking about. That’s a starting point.

Part of the problem is also that we have what you call stealth inflation, in that the way the government measures inflation allows them to basically eliminate certain components from the cost.

It also allows them to make what you call hedonic adjustments, whereby they say, well, the computer you're getting today is 50% faster than the one you had before, so consequently $30 or $40 increase in the price is actually a reduction in price.

Some of these things—TVs are actually coming down in price, Blu-ray players, and even some of the computers are coming down in price over time. I think they do factor that in.

Yeah, high-tech stuff like that, but food, energy, and some of the more basic things that we need—necessities, if you will—those are not.

So, very quickly, do you think that the policy of inflating our way out of debt will work?

It works in the short term. The people that suffer from inflation are the people who have wealth, because inflation is a tax on wealth.

We know that tax on income has become a no-no in terms of politics, so you can tax wealth and you can do it without having to pass any legislation. You just deny it's intentional and you can throw up your hands at the end and say, “Gee, who knew?”

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