Munis: Concerns Should Not Be Taken Lightly

Apr.19.10 | About: PIMCO Intermediate (MUNI)

Author and financial industry veteran Rick Bookstaber has suggested that the municipal bond market could be ground zero for the next financial crisis. But he is not the only one warning about the risks of what many seem to believe is the best thing since sliced bread. In an excerpt from "Munis: Riskier Than You Think," the Wall Street Journal highlights several concerns that investors should not be taking lightly:

Since the start of the year, investors have poured more than $13 billion into muni-bond funds and exchange-traded funds—nearly twice the amount they have put into all domestic equity funds and ETFs, according to Lipper FMI.

But new investors could be setting themselves up for more pain. "Too much money has stampeded in," says Marilyn Cohen of Envision Capital, a fixed-income money manager near Los Angeles. She and others like Dean Barber, of Barber Financial Group in Lenexa, Kan., now fear that rising interest rates might reverse the stampede and push prices way down.

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The recent rally isn't the only cause for concern. Many municipalities are struggling to balance their books, raising the chances of default in some places. Bond insurers, battered by the financial crisis, have fled the muni market. And if all of that weren't enough to frighten off investors, little-known tax traps might.

Personally, I wouldn't describe the fallout from deteriorating municipal finances as the "great unknown." Based on what we've seen so far, it seems clear to me that there are going to be more than a few state and local governments that are not going to be able to meet their financial obligations.