Are Municipal Bond Markets Collapsing?

by: Bruce Vanderveen

Look at last week's price action in PIMCO's Municipal Income Fund (NYSE:PML) -- the ETF plunged. Not surprisingly, the California ETF (NYSE:PCK) shows an even more precipitous drop. As of Monday morning trading, the ETFs are again steeply down.

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Six month ChartClick to enlarge

It might be argued that muni markets are merely reflecting similar declines in Treasuries (NYSEARCA:TLT). Fair enough. Bond holders, though, are probably are more interested in the fact that their bonds have declined rather than why.

Warren Buffett warned back in June on the muni bond market as local and state municipalities struggle to meet their obligations amid declining tax revenues.

There was a time -- before the 2008 crash -- when triple AAA rated, insured munis were seen as the safest of safe investments. Times have changed though. Only Assured Guarantee (NYSE:AGO) still insures municipals, but the company has been recently downgraded from AAA to AA. Ambac (ABK) is in bankruptcy. MBIA (NYSE:MBI) is entangled in litigation and no longer writes new policies. The financial guarantee business today is but a shadow of its past.

Even though defaults, so far, are rare, the Fed's zero interest rate policy has thrown a cloud of uncertainty over all bond markets. One can't help but wonder what happens when ZIRP is withdrawn. Declining tax revenues, rating downgrades, loss of insurance and rumors of bailouts all contribute to the uncertainity and suspicion.

It may be wise to lighten up on all medium to long term bonds at this juncture. Greece, Ireland and Portugal may not be as far removed from New York, Illinois, and California as we might wish.

Disclosure: No positions