Muni Bond ETFs in Trouble, No Kidding

 |  Includes: MUB, MUNI
by: Roger Nusbaum

One crucial aspect of having at least mediocre long-term results with investing is taking heed from very obvious observations. Catching the obvious observations makes every other aspect of the task of investing much easier.

One very obvious observation that I have been repeating over and over is that it makes no sense to have expected that the worst financial crisis in 80 years was going to wrap up in 12-18 months. I have said repeatedly that there will be more shoes to drop. The latest news in Ireland is probably developing into another shoe -- it is certainly market moving.

So it is with the state of the states, municipal bonds and muni bond ETFs. There was a quick segment on CNBC yesterday with Herb Greenberg talking about the S&P National AMT-Free Municipal Bond Fund (NYSEARCA:MUB), which has been selling off of late. It is down 5.5% since peaking on August 25th compared to a drop of 2.46% for the iShares Barclays 7-10 Year Treasury Bond Fund (NYSEARCA:IEF), which appears to be the closest Treasury ETF in terms of maturity.

These moves would not be a big deal for equities, but bonds are a different story. The "distribution yield" for MUB is currently 3.36%. Extrapolating the September 1st dividend, anyone buying at the high might have been expecting a yield of 3.59%, so they are down about 200 basis points beyond what they hoped to yield. The math in this process is simple math but still makes the point: obviously there is no par value for an ETF to return to and future payouts could be smaller depending on market conditions.

The states generally have a lot of problems in terms of having budget deficits, pension shortfalls and declining tax revenues (including sales, income and property) and these problems are not brand new and at this point should not be shocking to anyone. Given the telegraphing, of this I have been saying for a couple of years now that avoiding exposure to this problem however big it actually becomes seems like an obvious thing to do.

At times, recently, there have been pundits making the case for muni bonds for various reasons, but it seems to me that these arguments rely on the market and system working the same as it always has, that the ratings are accurate and that there would be enough insurance should any AAA paper default. Whether you remember this or not, 15 years ago the notion of Fannie (OTCQB:FNMA) or Freddie (OTCQB:FMCC) failing was unthinkable. Four years ago how many people were using the argument of there never having been a national price drop for real estate (which I don't think was actually true) to explain why real estate prices would not drop nationally this time?

Marc Ostwalt was quoted yesterday as saying 40 of the 50 states are technically bankrupt. It doesn't really matter if that number is accurate when you take a step back and think about the big picture. Repeated from above, 48 states have budget deficits (the last time I looked), many states have serious pension problems waiting for them and the typical (tax) revenue sources are producing less revenue.

Disclosure: No positions