I'm Out of Closed-End Muni Funds - For Now

I have discussed before that for my asset allocation plan, I had chosen to have muni bonds in taxable accounts instead of taxable bonds in tax-deferred accounts. In fact, I purchased some Nuveen Dividend Advantage Municipal Fund 2 (NXZ) at the beginning of the year. I got out of them last Tuesday, after the big panic. Although I managed to make a small profit, the selling price was below Friday's close. I wasn't too happy about the move at first, but my prudence may still be rewarded.

The motivation was of course the imminent downgrade of the bond insures Ambac (ABK) and MBIA (MBI), which has been all over the news. To be fair, the muni insurance business is profitable, serves a useful purpose and will never be allowed to fold. However, some has suggested a figure of $200 billion is needed to bail out the bond insurers. That may be too steep a price even for the billionaires who are circling around the (soon to be) carcasses. In all likelihood the $200 billion figure stems from the write-downs from CDS's (Bill Gross doesn't appear to be that far off), and you can bet that the bond insurers are clutching to their muni business like a lifeline. Barclays is now saying that if the bond insurers' rating are cut too deeply, banks faces additional $143 billion in write-downs. A hundred billion here, a hundred billion there, and pretty soon, we're talking real money.

Judging by the price action of those closed end funds, muni investors are nonplussed about all this ruckus. However, a little prudence may not be a bad thing. It's not unreasonable to assume that while Ambac and MBIA are drinking from the CDS cool-aid, some of that good fun got spilled over to the muni insurance side, and the default risks got underpriced in some issues. At the least one would expect the balance sheets of municipalities hard hit by the housing crisis not look as sound. So, while as the muni insurance business as a whole will never go away, it's not clear that all the muni bonds will keep their existing ratings in a re-shuffle.

I could pour over the latest quarterly reports of those muni funds to see what may be affected, but given the size of my investment that hardly worth the effort. I'll keep the cash, and jump back in after this brouhaha is over.

Comments

[pickaroonwyo:]

www.reuters.com/articl...

You may be on to something. Tax-free MM funds are exiting exposure to floating rate muni bonds which need insurance to have AAA rating.

2008 Jan 27 10:58 AM

[rocky:]

Many municipalities are going to have major problems honoring all their commitments to their public employee pension funds in a few years (including post retirement medical benefits). Don't be surprised if some issuers have to file for bankruptcy protection. Orange County, CA has retained law firms to see if it has grounds to invalidate its pension commitments, especially to recent public safety retirees. In Orange County, a sheriff's deputy with a lot of overtime in his final year of service can retire at age 50 and 30 years service with a pension of 90% of final year compensation. So if a deputy racks up $100,000 in overtime pay in his final year, he could easily qualify for a pension of $150,000 for life plus medical benefits. Even in Disneyland, that's a lot of money.

2008 Jan 28 03:08 PM