Easy Street

Why Are Households Still Nervous About Municipal Bonds?

Karl Baker Mar 30, 2012

When cities have financial troubles, they hit the headlines hard. For the past two years, stories have dominated the news about the financial troubles of the capital of Pennsylvania, Harrisburg; Jefferson County, Alabama; and this week, Stockton, Calif. 

But the majority of U.S. municipalities are not in financial trouble. So it’s tough to explain this little factoid from the Federal Reserve: US households withdrew over $80 billion from the municipal bond marketplace in 2011.

That’s according to the poetically named Balance Sheet of US Households and Nonprofit Organizations, released this month from the Federal Reserve. 

Over the final 3 quarters of 2011, household investments in municipal bonds slid four percent, to $1.88 trillion from $1.96 trillion.

It’s also the first time household municipal-bond holdings have fallen since at 2007, the farthest back that the Federal Reserve’s report reaches. 

What’s interesting about this sudden drop is that the municipal-bond market is heavily reliant on U.S. households.  In fact, nearly half of all buyers of municipal bonds are regular U.S. households; muni bonds are attractive investments for regular, or “retail,” investors because many are tax-exempt.   The other, wholesale investors in muni bonds are large US institutions, and foreign investors. 

So what triggered this nervous reaction last year from U.S. households?

One candidate: controversial analyst Meredith Whitney.  She is a financial analyst who, in 2007, was one of the few market observers to correctly predict the coming housing collapse.  In September of 2010, Whitney made another prediction of future crisis; this time about city and state finances.  She stated that, in 2011, up to a hundred “sizable” cities would default on their debt.

Whitney’s call was bemoaned by many professional investors, but it took a while to reach the kind of press outlets that are favored by households. At first, media coverage of her prophecy was sparse.  In the three months following the distribution of her report CNBC, the Wall Street Journal, and the New York Times, for example, published a total of four stories about her municipal bonds forecast. 

The turning point came in December 2010. That was when Whitney took her claims to CBS’s 60 Minutes. Soon after that, media hype around a coming city-oriented financial crisis began to bubble up.  In the first half of 2011, the popular press kicked up the heat: there were 23 reports from CNBC, The Wall Street Journal, and The New York Times focusing on Whitney’s dire bond prophecy. 

Perhaps unsurprisingly, starting in April of that year, households began to pull their money out of the municipal bond market. 

To be sure, news coverage of Meredith Whitney was likely not the only factor that influenced the investment decisions of households. High-profile government budget negotiations, like those in Jefferson County, Harrisburg and Stockton, also likely played a role in drawing out the worry in household investors.  

Chris Mauro, a municipal bond market analyst for RBC Capital, isn’t inclined to pin the nervousness of households on one analyst call (no matter how persistent). He is skeptical whether one prediction can have a significant effect on how investors move their money. He does note that news coverage plays a role.

“A lot of it is headlines for us,” he said about the movement of money into and out of the municipal bond market. 

He provided an alternative theory: that the yields on municipal bond investments have been relatively meager lately, and that could have persuaded some investors to cash out these assets.

In the end, despite a few high-profile municipal defaults, Whitney’s prediction of a bond cataclysm in 2011 did not happen.  Nevertheless, she still insists that city and state finances are a mess, and that many will soon face a Stockton-like decision of whether to pay creditors or city employees.

Whether investors will consider her claims influential in 2012 – well, that remains to be seen.

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