I have been invested in Vanguard's Municipal Bond funds i.e. VWIUX, VMLUX, and VMSUX for a long time, even surviving through the Meredith Whitney storm. They have served useful both from a tax perspective as well as for their total return. This year to date I am down -1.67% on a total return basis but the storm clouds are on the horizon and whether Vanguard use only high quality bonds this might not be enough to withstand what may be a repeat of the Whitney curse. As I have not seen much discussion on Municipal's and Detroit etc., I wondered what take on the current state of Municipal bonds was out there and what alternatives exist in the event of more Detroit's events.
Comments
I sense that these funds tend to hold better quality bonds.
Cities and Chapter 9
Detroit in particular, has been a monetary train wreck for a long time. Michigan is allowed to install emergency managers for failing cities and has several in place at this time. The emergency manager powers include many items. A few more prominent features allow for restructuring of local government and union worker contracts and related. Elected officials are removed from their "official/legal" functions and salaries may be reduced or eliminated, to the best of my understanding.
Michigan has constitutional restrictions in place that cap real estate taxes; which, of course provide monies for a variety of functions. This also restricts cash flow to communities for all of the normal functions.
The combination of real estate tax caps, a weak economy that was especially hit hard by the collaspe of the auto industry (which had already been leaving MI for many years) and the costly obligations towards pension funds has and is a heavy burden. Detroit's political turmoil and the usual corruption adds to the load.
Two last items of note and/or example. A local school district budget from last year (2012) must spend 87% of the budget for all areas related to the teachers...wages and benefits. One other community with a large population spends 46% of its budget towards just the police and fire retirement and benefits programs.
I am only offering information and not a viewpoint as to the above; but obviously a few things are badly broken. These conditions will not allow for properly functioning going forward. If not for special grants from the Fed. gov't (all taxpayers), many more police and firefighters would be gone as of June 30.
The above is not a direct reply to your concern for muni bonds; but it is not hard for me to imagine other cities closely watching what becomes of the legal status of Detroit's Chapter 9 filing. Bond holders are going to be included in the writedown of city(s) debt, in my opinion. I find no other way to relieve the debt burden. EXCEPT, whether the Federal gov't. intervenes to Detroit's monetary problem. I doubt this will happen; as such a move would be too dangerous and the Chapter 9 filings would likely increase the very next week.
I do believe the managers of your muni funds will maintain a proper holding benchmark.
Regards,
Catch
Here's quick look at some of most consistent established top performers...all MFO 20-year Great Owl funds:
Most drew down 8-10% in 1994. Even these top performers have drawn down about half that, or 4-5%, since May Day of this year. Seems in response to Fed action than to Detroit default.
Fidelity has several on the list. Here's M* YTD performance plot:
Regards,
Ted
http://www.learnbonds.com/heres-how-much-detroit-bond-exposure-your-etf-has/
http://www.nasdaq.com/video/the-detroit-debacle-is-a-municipal-opportunity-517865991
Where muni bond funds have taken a hit is to the principal thereby increasing their yield but quite a blow nevertheless. Besides the obvious bankruptcy of Detroit you had the negotiations leading up to it by Off, the Emergency Mgr appt by the Gov. He had already talked about creditors getting 10% and major changes to the existing union contracts AND as an aside had equated GO muni bonds with plain vanilla creditors. From the top, the bond holders puked, the unions gave him the finger and the the muni bond market took a severe hit. Hell, I'm sitting on NUM and it's off 17% YTD albeit the yield's up to 5.6%.
As for Detroit, think of is like the real estate mortgage debacle - lots and lots of people to blame and not a whole lot of folks in line to pay. You had an industrial age city shrink from 2M to 700K and they did nothing to shrink the legacy costs. Pensions and health care benefits? Not that juicy.
http://money.cnn.com/2013/07/23/retirement/detroit-pensions/index.html
That said, they're still using final salary * 2.5 * years service. State employees use 1.5 as the multiplier. Some municipalities around the country use 3 or 3.5 Some also allow spiking which if you're only using the final salary and not an average of 3 highest years like the state, you can backload the last year with unused leave, max overtime and everything else. Again, Detroit wasn't this bad.
But how do you shrink a city by 2/3? How do you turn off 2/3 of the streetlights and pull up 2/3 of the sidewalks and sewers and water mains? Kildee started in Flint with the Land Bank Authority process that seizes tax deliquint properties and either razes them or flips them. It potentially allows you to raze a square mile that in turn could be reverted to Ma Natures - woods, fields, farms, etc. Yeah, but the Widow Smith doesn't want to move and so you have a couple of holdouts preventing the shrinkage.
Oh, and Detroit is only the first kids. We all know Illinois has the poorest funded state pension system and Chicago is broke. I guess Minneapolis and Cinci are tapped too.
And what about those state constitutional guarantees on some of these pensions?
and so it goes,
peace,
rono
Regards,
Ted
"There are five more towns like Detroit in Michigan alone. There are many more municipalities across the country in similar positions."
http://www.cnbc.com/id/100909014
And, yes, are you proud to be in the state that most people without healthcare. Are we competing to the bottom, sweat shop conditions?
The problem with Detroit is the population. It shrunk so much that remaining population cannot sustain. If such things happened to Dallas, Houston or pretty much anywhere you would get into trouble.
I think this situation crosses political lines and is going to be an issue in cities across the country. I have no belief that there is any idea how to handle it, that anyone has planned for if it occurs, etc etc etc.
I agree with what investor said: "If Detroit bankruptcy is successful, it can be a blueprint for other munis to get out of their obligations."
Almost every municipality in the US is under strain of their debt. This problem is not going away soon.
Indeed, this is the model going foward, although I'm hesitant to credit it to Texas, TYVM. My God, they still eat paste.
You can take care of your employees now and later very easily without incurring any legacy costs. DC pension - 4% plus match 3%. Health care for active employees but med savings acct for retirees which you can contribute to along with the employees. Good plans are not unlike a 401K.
peace,
rono
It'll be an intersesting test case. The state should buy both Belle Isle and the DIA collection by floating bond issues based upon FMV. It would help.
peace,
rono