Bogleheads

[Gekko]

Time to Think the Unthinkable About Bond Insurers: Joe Mysak

By Joe Mysak

Nov. 6 (Bloomberg) -- Let's think about life after bond insurance.

For years, institutional investors have always told you to study the underlying credit of the municipal bonds you buy, even if they are insured. After last week, now you know why.

The stocks of the two biggest bond insurers, MBIA Inc. and Ambac Financial Group Inc., plummeted as investors worried that the two firms' exposure to failing mortgages might cost them their AAA credit ratings.

http://www.bloomberg.com/apps/....lTr.hZWskM

[bob u.]

There was some evidence in the MUNI bond market today that fear came into play. Bob U.

[larryswedroe]

this is a serious issue

The insurers while still keeping their rating are trading as real junk, with one of the MI insurers trading at close to 1000bp over treauries-

Now who do you believe? The Rating agencies or the market?

Now the insurers likely to get downgraded which means the bonds will get downgraded--leading to sales (many institutions have quality restrictions)

Which is why it is so important IMO to have the right policies in place--for example I recommend not buying any muni that is not at least A rated without insurance that is anything more than very short term, and at least AA if long term at all, say more than 2 or 3 years. And another reason to avoid funds if have enough cash to buy on own. That way you control the credit risk

The subprime mess is long way from being over IMO.

[grok87]

Larry,
Looks like you're talking about Radian (2011 maturity) which traded at a yield of 14.9% yesterday. Pretty amazing.

It seems like the thing to do would be to avoid all insured bonds. Otherwise one will get caught in the downdraft of forced selling when institutions sell on the downgrades. Of course the contagion might spill over into un-insured bonds as well.

Should be some interesting times ahead. I wonder what the credit default swaps for the bond insurers are trading at. Often they are more dramatic than the bonds themselves...

cheers
grok

[Murray Boyd]

Could this really amount to more than a few basis points of return for a fund like Vanguard's Intermediate Tax-Exempt?

[tfb]

I'd like to point out that this issue primarily applies to Muni bonds. Correct me if I'm wrong. I think taxable bonds generally don't have insurance. So if you don't have muni bonds or muni bond funds, don't worry about it.
_________________
The Finance Buff

[craigr]

[GRT2BOUTDOORS]

[larryswedroe]

I would not avoid all insured bonds--that is going too far--the issue is what the underlying rating is.
A AAA that is a natural AA is probably still a very safe bond, especially if it is relatively short term and not a "sector bond" like a health care bond where default rates can be pretty high

But this is not only munis of course--it is MBS that are not GNMAs, especially private label (non-fnma/freddie).

[grok87]

[Gekko]

should current holders of VG municipal bond funds have any worries?

[bearcat98]

[austinite]

How does one find the rating without insurance? I have not seen this type of rating from the usual rating sources.

Thanks in advance.

[MossySF]

[larryswedroe]

grok
I agree there is certainly some risk---and this is one of the advantages of owning individual bonds and not a fund

Keep in mind though the costs of trading out of an individual bond for most individuals is likely to be fairly expensive. That cost has to be considered in any switching strategy

But I hope this thread helps people with future buying decisions

[matt]

What is the bigger issue here, whether your munis get sold off due to downgrades, or the devastating recession that will occur if the problems at the bond insurers are as big as the market believes?

[Schooly D]

[jh]

...

[jh]

...

[larryswedroe]

Every bond is different

Many are double AA underlying and AAA with insurance. The reason is they buy the insurance is the companies were almost giving it away--cost was just a few basis points--and they pick up in yield reduction exceeded it (reason is you gain investors who will only by mandate by AAA). Those bonds not likely to get hit much, especially if short term---though likely will get hit some of course.

It is the bonds with lower underlying ratings and longer term that could get hit a lot.

Again, another benefit of buying individual bonds is you control the credit risk!!!

[Sphinx]

[larryswedroe]

sphinx
The issue is about what the UNDERLYING rating is without the insurance--that you would have to dig into each issue they own to learn

[brainstem]

Folks...
This topic came up in August and it was pointed out that funds diversify your risk --- the insurance game is usually not the main selling point for the bonds in the first place -- if the insurers go belly up, it would take a lot of muni defaults to hit hard in a diversified mutual fund

[btenny]

With all this selling of good bonds and bond insurers I see really large discounts in CEF funds like NVG and other AAA rated bond funds. Today NVG is selling at $13.35 which is over 10% discount from the $15 price of the underlying bonds. Plus the bonds are all AAA rated and insured. So is this a good time to buy. It seeems to be a good buy to me.....

Bill

[larryswedroe]

btenny
They may be AAA because of the insurance--but not AAA without them

Big difference

[stratton]

[Paladin]

[larryswedroe]

paladin
I agree, but it should be pointed out anyway

Larry

[Paladin]

[Valuethinker]

[matt]

Valuethinker wrote:

[larryswedroe]

"But in practice, at least according to Larry, there are few municipal bond defaults-- states and municipalities raise taxes, tolls, cut spending etc rather than default and ruin their credit rating forever."

NOT TRUE--I never said that. What I did say is that there are sectors within the muni world that have VERY HIGH DEFAULT RATES and should be avoided.

Now if buy AAA and GO bonds then almost certainly will not default

[Gekko]

i think i heard the author of this article say that municipal bonds have a less than 1% risk of default.

[Rick Ferri]

.
I have been managing municipal bond portfolios for almost 20 years. There is one rule of thumb I that have always lived by; Don't buy insured bonds for the insurance. Buy municipal bonds based on their underlying credit quality. If the bond has insurance, that is a bonus.

Rick Ferri

[Gekko]

i'm confident that VG bond fund managers are on top of it.

[btenny]

I could not find underlying bond ratings for the NVG fund but maybe I don't know how to read all the data. Basically most of the bonds are rated AAA or there abouts by Fitch or Moodys but as you guys have pointed out this may be after insurance or it may be the raw bonds. What I do find is that 30% of the bonds are pre-funded and another 30% (?? overlap) are government guranteed and another 13% are general obligation bonds. So depending on how you interpret this data I see a pretty good risk mix.

Yes the fund is leveraged so the fund price does wipsaw somewhat with the market and yes the bonds are longer term but so are Vanguard Intermediate bond funds. So those Vanguard bond funds wipsaw around in price also. Plus this particular fund is really sale priced right now and yields way more than a similar taxable Vanguard fund...

Bill...

[Valuethinker]

[Valuethinker]

[larryswedroe]

valuethinker
Housing
Health Care
Industrial Development

We avoid those three sectors when building portfolios