No discusson of bonds now that Stockton officially bankrupt?

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
Jfet
Posts: 1081
Joined: Tue Dec 21, 2010 7:20 pm

No discusson of bonds now that Stockton officially bankrupt?

Post by Jfet » Mon Apr 01, 2013 5:32 pm

Any ripples in the muni bond market? Good time to buy, sell, ignore?

Calm Man
Posts: 2917
Joined: Wed Sep 19, 2012 9:35 am

Re: No discusson of bonds now that Stockton officially bankr

Post by Calm Man » Mon Apr 01, 2013 5:40 pm

I think ignore. I made a rather long post about this issue an hour ago. There were no responses and I deleted it. TO Vanguard's credit, I just reviewed all of the bond holdings in their California long term fund and the word Stockton doesn't appear. I am concerned though although I have a feeling that since the muni funds are managed and not indexed, Vanguard will avoid these horrible situations or sell before the damage is too bad. The after-tax yield is so much higher now for munis than taxables that I think I will just hold for now. In fact I am due for my quarterly NJ long term investment on Friday and plan to do on schedule.

User avatar
JamesSFO
Posts: 3107
Joined: Thu Apr 26, 2012 10:16 pm

Re: No discusson of bonds now that Stockton officially bankr

Post by JamesSFO » Mon Apr 01, 2013 8:16 pm

I think also the final chapter on this won't be written for another year or so.

The CalPers issue is going to take a long time to resolve and depending on how it resolves there will be a backlash within California to make changes to the CA constitution/etc.

The flip side is, now that the municipality is in bankruptcy, some bond holders may be willing to start taking haircuts to move on.

Calm Man
Posts: 2917
Joined: Wed Sep 19, 2012 9:35 am

Re: No discusson of bonds now that Stockton officially bankr

Post by Calm Man » Mon Apr 01, 2013 8:24 pm

JamesSFO wrote:I think also the final chapter on this won't be written for another year or so.

The CalPers issue is going to take a long time to resolve and depending on how it resolves there will be a backlash within California to make changes to the CA constitution/etc.

The flip side is, now that the municipality is in bankruptcy, some bond holders may be willing to start taking haircuts to move on.
James, I lack a good understanding of the Calpers situation. As I understand it, they aren't really a creditor but simply a middle-person to pay the pensions. So can the court rule that Stockton contributions to CALPERS declines along with a corresponding decrease in the pensions to Stockton retirees or is Calpers on the hook for it regardless of whether Stockton can make the payments?

stan1
Posts: 5896
Joined: Mon Oct 08, 2007 4:35 pm

Re: No discusson of bonds now that Stockton officially bankr

Post by stan1 » Mon Apr 01, 2013 8:35 pm

There are no good answers here, but as a CA resident and someone who has owned Vanguard's CA Tax Exempt Money Market, Intermediate Muni, and Long Term Muni funds:

1) State government bailout of bondholders (including hedge funds who fully understood the risks being taken)? No thanks.
2) Further underfunding of CALPERS (e.g. other counties/cities and future generations pay the bills)? No thanks.
3) Bond holders take a haircut? That's why I diversify, but it does leave someone's 80 year old Aunt Mildred high and dry after she was sold a high yielding bond at her neighborhood bank by a helpful/friendly broker ("salesman") she thought was a teller or "greeter".

User avatar
JamesSFO
Posts: 3107
Joined: Thu Apr 26, 2012 10:16 pm

Re: No discusson of bonds now that Stockton officially bankr

Post by JamesSFO » Mon Apr 01, 2013 9:33 pm

CA resident too, not sure I fully understand the CalPERS situation either, I think the fear is that CalPERS will still have to pay the benefits but not get the $s to cover the expense.

Hoping others on this forum have more insight.

User avatar
JamesSFO
Posts: 3107
Joined: Thu Apr 26, 2012 10:16 pm

Re: No discusson of bonds now that Stockton officially bankr

Post by JamesSFO » Mon Apr 01, 2013 10:41 pm

This blog has some insights on CalPERS/Stockton (and San Bernadino) situation: http://calpensions.com/category/bankruptcy/

Elbowman
Posts: 491
Joined: Tue Apr 03, 2012 2:25 pm

Re: No discusson of bonds now that Stockton officially bankr

Post by Elbowman » Tue Apr 02, 2013 12:18 am

Jfet wrote:Any ripples in the muni bond market? Good time to buy, sell, ignore?
Always a good time to ignore. :D

Scooter57
Posts: 782
Joined: Thu Jan 24, 2013 9:20 am

Re: No discusson of bonds now that Stockton officially bankr

Post by Scooter57 » Tue Apr 02, 2013 9:18 am

This points out why if you have to buy a high yield bond fund, you should think twice before investing in a high yield municipal bond fund.

From what I've read, the highly rated muni bonds are very safe, historically, but when the rating drop Munis are far more likely to default than are corporate bonds with the same rating.

But it's also worth noting that most investors aren't highly educated about market basics, so if the hordes who have rushed into bonds over the past 2 or 3 years think "Muni bonds are in big trouble" they may cash out and take their profits from those investments right now no matter whether it makes sense or not. And if they do that, holders of all municipal bonds will see prices fall.

Long term that makes them a better buy. But given all the other issues hovering around bonds right now, it might just hasten the capital loss of these funds. I just looked at my VMLUX and noticed that though the posted SEC return was 1.79 when I bought it, my actual annualized return given the slight drop in price since I bought in gives me a .9% yield for 2 months--less than I'm getting in my savings accounts. And no, the rise in rates did not make up for the loss in NAV.

Valuethinker
Posts: 35983
Joined: Fri May 11, 2007 11:07 am

Re: No discusson of bonds now that Stockton officially bankr

Post by Valuethinker » Tue Apr 02, 2013 10:30 am

Jfet wrote:Any ripples in the muni bond market? Good time to buy, sell, ignore?
the State of California is lurching towards a government *surplus*.

Some municipalities will get hit, but so far, what Meredith Whitney foresaw has not come true. Stockton. Ventura. Harrisburg PA, Jefferson County Alabama. Each had a unique political culture and structural issues. Corruption. Incompetence. Massive unfunded promises. I think in Harrisburg the mayor talks daily with God, but is literally not on speaking terms with the Financial Controller?

There are implications for public sector pension schemes and those are not pretty (Illinois, that phone is ringing). That story is not over-- and I'm not up on the particular issues in Stockton and the California schemes.

But widespread municipal default seems unlikely, given the US housing market is rallying (housing related fees and taxes are a significant part of most municipal budgets). Municipalities need to get infrastructure built, to do that they need to access the bond markets. To access the bond markets, they have to not default on bonds. So taxpayers will knuckle down and pay -- once they've strung up a few politicians ;-).

Valuethinker
Posts: 35983
Joined: Fri May 11, 2007 11:07 am

Re: No discusson of bonds now that Stockton officially bankr

Post by Valuethinker » Tue Apr 02, 2013 10:38 am

Scooter57 wrote:This points out why if you have to buy a high yield bond fund, you should think twice before investing in a high yield municipal bond fund.

From what I've read, the highly rated muni bonds are very safe, historically, but when the rating drop Munis are far more likely to default than are corporate bonds with the same rating.
Fascinating if true. On Investment Grade, the muni default rate is a fraction of IG for corporates.

A 'high yield municipal bond fund' just seems like an oxymoron, or a recipe for disaster. If the rating agencies rank a muni sub investment grade then there is a real reason for it-- they know their business.
But it's also worth noting that most investors aren't highly educated about market basics, so if the hordes who have rushed into bonds over the past 2 or 3 years think "Muni bonds are in big trouble" they may cash out and take their profits from those investments right now no matter whether it makes sense or not. And if they do that, holders of all municipal bonds will see prices fall.
US munis are highly illiquid. A few funds having to sell, and the prices will crash. Also the dealers don't put the capital into trading in that they used to pre 2008, and that makes illiquidity worse. It's a buy and hold to maturity market.
Long term that makes them a better buy. But given all the other issues hovering around bonds right now, it might just hasten the capital loss of these funds. I just looked at my VMLUX and noticed that though the posted SEC return was 1.79 when I bought it, my actual annualized return given the slight drop in price since I bought in gives me a .9% yield for 2 months--less than I'm getting in my savings accounts. And no, the rise in rates did not make up for the loss in NAV.
When the underlying asset is so illiquid there's a real risk if you are in a fund and the exit button is pushed. Those who sell units and get out first will in effect inflict significant dilution on the NAV for those who stay in, because the fund will have to take down the price of its bond holdings to sell. Like the rush for the door when there's a fire in a theatre or nightclub.

The movie 'Margin Call' with Kevin Spacey (the director's father was a trader at Merrills for 25 years) has a beautiful depiction of this in the securitized mortgage bond market. For that 5 minutes of movie whilst the trading desk makes those calls, alone, the movie is worth it.

rkhusky
Posts: 5531
Joined: Thu Aug 18, 2011 8:09 pm

Re: No discusson of bonds now that Stockton officially bankr

Post by rkhusky » Tue Apr 02, 2013 10:47 am

Scooter57 wrote: From what I've read, the highly rated muni bonds are very safe, historically, but when the rating drop Munis are far more likely to default than are corporate bonds with the same rating.
I thought it was just the opposite, munis were safer than corporates with the same rating. At least that is what one well-publicized study from 2009 showed.

Valuethinker
Posts: 35983
Joined: Fri May 11, 2007 11:07 am

Re: No discusson of bonds now that Stockton officially bankr

Post by Valuethinker » Tue Apr 02, 2013 11:00 am

rkhusky wrote:
Scooter57 wrote: From what I've read, the highly rated muni bonds are very safe, historically, but when the rating drop Munis are far more likely to default than are corporate bonds with the same rating.
I thought it was just the opposite, munis were safer than corporates with the same rating. At least that is what one well-publicized study from 2009 showed.
For investment grade, your understanding is correct by some phenomenal amount (I have this memory that the default rate on IG munis is something like 1/5th or 1/10th? of IG corporate bonds).

What Scooter is saying is that if we are below BBB-, then the reverse is true. If so... ouch!

User avatar
Peter Foley
Posts: 4538
Joined: Fri Nov 23, 2007 10:34 am
Location: Lake Wobegon

Re: No discusson of bonds now that Stockton officially bankr

Post by Peter Foley » Tue Apr 02, 2013 11:12 am

I listened to a presentation from a "private placement" marketer who, when questioned about bond returns and defaults, stated that they were staying away from California and Illinois in general, as well as a number of municipalities. The point being, people who work in this area have knowledge of what is going on and invest accordingly. These are not unknown, black swan risks.

rkhusky
Posts: 5531
Joined: Thu Aug 18, 2011 8:09 pm

Re: No discusson of bonds now that Stockton officially bankr

Post by rkhusky » Tue Apr 02, 2013 11:20 am

Valuethinker wrote:
rkhusky wrote:
Scooter57 wrote: From what I've read, the highly rated muni bonds are very safe, historically, but when the rating drop Munis are far more likely to default than are corporate bonds with the same rating.
I thought it was just the opposite, munis were safer than corporates with the same rating. At least that is what one well-publicized study from 2009 showed.
For investment grade, your understanding is correct by some phenomenal amount (I have this memory that the default rate on IG munis is something like 1/5th or 1/10th? of IG corporate bonds).

What Scooter is saying is that if we are below BBB-, then the reverse is true. If so... ouch!
Not sure what the ratio is now after muni ratings were adjusted in 2010, but it used to be a factor of 20 lower default ratio for IG munis over corporates. And the non-investment grade defaults rates were about the same as the corporates. One should also not depend on the title of the mutual fund: Vanguard High Yield Tax Exempt is 90%+ IG, whereas the Vanguard High Yield Corporate is 6% IG.

Valuethinker
Posts: 35983
Joined: Fri May 11, 2007 11:07 am

Re: No discusson of bonds now that Stockton officially bankr

Post by Valuethinker » Tue Apr 02, 2013 11:25 am

rkhusky wrote: Not sure what the ratio is now after muni ratings were adjusted in 2010, but it used to be a factor of 20 lower default ratio for IG munis over corporates. And the non-investment grade defaults rates were about the same as the corporates.
To clarify.

For sub investment grade corporates? Ie if they show 6% default rate then sub IG munis have 6% default rate?

For a muni bond, that's a huge rate, if true.
One should also not depend on the title of the mutual fund: Vanguard High Yield Tax Exempt is 90%+ IG, whereas the Vanguard High Yield Corporate is 6% IG.
Ahhh.. that's pretty important!

What then defines HY Tax Exempt? What's the mandate/ purpose of the fund? How does it select bonds?

rkhusky
Posts: 5531
Joined: Thu Aug 18, 2011 8:09 pm

Re: No discusson of bonds now that Stockton officially bankr

Post by rkhusky » Tue Apr 02, 2013 11:41 am

Valuethinker wrote:
rkhusky wrote: Not sure what the ratio is now after muni ratings were adjusted in 2010, but it used to be a factor of 20 lower default ratio for IG munis over corporates. And the non-investment grade defaults rates were about the same as the corporates.
To clarify.

For sub investment grade corporates? Ie if they show 6% default rate then sub IG munis have 6% default rate?

For a muni bond, that's a huge rate, if true.
One should also not depend on the title of the mutual fund: Vanguard High Yield Tax Exempt is 90%+ IG, whereas the Vanguard High Yield Corporate is 6% IG.
Ahhh.. that's pretty important!

What then defines HY Tax Exempt? What's the mandate/ purpose of the fund? How does it select bonds?
Below is a government report from 2008 that shows that muni default rates have historically been less than corporates:

http://frwebgate.access.gpo.gov/cgi-bin ... :hr835.110

However, it would interesting to see a more current analysis, since the rating agencies changed their muni ratings in an attempt to get them closer to the corporate ratings. Also, I've seen some articles that indicate that there have been many more defaults with unrated muni bonds than with rated bonds. Perhaps that is where some of the concern arises.

OverTheHill
Posts: 308
Joined: Wed Mar 27, 2013 4:58 pm
Location: North Carolina

Re: No discusson of bonds now that Stockton officially bankr

Post by OverTheHill » Tue Apr 02, 2013 3:33 pm

Valuethinker wrote:
rkhusky wrote:
Scooter57 wrote: From what I've read, the highly rated muni bonds are very safe, historically, but when the rating drop Munis are far more likely to default than are corporate bonds with the same rating.
I thought it was just the opposite, munis were safer than corporates with the same rating. At least that is what one well-publicized study from 2009 showed.
For investment grade, your understanding is correct by some phenomenal amount (I have this memory that the default rate on IG munis is something like 1/5th or 1/10th? of IG corporate bonds).

What Scooter is saying is that if we are below BBB-, then the reverse is true. If so... ouch!
I stand to be corrected by the data miners, but I seem to recall that there has never been a bond default in any of Vanguard's investment grade bond funds, not ever.

Valuethinker
Posts: 35983
Joined: Fri May 11, 2007 11:07 am

Re: No discusson of bonds now that Stockton officially bankr

Post by Valuethinker » Tue Apr 02, 2013 4:00 pm

OverTheHill wrote: I stand to be corrected by the data miners, but I seem to recall that there has never been a bond default in any of Vanguard's investment grade bond funds, not ever.
It's unlikely they *would* hold a defaulted bond. When the bond drops below BBB- they sell. It's very unusual for a bond that is Investment Grade to default, instead they get downgraded to Junk, and *then* they default.

However I do recall they got badly caught on telco bonds-- Worldcom in particular. Leading to a change in strategy and how they run the fund, to avoid a repeat of that (ie less risk taking).

PS 'data mining' is looking at statistical data and then massaging it to get the answer you want.

That's not the same thing as checking history on Google or other ways. That latter may be obsessive, but it is not 'data mining'.

It does matter that we are precise about it, because in finance data mining is common, and a venal sin.

Scooter57
Posts: 782
Joined: Thu Jan 24, 2013 9:20 am

Re: No discusson of bonds now that Stockton officially bankr

Post by Scooter57 » Tue Apr 02, 2013 5:55 pm

The issues arise in a market, unlike one anyone living has seen, where for extended periods no one will buy munis whose ratings have dropped. There have been so many buyers coming into the bond market that asn abnormally high amount of bonds have been issued in response to demand.

When bond demand drops to normal, bonds may become tulips and beanie babies. Note that you can still buy both today, but not for hundreds and hundreds of dollars a piece.

User avatar
nisiprius
Advisory Board
Posts: 36646
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: No discusson of bonds now that Stockton officially bankr

Post by nisiprius » Tue Apr 02, 2013 7:00 pm

Scooter57 wrote:...When bond demand drops to normal, bonds may become tulips...
How can they be tulips?

How excited can anyone ever get about getting their principal back at maturity? How much of a mania can develop over "Wow, I get a sweet, sweet $3.60 rolling in every 6 months and then in 2018 I get every penny of my $1,000 back?" This is the stuff on which you build castles in the air?

Where are the people who have quit their jobs to day-trade bonds?

Where are the "why not 100% bonds?" postings in this forum?

The tulip index was up twentyfold at the peak:

Image

Which bonds, exactly, have multiplied in price twentyfold... or tripled... or even doubled in price?

Image

Where is How To Be A Bond Millionaire? Make Fast Cash With No Money, Credit, or Previous Experience?
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

Jfet
Posts: 1081
Joined: Tue Dec 21, 2010 7:20 pm

Re: No discusson of bonds now that Stockton officially bankr

Post by Jfet » Tue Apr 02, 2013 8:06 pm

well, to be fair, there must have been some mania over bonds, as over $100,000,000 was loaned to Stockton via bonds so that it could make its pension payment.

Why, if there were no mania, would anyone loan an entity that much money when said entity is already behind on their payments?

Scooter57
Posts: 782
Joined: Thu Jan 24, 2013 9:20 am

Re: No discusson of bonds now that Stockton officially bankr

Post by Scooter57 » Tue Apr 02, 2013 8:13 pm

Jfet nailed it.

And I have only to think of a naive friend whose first investment pick was a tax free high yield fund, because, wow, no taxes! And lots of yield! No idea what he was buying, which is the case for far too many retail investors.

Bond funds have had huge inflows as people flooded into them seeking safety. If fundholders stampede back out, the funds have to come up with the money to pay them for their shares. How do they do this if no one wants to buy those bonds? Selling fund holdings for much less than they were purchased for, which harms those still in the fund. Yes you still get payments from the bonds left in the fund, but if you need your principal, a lot of it could be gone. Retirees trying to live on 2% dividends in an inflationary period have lost the potential earnings of that lost capital. That plus the capital loss could eat up a significant amount of their assets. All the worse since the role of bonds as a diversifier is to preserve capital in contrast to riskier stocks.

The tulip factor here is that people bought into these stock/bond allocations being told for decades they could expect to earn 10% on average a year (much like what Madoff promised.) Now, in retirement, "conservative" bond allocations may turn out to be as destructive to savings as thinking rises in home value are "wrealth".

Post Reply