Sunday, March 2, 2008

US Municipal Bond Market

The sub-prime mortgage crisis and the problems faced by hedge funds and other investors, have meant that the yields on tax exempt Municipal Bonds (Munis) have shot up. The WSJ reports that the average AAA-rated, 30-year municipal bond yielded 5.14% this week, compared with 4.42% on a US Treasury 30-year bond.

This latest rise in yields have been prompted by dumping of these securities by hedge funds seeking to cover their margin calls elsewhere, forcing down the prices of munis. The problems faced by sub-prime mortgage debt insurers like Ambac Financial Group and MBIA, who also insure Munis, have also contributed to exits from the Munis market, forcing down prices and thereby raising yields.

Munis typically yield less than the T-Bonds, since its holders do not have to pay taxes. Municipal bonds are considered relatively safe and stable, being the domain of the retail investors who are attracted by their tax-exempt status. But in recent years, hedge funds and foreign investors have become ever-bigger participants in the municipal-bond market, thereby adding volatility to the market in Munis. The high yields will only make it more attractive to speculative and short term capital, thereby making the munis market more volatile.

For hundreds of municipal-bond issuers, the high yields could mean that the cost of borrowing will soar, a problem at a time when tax revenues are coming under strain from a slowing economy. Many infrastructure municipal bond issues on the anvil are being put off due to the prohibitively high cost of capital.

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