Should Investors Be Concerned About Their Muni Bond Portfolios?

Wall Street analysts and the rating agencies (Fitch, Moody’s) are telling retirees and conservative investors not to worry about the increasing volatility and declining yields of their municipal bond portfolios.

Fidelity and Vanguard tell us that default worries are “overblown.” Fitch says munis are Triple-A rated. And T Rowe Price says “the prognosis for an avalanche of defaults is way over the top.”

A host of top tier firms trashed Meredith Whitney for sounding the alarm over a coming muni bond crisis. She’s been on the airwaves in the past few weeks, warning investors of potential defaults in the $3 trillion municipal bond market.

In interviews on CNBC and 60 Minutes, Whitney predicted defaults or restructurings of 50 to 100 municipal issuers, representing “hundreds of billions of dollars.” The Princes of Wall Street collectively scoffed at that notion, quickly pointing out that the record for muni defaults, set in 2008, was about $8 billion.

But wait. Aren’t these the same guys who—also back in 2008—told investors not to worry about the safety of Lehman bonds and Fannie and Freddie preferred stocks? Aren’t these the same guys who told investors that firms like Bear Stearns, Merrill Lynch, Wachovia and Citigroup would always be strong and wouldn’t cut their dividend payments?

They also tell us the States’ (California, Illinois, New York) financial crises cannot be compared to that of Ireland, Greece, Iceland and the rest of the European sovereign economies, which are on life support.

Something tells me investors better be careful or they will get burned again.

For one thing, Chairman Bernanke has ruled out a federal bailout of state and local governments.

Second, we shouldn’t hold our breath waiting for state or local politicians to get fiscally responsible or consider raising taxes to balance their budgets anytime soon.

Third, Whitney simply exhibits too much common sense to ignore. In her television interviews, she said that municipalities are facing a $1 trillion hole in their public pension funds. She also pointed out that municipalities have also borrowed aggressively over the years, overspending $500 million more than they collected since 2008.

Of course, our friends, the Princes of Wall Street, could always “kick the can down the road” by rolling over the municipal debts with new offerings generating huge underwriting fees. But that leaves you—the investor—suffering.

Investors are scared, and have withdrawn more than $22 billion from muni bond mutual funds since the end of October. The exchange traded iShares S&P National Municipal Bond Index fund is down over 5% the past year, and down 9% in three months.

Meredith, I’m with you. I’ve seen this movie before, and the ending seems horrific.

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