Some cities are in desperate financial shape, but its not clear
which ones are. The Forbes article on "gilt-edged" public em[ployee
pensions said the Vallejo bankruptcy was triggered by a double
than normal number of public employees retiring and taking lump sums.
Chicago's pension system is just 19% funded.
Most pension funds report on a June fiscal year, so we'll be hearing
things in the summer.

beliavsky[at]aol.com wrote:
- quote -

I figured you of all people had already dug into this and were aware of
the issue. Agree with your premise that CEFs may have unique
opportunities because of who owns them, and why, so it might be a matter
of doing the homework - and having that done when the buying opportunity
crops up.

I'm aware of one muni CEF that had a recent few-day window where the
price represented a 9% tax-exempt yield. It since has gained over 40% in
value (and is still at a discount, and a yield far above comparable
Treasuries). It's entirely possible the shoe just hasn't dropped yet and
something is still amiss with its ARPS (though not the bonds, which are
priced just fine). But so far it has the appearance of "too many
sellers," in what is at the end of the day a somewhat illiquid part of
the market.

When you think about it, by definition most muni CEF investors should be
higher-income individuals. If that category of individuals faced
abnormally high "liquidity needs" it makes sense that you might find
some odd pricing in the things they invest in. Just a theory of course!

-Tad

On Feb 9, 1:28*pm, Tad Borek <bore...[at]pacbell.net> wrote:
- quote -

Thanks for your comments. Closed end funds cannot pay dividends if
their NAV falls so far that they exceed 2-1 leverage. When that
happens, the CEF suspends common dividends until enough auction rate
preferred securities (ARPS) have been redeemed to get the leverage
under 2-1. Many CEF investors are irrational individuals who just look
at the dividend, and when the dividend is cut, some will sell at
absurd prices. Schedules of ARPS redemptions are posted at CEF web
sites, and if one does some analysis and buys soon before the common
dividends are resumed, one can make money. One CEF where this occurred
is Nicholas-Applegate Convertible & Income Fund II, symbol NCZ.

Igor Chudov <ichudov[at]algebra.com> wrote:


- quote -

But it's not. According to Bloomberg the 30 year treasury is yielding 3.75% and
30 year munis are at 4.86% for AAA general obligation bonds. At a 28% tax rate,
that is a tax equivalent yield of 6.75%. That spread has been narrowing in the
couple of months I have been watching it. Mostly by treasuries going up, some
by the munis going down (in yield).

But I don't think it is fear of default that is driving that. Historically,
defaults have been extremely low. 0.07% for investment grade muni ratings,
not just the AAA we are talking about.

Many investment houses sold munis because they needed liquidity and munis were
easy to sell. There was an unusually high number of new issues last year,
according to Morningstar, which drove the yield up. Also flight to quality
drove treasuries down. So I think that there is an unusual opportunity to buy
munis for both a nice yield and some capital gains.

This Morningstar article makes the case:

http://news.morningstar.com/articlen...aspx?id=271502

it may be premium content, requiring a membership.

-- Doug

beliavsky[at]aol.com wrote:
- quote -


Be sure to understand how the closed-end fund uses leverage. The
"auction rate securities" that are in the news include preferreds of
Municipal-fund CEFs. When those auctions break down and the interest
rate is set at 10%, 12%, etc instead of something like 2%, the CEF is
losing money on the leveraged part of the portfolio. CEF leverage is
premised on borrowing at low short-term rates and investing at (only
slightly higher) long-term rates.

That said I was seeing CEFs recently that looked as if they were priced
for "a Madoff investor or hedge fund needed to sell to raise cash" or
some similar "liquidity event", rather than risk related to leverage.
That's an unknown and a risk factor though. Before buying it would be a
good idea to investigate whether there are "blow-up" scenarios specific
to a CEF - its use of leverage, its reliance on the auction-rate market,
etc. The CEF structure provides some protection because you don't have
the risk of mass redemptions that you do with an open-ended mutual fund.
But I haven't looked at many specific muni CEFs and it's possible the
CEF pricing reflects true risks rather than just "no buyers."

Regarding muni defaults, your main question - while I'm tempted to fall
back on "unless taxes permanently go away, munis always have a fall-back
source of revenue" I could see a cash crisis on a macro level resulting
in suspended interest and principal payments - IOUs for your IOUs. Why
not? CA state employees might not be paid this month so anything is
possible. And there's the risk of hits to principal if the market is
flooded with new issues, to fund deficit spending by states and
municipalities. I also think that such an event would be driven largely
by fiscal mismanagement on the part of the elected officials. CA being
an excellent example of this at the moment.

-Tad

On 2009-02-09, beliavsky[at]aol.com <beliavsky[at]aol.com> wrote:
- quote -

If the munis yield is comparable to Treasuries, even taking tax
deductibility in mind the market does not expect widespread defaults.

Just how many defaults exactly will occur, is open to question, your
guess could be better or worse than the market.

--
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Municipal bonds currently trade at higher yields than U.S. Treasury
bonds of the same maturity http://www.bloomberg.com/markets/rates/ ,
even though their interest is generally exempt from Federal income
tax. The market is pricing muni bonds as if there is substantial risk
of default, much higher than has been seen historically. Another
factor in the high yield of muni bonds is probably the current high
premium placed on liquidity. A bank can be more confident than it can
sell $1 billion in Treasury bonds in a hurry, compared to muni bonds.

Do people think widespread defaults on muni bonds are coming? What
form would such defaults take? I think it is possible that California,
which is months late in producing a budget and which has been
deferring tax refunds, could defer interest payments on muni bonds,
but not for very long, because no state can afford to be shut out of
the muni bond market. In other words, the "recovery rate" of muni
bonds, especially of the general obligation variety, ought to be very
high. By contrast, in a poor economy, the recovery rate of defaulted
corporate bonds can be close to zero.

I don't plan to buy individual bonds. Looking at the closed end fund
listing in today's WSJ, I see single-state muni bonds for the states
of CA, NJ, and MI trading at about 20% discounts and 6% current
yields.
An article on the recent credit downgrade of CA is at
http://www.bloomberg.com/apps/news?p...fer=govt_bonds