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By Ben Baden
Before turning positive in June, muni bonds funds experienced seven consecutive months of outflows
Turn the clock back to late 2010, and all the talk in the investment community was about potential Armageddon in the municipal bond market. In December, analyst Meredith Whitney famously predicted a "sizable" number of defaults in the municipal bond sector, in the range of 50 to 100 that would result in losses of hundreds of billions of dollars for investors. Midway through 2011, not a single rated municipality has defaulted on its debt this year.
Municipal bonds, which are generally regarded as some of the safest investments available, are issued by states, municipalities, or counties, and are usually exempt from federal, state, and local taxes. Since 1970, there have only been 57 rated defaults, including three in 2010, according to
"We've seen a number of what we refer to as 'near misses,'" says Robert Kurtter, managing director in public finance at
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Kurtter isn't ruling out defaults in 2011, but what he's predicting isn't anything close to "sizable." "We do think that there could be more defaults in the general government sector in 2011 and 2012 -- perhaps more than the very low number that there have been, but not widespread at all," he says.
That's because state and local governments are strapped. As the nearly $1 trillion federal stimulus program winds down, most states, unlike the federal government, must balance their budgets through spending cuts, tax hikes, or a combination of the two. "In our view, state and local governments continue to experience unprecedented fiscal stress," Kurtter says. "We've had negative outlooks on the state government sector and the local government sector for three years now."
For 10 consecutive quarters, ratings downgrades of U.S. public finance credits by
Nervous retail investors have responded accordingly. Since November 2010 when the net outflows first began, investors pulled more than $42 billion from muni bond funds, according to
[See 6 Risks Every Investor Faces.]
But plenty of risk still remains in the normally tranquil muni bond market. Last week,
Rob Williams, director of fixed-income research at
Going forward, Sjoblom says, the worst may be over, but investors should still be prepared for more volatility than they've seen in the past. "This is the new environment that we're in after the financial crisis," Sjoblom says. "No one is under any illusions that there isn't credit risk in the muni market. There is credit risk in the muni market."
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