Debate over potential fixes for the "fiscal cliff" has thrown the municipal bond market into turmoil, but the selling may now be overdone, Alexandra Lebenthal, CEO of Lebenthal & Co., told CNBC's "Squawk Box" on Monday.
"What has happened is that the latest round of proposals not only had this 28 percent cap on deductions which would include munis, but it would be all retroactive," said Lebenthal, whose firm specializes in municipal debt. That would mean that all muni bonds outstanding would be subject to the cap on taxable deductions.
"It's throwing the market into real turmoil," she said, noting that muni yields have risen about 39 basis points in recent weeks compared with a 29 basis point rise in Treasury yields.
Lebenthal also said brokerage firms have been telling investors to sell all fixed-income securities after the huge gains they've had this year to avoid much higher capital gains tax rates next year. That, Lebenthal said, has added to the downward pressure on muni bond prices.
While Lebenthal does not expect a tax fix for the automatic spending cuts and tax increases that hit on Jan. 1 to be retroactive on all munis, she does expect a 28 percent cap on deductions, a move that may make the tax benefits of munis less attractive.
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Municipalities would also find it more expensive to borrow. "It's really the governors, mayors, cities and states who are going to say, 'Hey, this is going to increase our cost of borrowing. We're barely coming out of recession. You can't do this to us,'" she said.
Lebenthal said the muni market looks oversold right now and that yields should come down.
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California has been one municipality that has outperformed this year, Lebenthal said.
On the flip side, Puerto Rico is in what Lebenthal called a "sad situation." It has $67 billion in debt outstanding and its debt-to-GDP ratio approaches "Greek-like levels." She also said they went so far as to issue bonds to pay their interest payments.