“Now, however, with many states and local governments struggling to close large deficits, it’s time to acknowledge that defaults could happen, even in large and systemically important municipal issuers.”
Was it Meredith Whitney? A fund that is shorting muni debt? A doomsaying market pundit? Nope. That’s from Pimco.
So how can Pimco and other bond specialists still be launching new muni funds in that kind of risky environment? How can they conclude that the market is mispricing risk by overestimating the size and severity of defaults?
The answer seems to be based on a claim of expert knowledge and forecasting ability. Pimco and others believe that they can accurately predict defaults, protect against losses through selective and diversified strategies, and outsmart the market. It makes sense to invest in munis, in other words, because the market is inefficient, panicked, and over-pricing risk.
I take these kind of claims as evidence of overconfidence. In a series of posts today, I’ll cut through a number of over-looked fragilities in the muni space, political science naiveties, and other blind spots committed by those seeking to reassure investors about investing in munis. I’ll show how concepts such fallibility, reflexivity, and political risk are ignored or misunderstood in the muni landscape. The cumulative effect of this collection of errors is enough to not only undermine the case for investing in munis despite the panic, it suggests that the alleged panic might not yet have gone far enough.
What I’m not doing is forecasting muni defaults or the future prices of muni bonds. In fact, I think my analysis reveals that muni bonds are particularly poor subjects for forecasting. There are too many unknowns and unknowables, including the risk of bailouts that would leave muni bond holders whole.
Next up: Why there’s no such thing as a muni default expert and why that’s a scary thing.
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