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The Uses and Misuses of Knowledge and Math in Muni Bond Markets


Our world does not lack for self-styled experts—people who claim to have experience, knowledge or systems that allows them to understand and forecast better than ordinary people. But, especially when it comes to municipal bonds, it is clear that our world has an inadequate amount of expertise—actual ability to understand or forecast—to justify these claims

The fallibility of experts probably won’t be news to many people. But it is amazing how persistently deference to experts is demanded and granted.

Experts have many ways of convincing others to defer to them. One is to claim to have access to secret knowledge. In religious cults, this is often the esoteric teachings of God. In finance, we hear a lot about “proprietary portfolio management.” The gist is the same: defer to us because we have special access to truths you do not.

Another method of obtaining deference is the use of mathematics. Many people are intimidated by math and do not understand it well. This often makes them amenable to being persuaded when a proposition is presented to them as a mathematical proof. An alternative strategy is to demand that, say, a bearish pundit produce a “technical” or “quantitative” explanation for the negative outlook.

Both of these play prominent roles in the debate over muni bonds.

Bond fund managers claim that they have experience and systems that will allow them to pick muni bonds that will be unlikely to default.

But since they are unwilling to share these systems, the claims are impossible to evaluate. The only thing for a skeptic to do is shrug.

This is faith-based investing for those who trust the experts.

The demand for quantifiable evidence for the bearish case misunderstands both the available data and its relevance. Since so few defaults have occurred, we lack quantifiable significant data about the causes of defaults. This means that any data about the states now cannot produce a technical or quantifiable case for muni bond optimism or pessimism.

In short, these are attempts to bamboozle and intimidate the uninitiated.


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