Alexandra Lebenthal and Meredith Whitney Square off in Muni Land

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Alexandra Lebenthal and Meredith Whitney are squaring off over municipal bonds.

Both are lovely ladies—and as tempting as it is to strike the cat fight note—there is a substantive story here. (Note: Lebenthal isn't making the metaphor easy to ignore: She's challenged Whitney—and I quote "on TV [or] outside in the school yard".)

Among those substantive issues, quite a few seem to be getting glossed over in the mainstream press.

First, the big picture—beginning with the background: A few weeks ago, Meredith Whitney predicted defaults by up to 100 municipal issuers—representing "hundreds of billions" of dollars in debt.

Alexandra Lebenthal has been in the municipal bond business for decades.

(She was born into it, actually.)

Based on that experience, Lebenthal makes some excellent points—about why a huge raft of municipal defaults is unlikely.

Again, from Reuters:

"For one thing, bond holders have long enjoyed strong protection in the courts, she said, even when New York City teetered in 1975. They come first in line ahead of police, fire, trash collection and other obligations, she said."

Getting paid ahead of essential services workers is a very good thing for investors. (Such provisions are typically explicitly spelled out under the terms of the indenture.)

Another solid point made in the Reuters article: "The rate of defaults on investment grade muni bonds has been "minimal" going back to the Great Depression because governments can raise taxes and cut spending. Moreover, tax receipts recently have started to revive, she said."

Of course, that argument is only true of GO's—general obligation bonds—which are typically backed by the unlimited taxing authority of the obligor.

But there are other types of bonds included in the municipal securities universe.

Perhaps the best known among them is the revenue bond—often shortened to just 'rev bond'.

Rev bonds are backed by the cash flow of a specific project. (An example of this would be a toll road or a sewage treatment facility.)

If revenue from the project collapses, the issuer may become unable to pay principal and interest on the bonds. In the case of a revenue bond, there is usually no recourse to the taxing authority of any actual state or municipality.

Which, for the bond holders, is a very scary proposition.

Sometimes the sheer number of municipal debt structures can seem dizzying.

There are also, for example, 'moral obligation' bonds —which declare that a government body has a moral obligation to support payment to bondholders if the cash flows supporting a security should falter.

But how that so-called 'moral obligation' will shake out —if and when the going gets ugly—is really anyone's guess.

That many investors have never thought about these kinds of issues before is testimony in itself to how safe the municipal bond market, historically, has been.

But the broader point maybe this: Municipal bonds are not a monolithic market: It's a complex and richly ramified constellation of securities. Look forward to hearing far more about these distinctions—more than you ever wanted to know—if market conditions continue to deteriorate.

(Disclosure: I learned about the municipal bond market while working at a broker/dealer specializing in municipal securities several years ago. I no longer have any formal affiliation with that or any other financial institution.)


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