This weekend's The Economist had an article about municipal bonds titled: 'The Mortgage Parallel: Nerves jangle again in a huge and supposedly stable market.' Dr. David Krause, AIM program director stated, "The unfunded pension liabilities and growing structural deficits of state governments have been a ticking time bomb the past several years. While not yet a crisis, the risks in the muni bond market are substantial and the credit risk premium is likely to rise in the near future. Muni bond prices have dropped the past two weeks."
From The Economist: "America’s $2.8 trillion municipal-bond market was rocked in the crisis of 2008. It regained its poise, however, and has rallied strongly in the past two years. Now a sudden jump in yields (and drop in price) has renewed fears that the main source of finance for America’s 50 states and thousands of towns and cities is ripe for a crisis all of its own. Investors have long been drawn to “munis” for their supposedly steady, largely tax-exempt returns. This month, though, municipal-bond funds have seen their first weekly net outflows since the spring, estimates the Investment Company Institute. Some leveraged funds fell by more than 10% in a few days. As the market grew more volatile many fund investors fled on the assumption that there’s no smoke without fire.”
Dr. Krause said, "The recent California $10 billion bond sale went out at higher yields than expected. Other state governments are borrowing heavily from the federal government to keep paying unemployment benefits California borrowed nearly $8.8 billion in mid-November. Municipalities are running almost $600 billion in unfunded pension liabilities - on top of the nearly $3 trillion in statue unfunded pension liabilities. The markets are just waking up to the facts. Philadelphia, Boston, and Chicago will all see their pension funds run out of money by 2020. The Irish debt crisis has forced muni bond investors to look more closely at their own government bond portfolios. This is likely to continue to be a growing story the remainder of the year."