Why Retirements Are Going Bust, Again

Forget 2008… We’re seeing the worst hit to retirement accounts right now!

Mutual funds, specifically tax-exempt funds, have long been favorites among near retirees. With the clock ticking, where would you go for an edge on retirement building? And if you could find tax-free, high-yielding, considerably safe income, wouldn’t you take it?

Unfortunately, those who bought into this line of thinking over the past several years have just rudely awoken to a major collapse.

Many municipal bond funds offer investors a tax-exempt source of income that is backed by the full faith and credit of US cities and states. These, in turn, have an implied backing by the federal government. (After all, would Obama really let California break off into the ocean?)

And with a gigantic slew of near-retirement-aged baby boomers, weak interest rates, and 2008’s stock performance stuck in the back of investors’ minds, the municipal market has looked as sexy as ever. Over the past two years, we’ve seen nothing but cash inflows into muni funds. But that trend has reversed with a vengeance.

We’ve noted the recent outflow of bond funds in weeks past. But that was just headline stuff. A mere sampling of the pain funds in general have felt. Here’s what the muni universe has looked like:

Weekly Net Investment Flows Into or Out of Muni Bond Funds

Quite a hit. And of course, when a panic like this starts, bottoms can be a tricky subject.

The muni market isn’t a clear one. We’re not saying it has no transparency. We’re saying that often, no one can really make heads or tails out of the figures. But here are the steps, as best as anyone can understand so far, that caused this two and a half month panic.

First, we saw a QE2 build up. We discussed this program before. But quickly, it simply opened up a pile of $600 billion (plus another $300 billion potentially) to buy up medium-term Treasuries. In theory, this should push yields down, spitting more cash into the rest of the economy, nudge the inflation rate higher, stimulate job growth, and save the planet from a flesh-eating super robot. Okay, one of those things wasn’t part of the deal. Nonetheless, what it did was virtually nothing…so far. But the anticipation of the program led investors out of the muni market and into Treasuries.

After QE2, the new threat to city and state debt was the potential end of the Build America Bonds program. Then the actual end of BAB. And it certainly doesn’t look like the new “deficit-conscious Congress” will inspire similar attitudes at the state government level any time soon.

In this time period, we also had a number of rating downgrades and bad press, such as the rating cuts to San Francisco and Philadelphia. We saw threats to California and Illinois as well, even going so far as comparisons to Greece and Ireland.

Sure, all of these factors, combined, led to some of the muni outflows. But all they really did was lightly nudge the giant calamity of muni investor losses down the giant figurative hill.

Once investors started pulling out of muni mutual funds, the funds had to sell some of their muni bonds. That led to a decline in actual muni prices…which led more fund investors to sell. This circular pattern is actually still happening. Take a look at this:

Plummeting Muni Bonds, as Represented by iShares

Even if you know nothing about charts, you can tell this ain’t pretty.

This chart represents the past nine months of trading of the iShares municipal ETF. It tracks the most popular municipal bonds on the market. And since the first week in November – which corresponds to the first week of fund outflows – all bets have been off.

All the technicals, all the support, all the buyers have turned away from the municipal market completely. And this pattern may continue for some time. Of course, as we noted above, no one can truly read the muni market 100% of the time… That is especially true now.

So what does this say? We don’t know. There seems to be two drastically different points of view in the press. That much we do know.

Meredith Whitney, the “genius” that called the banking crash of 2008, went on 60 Minutes last month claiming that the muni market will see more defaults than anyone can imagine. She called for “hundreds of billions” in losses.

As widespread as that show is – and her own newly-acquired following – it wouldn’t surprise us if some of the recent selling came from that interview. And we’re even less surprised by the backlash it caused in the rest of the media.

Joe Weisenthal, a largely-followed and highly-syndicated author for Business Insider, struck back at Whitney, claiming the free fall in muni prices is 100% attributable to the downward selling spiral we summed up above, which he called “the feedback loop”… instead of actual risk of defaults.

Charles Gasparino wrote on Huffington Post that Whitney needed to “finally come clean.” He wants her to show her evidence of the “hundreds of billions” in losses prediction.

Celebrity (kind of) economist David Rosenberg went so far as to claim that the muni market fall is “a huge long-term buying opportunity”.

And who knows? Maybe they are all right. We expect muni funds will find a bottom at some point. And then, just as quickly as they stabilize, they’ll fall again on actual news of defaults. It won’t take much in the way of a real scare to truly collapse these investments.

Regardless of their future, the point is: we’re entering into panic mode on some of the best performing and hottest assets for pension plans, 401(k)s and IRAs. Pensioners are no doubt beginning to reel again.

We’re keeping a critical eye on this whole situation. And, of course, we never stop looking for solutions.


Jim Nelson
for The Daily Reckoning