Muni market showdown

In one corner, you have Mr. Market himself. He's composite of stock market participants from mom and pop sitting at their computers, speculating on everything from Netflix to the Double Short Euro ETF, all the way up to massive Wall Street mutual fund houses like Fidelity and Vanguard, whose managers try to earn bonuses by tracking some index or other...

And opposite them, you have Interactive Data, a company that prices municipal bonds (among many other services). Muni bonds need this type of service because most of them are illiquid.

They're having an altercation, and Mr. Market is winning.

According to information from this morning's The Bond Buyer, buyers of the muni bond ETF understand muni bond valuations better than the math whizzes at Interactive Data.

Muni bonds are notoriously illiquid. But bond salesmen need a price they can quote to their clients. So they hire Interactive Data to provide one for even the most illiquid bonds. If you're a bond broker, you don't want your clients calling up asking why their investments are tanking. You want to tell them everything is OK. So Interactive Data has a strong incentive to skew its pricing upward.

I'm not saying Interactive Data is dishonest... just that valuation is not a science, and Interactive Data probably sees the glass as perpetually half full.

Yes, the Kansas City Fed's Financial Stress Index (KCFSI) is back to where it was in mid-2007. (And you know how wonderfully everything turned out shortly thereafter!) It's showing a negative value, which means the overall level of financial stress is below the long-term average. So... things are better than they've been in three years, and better than they normally are. Oh, happy day!

One of the inputs for the KCFSI is the yield spread between on-the-run and off-the-run 10-year Treasury notes. "On the run" is the most recent issue, and the most liquid. It should trade at a slightly higher yield than the next most recent issue, since it's a slightly longer maturity bond. The on-the-run/off-the-run 10-year Treasury spread is showing a higher level of financial stress than any of the other 10 inputs of the KCFSI. In other words, other indicators show financial stress falling, but not Treasury spreads.

The input showing the least financial stress was the spread between triple-A bonds and 10-year Treasurys. In other words, the love affair with bonds was alive and well last quarter. The index is saying that, as long as investors are jubilant, it's happy.

But the establishment "gods" routinely fail to show up. There's no price stability. There's no maximum employment. There are no great returns for the army of retail investors the Street fleeces for its living. There's no Great Society for the taxpayers government fleeces for its living. There's no safety for Treasury holders or muni bond investors. It's all a massive lie. And it's all falling apart.

A record 2.87 million people received notices of default, auction, or repossession in 2010 – a 2% increase from the year before. And banks seized more than 1 million homes in 2010 – up 14% from a year earlier and the most since the company began reports in 2005. Since the peak of the housing boom in 2006, around 3 million homes have been repossessed. Sharga says that number could double to 6 million by 2013 as the market may "absorb the bulk of the distressed properties."

Currently, 5 million loans are seriously delinquent but not yet in foreclosure. Banks have had to delay foreclosures as the government looked into their lending practices. Last quarter alone, banks delayed 250,000 foreclosures that should have happened. Eventually, these loans will work their way through the system unless the borrowers fix everything – unlikely considering employment is still more than 9% (445,000 people applied for unemployment insurance last week... up 35,000 from the previous week).

"Former governor, Rob Blagojevich, was reportedly sending IOU's to nursing homes because the state did not have any money to pay the nursing homes money needed to care for the elderly. Imagine the ensuing riots that will come when children find out that mom and pop are being left to die because of their failed government's attempt to paper over their obligations to those who likely suffered through the last great Amercian Depression as children and now have to suffer through as elderly.What a way to remember your life as an American citizen." – Paid-up subscriber SR

"(a) It is, of course, not bad to aspire to achieve a monopoly but to sell a product that actually damages competing products seems to verge on criminal behavior. Their 'Terminator' technology makes plants which produce sterile seeds after one season. This means that farmers have to buy more seeds for the next harvest. Such is a major cause of inflating ag produce prices. Check it out as there is a lot more than meets the eye.

"(b) Also, during human consumption of GMO produce, these GMO modified foods affect individual human physiology. A study of people in the Philippines reported that their bodies developed antibodies when GMO foods were ingested. What this means is that the human body processed these GMO engineered traits into their guts and reacted by developing antibodies. This is generally not good, but it is life threatening to people like myself which have anaphylactic reactions. I have been hospitalized with an anaphylactic reaction to a natural substance (no fun); I don't want to tempt fate with an unnatural possibility.

"So, I am very negative to companies which I believe are charging ahead with both economically and psychologically dangerous products. There is certainly more to investing than making investments in what some might consider 'pirate companies.' You might even stand to lose some credibility!" – Paid-up subscriber Bud Wood  

Porter comment: We'll take our chances. I think you speak for the crowd when you say, "I am very negative to companies which I believe are charging ahead with economically and psychologically dangerous products."

In this regard, we simply disagree.

All great innovations are "economically dangerous." Ask the former long distance providers how they feel about urbium pump lasers and wave-length fiber optic cables. Those are the new technologies that made long-distance an antique business.

Your argument is the core of the Luddite position. You're afraid of something simply because it's new and it upsets the previous social order. But like it or not, Monsanto's technologies have vastly improved crop yields and greatly reduced farming expenses. If they didn't, farmers wouldn't flock to their products.

These technologies – while potentially dangerous – are also potentially life saving in the many places around the world where food is scarce.