Lawrence Carrel
In a normal market movement, that [hedge] works fine," says James McCullough, senior regional sales manager for the Aquila Funds' (OFTFX Quote - Cramer on OFTFX - Stock Picks)Tax-Free Trust of Oregon (ORTFX). "But we have an abnormal market situation and in that these best-laid plans don't work."
The selling reached a crescendo around midmonth, when one player reportedly offered $300 million in long-term muni bonds for sale. Investors unloading large quantities of bonds typically try to break them up into smaller chunks and spread the trades out over several days to avoid disrupting the market. They may even parcel the trades out to multiple brokers. Putting such a large amount of bonds up for sale at once smacks of desperation. The offer had a profound impact; liquidity in the muni bond market, which is normally relatively active, dried up. Thomas Doe, president of Municipal Market Advisers, says that the following day, there were no buyers; investment banks were telling their trading desks not to buy at any price. "We haven't seen a day like that since 1994," he says. Selling by hedge funds and prop desks isn't the only thing hurting munis, however. Local governments have also flooded the market with a record amount of new issuance. For the first half of the year, short- and long-term municipal securities issuance from state and local governments surged 27% to an all-time high of $249.0 billion, according to the Securities Industry and Financial Markets Association. "It was a perfect storm," says Bryan Williams, managing principle at Rockwater Hedge, a managing member of municipal arbitrage hedge funds in Newport Beach, Calif. "The dislocation that occurred was greater than 9/11 or the Asian crisis in 1998. We can't find any historical parallel for this. Because [the market's] being sold for other reasons than value, triple-A municipal bonds are mispriced and this has created a tremendous buying opportunity." For the first time in years, the yields have diverged, with munis paying a higher interest rate than Treasuries. Typically, because the interest paid on Treasuries is taxed, they yield more than munis. "This is a very good opportunity to buy munis," says Bill Walsh, president of Hennion & Walsh, a Parsippany, N.J., broker-dealer that specializes in muni bonds. "If you invest $100,000 in both munis and Treasuries and they both pay 5%, that's $5,000 at the end of the year. But a New York state resident gets a triple tax deduction (local, state and federal) with a New York muni, making that worth about $8,000 of a taxable bond." Williams of Rockwater Hedge says triple-A munis are likely to recover faster than some other asset classes that have been battered by the mortgage bond crisis, such as stocks. "The likelihood of another selloff is high, but it won't be huge. The smart money will move back into munis in a big way in the near future. So, if you're looking to make an investment in munis, the prices could get a little cheaper, but the price today is very good."
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