Municipal Bonds

Municipal bond prices have been weaker over the past several months due to ongoing negative media attention given to the potential for rising defaults.  Investor nervousness about the potential for more defaults has led to redemptions from municipal bond funds, and selling of individual bonds.   

We believe many of the media reports and negative commentaries have greatly exaggerated the potential default risks.  Yes, careful credit evaluation is more important than ever and challenges do exist in many states (California and Illinois) and cities (Vallejo, CA and Harrisburg, PA).  However, in our opinion these examples represent localized problems, not systemic risks that will lead to wide-spread defaults across the entire municipal market.

Crossroads

Our country is coming closer and closer every day to financial crossroads that must eventually be faced.  Two options as to the path we take to move forward have emerged- one that closely resembles the path we are on today (and have followed in the past) and a second that takes a hard turn in a different direction.  There are vastly different opinions on which of these paths is most appropriate for the country going forward. 

Home Prices

Even though we’ve seen home prices decline 24% over the past 5 years, two key home indices show that prices nationwide are continuing to trend lower.  We saw a drop in prices last year due to the expiration of the homebuyer tax credit.  Now, home prices are being driven gradually lower by foreclosures and the ongoing imbalance between high supply and low demand. 

Current banking reform proposals requiring at least a 20% down payment are good for the long-term health of the housing market; however, it would surely lengthen any price recovery.  First-time buyers will find it harder to get on the property ladder and existing homeowners will find it even harder to move up. 

We’re not sure if home prices have bottomed yet, but affordability is certainly at the most attractive level we’ve seen in 30 + years.  Between 1979 and 1990 the average interest rate on a 30 year fixed rate mortgage was at least 10%.  Today the national average for a 30 year fixed rate mortgage is 4.8%.  A popular home affordability measure calculates that the average family will spend roughly 12% of their household income on mortgage payments this year.  Compare this to the early to mid – 1980’s when the average household spent closer to 35% of their personal income on mortgage payments.  This historical comparison shows the magnitude of affordability changes. 

Home prices are important for one key reason - they affect consumer confidence.  If we see a significant further decline in prices and subsequent declines in consumer confidence it could slow consumer spending and challenge our economic recovery.  This makes home prices an important indicator going forward.

Sources:  HUD, Freddie Mac, Case-Shiller, Capital Economics and JP Morgan.