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What Dragged Munis Into the Storm

Eaton Vance co-director of muni investments Bob MacIntosh outlines the factors behind municipal bonds' performance.

Eric Jacobson: Hi, I am Eric Jacobson, fixed-income specialist with Morningstar. I'm here today at Eaton Vance with Bob MacIntosh. He is the co-director of municipal investments here at Eaton Vance and Bob, thank you so much for joining us this morning.

Bob MacIntosh: I am glad to do it. Thanks for taking the time with us.

Eric Jacobson: So Bob, this crisis has brought, the financial crisis, that we are in right now has done things with the municipal market that I don't think certainly anyone of your tenure has ever seen before. I know I haven't. Talk to us a little bit about what, you know, how you assess that. What things look like today?

Bob MacIntosh: Well the unfortunate situation is this crisis really came on and no one has been able to really stop it. It's really not a problem with the municipal market per se. We have been unfortunately caught up in this maelstrom and it's so frustrating from the managers perspective because this is not a credit crisis.

There has been obviously other times over the years where credit issues have arisen and that's caused an asset class to perform poorly. Nothing like that whatsoever. This is purely us getting caught up in a liquidity crisis that's something we have never seen before.

Eric Jacobson: So as far as the mechanism for you know what is it that brought municipals, that short of dragged municipals into the crisis if you will?

Bob MacIntosh: Probably the area where its hit us most has been the broker-dealer community, the investment banks of which there are few any more. The one's that did survive have turned themselves into commercial banks now. Along the lines over the past year we have seen a dramatic pull back in their willingness to position bonds, to acts as principals and virtually all of the trading that's going on now is investment banks acting more as an agent rather than a principal. And until we see them come back to more willing to take even a little bit of risk, its going to be a difficult market place.

Eric Jacobson: I think a lot of people have been a little bit surprised you know for one thing as you said, the municipal market has been dragged into this but people have been surprised by the depth of pain that the market has felt. We have been hearing a lot of things about you know hedge funds dumping bonds, structures like tender option bond structures where there sort of not the same thing at all but analogous if you will to the SIVs on the taxable side where there is leverage in a structure that's set up that's been unwound and bonds getting dumped.

Would you point to that as a major factor or are there other things that you think have weighed on the municipal market any more differently than any other market?

Bob MacIntosh: Well that the leverage aspect is certainly something that's pervasive. People didn't realize how much leverage there was out there across all the different investment types or vehicles.

Municipals have had some leverage introduced over the years. Not nearly as much as what's happened in other fixed-income areas and other equity areas for that matter but we did have some leverage and much of that has actually been squeezed out now and we are down essentially to the away type of buyers as we used to call them: the mutual funds primarily.

It has again unfortunate we have caught up in all this because its driven the municipal market place to a relative value compared to treasuries that's, we never could have dreamed at the relative yields of the municipal verses treasuries today. May be that's a combination of treasuries being way ahead of themselves, may be the bubble mentality has moved into treasuries, whatever it may be, its left munis way back and now we are looking for that time when we get back to a more normal and more sane relative value compared to treasuries.

Eric Jacobson: So in terms of getting back at some point to a more, more normal more sane place for the value of municipal bonds, do you think it's going to return to something similar to that we used to see in previous years or is the muni market going to look different going forward?

Bob MacIntosh: I got a believe its going to be very difficult to ever get back to those historical levels. The rule of thumb was on a thirty-year AAA municipal bond, it should have a yield that's about 85% maybe 90% of the long treasury bond. Reflecting the fact that you have a tax exemption.

That tax exemption has not gone away and yet today that same bond compared to the thirty-year treasury is 180% may be even a 190% when you take yield over yield and its absurd. You still get the tax exemption. We think it's a tremendous time to be investing in munis if you have the gumption to do that and now we hope we hope people continue to do that.

Eric Jacobson: Yeah, rough if you had to ride it on the way down certainly but on the other side some value to be had there it sounds like.

Bob MacIntosh: Yeah, yeah absolutely.

Eric Jacobson: Well listen, thank you so much for joining us today Bob. We really appreciate it.

Bob MacIntosh: You are welcome… Thank you.


Eric Jacobson does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.