As suspected and reported anecdotally, municipal-bond issuance fell off the charts in September and October. Municipal Market Advisors, in its weekly outlook today, notes that such bond issuance was 54 percent below last year’s levels for September and October so far, after having actually increased by 2 percent during the first eight months of the year compared to the same period last year. But what’s the long-term outlook?

Even as things slowly improve from the past two months, municipal issuers may have to get used to a “new normal” that’s not so good for taxpayers.

Why? Municipal-bond issuers around the country, including New York City and State (and their taxpayers), have for the past several years benefitted from the tremendous demand for their bonds. That demand came along with tremendous demand for all kinds of financial instruments between 2003 or so and mid-2007.

Whence did that demand come? Hedge funds and other asset managers that had borrowed massively to amplify their returns were big buyers of muni bonds, as were all kinds of other players on the secondary market. Such institutions weren’t “buy and hold” muni-bond investors, like your grandma might be, but rather bought and sold huge volumes of the bonds regularly to take advantage of tiny changes in prices.

As with anything else, heavy demand kept prices high, and thus yields — the “price” that the issuers must pay in interest costs — low. Sustained low yields benefited taxpayers temporarily, but this pretend-happy era also lulled municipal issuers into floating tremendous amounts of debt.

As borrowing and lending has dried up, hedge funds and other institutions that bought and sold those muni bonds heavily have started “deleveraging” — that is, reducing their borrowing, and thus reducing the assets, including muni bonds, that they could hold with all of that debt.

It is more than quite likely that the muni market, as well as other asset markets, won’t see demand return to levels of recent years anytime soon, meaning years, not months.

As Municipal Markets Advisors says:

In the longer-term, we expected the market is still searching for its ‘new normal’ with higher-than-historical yields, retail-friendly par bonds, wider credit spreads, a steeper yield curve, chronic primary market supply pressure, and thinner secondary-market liquidity.

In plain English, that means municipal issuers will have to pay more to issue the same old debt, even if their credit ratings don’t face pressure due to their own budgetary and economic problems and even if the market doesn’t expect inflation in the US to rise significantly, two factors that certainly aren’t assured.

While you’re paying more for your city or town’s municipal bonds, you may have to get used to less bang for that buck, as well. MMA concludes today by saying that as cities and states have to pay more in the coming years to fund pension obligations as existing pension investment values fall, those same cities and states will have even less money available for infrastructure investments.

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