Kotok: Why You Should Buy Munis Now

July 31, 2013


Kotok (cont’d.): We see this coming; we lower our bids in price substantially, and we watch the distressed seller forced to sell to people like us.

And so for our clients, we obtain great bargains. You cannot do that in the ETF mutual fund space. You can only do it in separately managed accounts. That’s why we don’t go into the ETF mutual fund space when it comes to munis.

IU.com: What about what Detroit is doing with possibly mixing general obligation bonds and revenue bonds? Is that something to be concerned about?

Kotok: Well, what the emergency manager is trying to do in Detroit is two things. No. 1, he's trying to lump all types of bonds into one pot and say they're all unsecured credits and we'll treat them all alike. There's a long history of a priority of liens, a first mortgage versus a second mortgage, a senior lien versus a junior lien. Bonds were sold, descriptions were made, documents were prepared, official statements were made public on these various structures.

The emergency manager's trying to throw all that out. Whether a judge will permit him to do it is a separate question; we're going to find out. But the fact that it’s been proposed is a shock to the muni market because the muni market operated for decades under the assumption that if you had a first lien, you had a senior claim relative to a second lien. And the emergency manager in Detroit’s trying to change the rules after the checker game started. That's the metaphor for what's attempted now.

IU.com: And are you suggesting he doesn't have a chance to get away with this?

Kotok: I don't know. Now, once you're into the realm of a judge having to arbitrate differing claims and there's an appeals process and you're in a legal system and the legal system is Michigan law, you're into a new area. And what the emergency manager is doing with the Detroit proposal is causing bond buyers to alter their assessment of risk on everything in Michigan because if he succeeds, then something else in Michigan is now suspect because of a change in legal structure.

IU.com: Now, this goes beyond Detroit and Michigan, and to places like California.

Kotok: Yes. I was going to get to that. We have a number of cities in California that are using California legal structures and bankruptcy to reorganize themselves. Now, this fight in California is unresolved. When it's resolved, it will be resolved by judges and courts and a legal process. Therefore, there's a risk profile in California today.

Illinois is a different state. It’s the state poster child for the weakest credit in the United States. It doesn't fund its pension obligations. The legislature is at a political stalemate. The amount of unfunded liability grows, and we see this constant debate in Illinois, and it, therefore, is carrying the weakest of the state credit ratings. And there are good reasons behind that.


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