Investing in the High Yield Municipal Market: How to Profit from the Current Municipal Credit Crisis and Earn Attractive Tax-Exempt Interest Income

The Credit Crisis of 2008 and Its Aftermath

By the summer of 2007, the market was set up for a financial “perfect storm.” The same financial counterparties that supplied liquidity to the TOB trade were the primary victims of the subprime mortgage crisis that shook the entire world financial market to its core during the summer of 2008.

While the entire municipal market suffered along with every other asset class, the high yield sector experienced a complete meltdown in liquidity. High yield spreads gapped out to more than 600 basis points, a new historical wide. As usual, the market stress showed up in mutual fund redemptions: A couple of major muni fund complexes were forced to raise cash and liquidate bonds at levels that were 20 to 30 points below precrisis levels. At one point, this was further compounded by selling pressure from closed-end funds trying to unwind leveraged positions. Many of these distressed sales ended up benefiting a handful of major dealers who were able to act as liquidity providers of last resort. (Ironically, one suspects the main reason these dealers could step up to the plate was because they had access to U.S. taxpayer–funded bailout funds!)

Thankfully, just as quickly as it went down, the market rebounded strongly during much of 2009 and early 2010 on the back of the massive bailout effort from the Federal Reserve and the Treasury. Although high yield spreads did snap back from the outlier levels seen during 2008, they remained relatively wide by ...