Municipal securities are called Munies and are issued by state and local governments. There are several types and several risks associated with municipal bonds. Obviously, one of the significant differences between Munies and Treasuries is the credit rating of the insurer. The federal government is considered to be just about “risk free” where as Munies have credit risk and ratings. There have been defaults in some Munies but they are rare.
“Moral hazard”
How many things are out there that the government, essentially the tax payers, are going to have to cover in the event of a disaster? Fannie and Freddie are but two. The underlying issue is encompassed by “moral hazard”. Essentially, if you have put the downside risk on others, you are prone to take more chances. The common example is the insurance that covers a rental car. Once a driver has it, they tend to take more risks and don’t take the care they would if they had to pay for any damage. If the government will bail them out, why not take on risk?
The low interest rate fire
As for subsidizing housing, it’s hard to put that totally in a bad light. Adding liquidity to a market is usually thought of as a good thing and if run properly, they are simply intermediaries between the banks and the investors. In fact, a case could be made that they are very helpful and in some ways subsidizing the banks. They banks no longer hold homeowner debt, they simply pass it on to the market. They have become paper pushers making more on fees than on the carry trade. Therefore their incentive isn’t so much to make good loans, but rather to make a lot of loans. This has lead to a reduction in the credit worthiness of borrowers and the flexibility of loan terms. Those two factors, really add fuel to the low interest rate fire.
Dr. Douglas Rice 