Recently, I have been following an analytical debate on both the wisdom of investing in municipal bond funds and the potential for solid returns. One side says that investing in these bonds at this time is sheer lunacy, as a tsunami of defaults are coming to governments at the state and local level. The other says that is unlikely, so muni-bonds are an excellent investment. Up until a couple months ago, I agreed with the latter position, but now, as I watch extreme politics play out everywhere, I am rethinking my position, which makes the question below quite timely.
What about highly-rated “high-income” muni bond funds. Are they a bargain or “value trap?”
The question above is so general I cannot answer it with specificity. What state are we talking about, what municipality, etc.? Furthermore, the municipal bond market is complex, so you had better understand it before plunking any money down. To help with that, I suggest going to the following website to start your education (http://www.publicbonds.org/public_fin/default.htm).
As I wrote just a moment ago, a couple months back, I would have argued in general municipal bonds, and thus bond funds, were and will be a good investment. As I understand it, federal law prohibits states from going bankrupt, which is a good start because local municipalities are not so constricted. Generally, as the federal government has bailed out states, the states have bailed out municipalities. Again, generally, this has kept the municipal bond market relatively safe as an investment; however, for those who can remember …
The most infamous default cases … include New York City’s default in 1975 and Cleveland in 1978. The largest default in the history of the municipal bond market was the Washington Public Power Supply System’s (WPPSS) default on $2.25 billion in bonds.
So, it can happen, but when it does, a safety net is there to catch most all investors.
In the event of a default, bondholders seldom lose all of their principal value of the bond. Often, a default could result in the suspension of the coupon payment. Defaulted bonds can become speculative as they can be purchased cheaply. If the issuer files for bankruptcy but reemerges successfully, then anyone who purchased the bonds when the company was in default stands to gain from the transaction.
As you all know, when it comes to my money, politics stops at the water’s edge. Nevertheless, facts are facts. Back in January Newt Gingrich (potential GOP presidential candidate), proposed changing the federal law that prohibits states from going bankrupt. More recently, some GOP run states have proposed and passed legislation that would force cash-strapped municipalities into bankruptcy with no reprieve from those states. Along with the tax and spending cuts taking shape in those states, it is likely those states will suffer even more financially, so, my advice is to see how the politics play out before investing your hard-earned dollars. If the rising extreme tide is pushed back, then, and only then, consider adding municipal bond funds to your portfolio.
Trade in the day – Invest in your life …
