Tags: Munis | govt | trouble | debt

Money Magazine: Muni Buyers, Beware of Trouble Ahead

Sunday, 30 Sep 2012 02:57 PM

By Michael Kling

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Municipal-bond buyers should beware of more local governments having trouble repaying their debts.

Three cities in California — San Bernardino, Stockton and Mammoth Lakes — filed for bankruptcy this summer, and rating agencies warn that investors should expect more trouble ahead.

"We expect local governments to be struggling with this through 2013," says Robert Kurtter, managing director of public finance at Moody's Investors Service, according to Money Magazine.

Editor's Note: Startling Proof of the End of America’s Middle Class. Details in the Video

Local and state governments have been financially stressed from the recession and housing downturn, which has reduced their tax revenue, especially property taxes. Just this summer, three California cities filed for bankruptcy. Plus, talk of limiting tax deductions for muni buyers in an attempt to reduce the federal deficit is circulating.

With Treasury yields at rock-bottom levels, investors have piled into munis in an effort to chase yield. But they've scooped up risky, higher-yield bonds along with higher-quality munis, not always distinguishing between the two, Money Magazine reports.

In the process, investors have pushed down average yields to 5.9 percent from 7 percent a year ago.

"The bull market in munis has lifted all boats, no matter if it's a dinghy or a cruiser," Marilyn Cohen, president of Envision Capital, tells Money Magazine.

Some strategies for investing in munis, according to Money Magazine, include: sticking to safer munis with AA or higher ratings and dumping low-quality ones since they don't offer appreciably greater yields; avoiding 30-year munis because the extra return is probably not worth locking up your money for long terms and choosing intermediate terms between seven and 15 years; opting for general-obligation bonds, which are backed by taxing power, or bonds backed by essential-service revenue like water and sewer services.

And if you own munis, keep close tabs on the local governments' finances.

Munis are showing signs of stress, with cities and counties declaring bankruptcy and financial emergencies, writes Gregory Wallance, a partner at Kaye Scholer law firm, for Forbes.

The market depends on investor confidence, and that should not be taken for granted, Wallance warns.

Warren Buffett's Berkshire Hathaway reportedly terminated credit default swaps that insured $8.25 billion of municipal bonds.

"When the shrewdest investor in America pulls back from a major market, attention must be paid," Wallance writes.

Editor's Note: Startling Proof of the End of America’s Middle Class. Details in the Video

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