Published on January 14th, 2011 | by Leonard Jackson


Should We Still Own Municipal Bonds?

Municipal bonds, which have always been the cornerstone of any conservative investment portfolio, are going through a period of uncertainty and for the first time in our memory are causing investors a certain amount of anxiety. Many investors or I’ll venture to say, most investors with substantial holdings in municipal bonds bought them to hold not for just a rainy day but forever. A typical bondholder considers his/her bonds their real, serious nest egg. Stocks and other investments, with the exception of real estate, are for investment opportunities or ventures; bonds are sacrosanct – not to be tampered with or sold.

But a combination of events in recent months has caused some doubts never considered before. Who could have imagined not so long ago that more than a few cities and states are in serious financial trouble today? These are not the usual predicaments that the states of New York, Illinois and California have lived in for the past century and could usually tax their citizens enough to kick the problems down the road for the next generation. These problems are not as “easily fixed” as before. The customary sources may be running out and talk persists about federal government bailouts and rescue strategies.

The Obama administration included in the 2009 stimulus the Build America Bonds program which is a new type of bond that is not tax exempt, but carries a direct federal subsidy of one-third of the interest payment. Predictably, the weakest states, California, Illinois, New Jersey and New York accounted for half of the BAB handouts. California with the lowest bond rating in the country issued $30 billion. The extension of this bond trader’s cornucopia was not included in the new tax deal so it may appear that it is gone. But $174 billion of debt was issued and $1 billion of fees were created (Goldman Sachs, of course, was the largest underwriter) so I wouldn’t consider this quite over yet – subsidies don’t usually disappear permanently in Washington.

The recession has affected people in many different walks of life and credit worthiness has again become of utmost importance in evaluating individual bonds and total portfolios. Every city, county, state and their respective water districts and utility service districts bear examination now and each must stand alone on its own financial conditions.

In earlier days Moody’s Investment Services published for subscribers a record of every municipal bond issue that had sold in the last 50 years. (Don’t hold me to that number, but it went way back and came in two volumes the size of library dictionaries). It was updated each year and included all the financial information of the issuing entity: outstanding debt, history of debt payments, mayor/governor or city/state officials and the largest taxpayers as well as the pricing of the winning bid, who bought it, who wrote the legal opinion and any other pertinent information. Many of us spent a great deal of time poring through those pages evaluating bonds that we were buying or selling. All A rated bonds were not the same.

In 1973 it was decided that municipal bond insurance would be a “protection” for investors as well as an excellent way to create fee revenue that would be paid eventually by the issuing body. We now had almost every issue guaranteed by a consortium of insurance companies. Unfortunately these companies, like so many others, overlooked the sub-prime mortgage fiasco and now have ratings like Caa2 and Ba3 and one of the big groups in now in bankruptcy proceedings.

Today the Municipal Securities Rulemaking Board (MSRB) has their Electronic Municipal Market Excess (EMMA) available online and the old Moody’s volumes are replaced by a much easier method of obtaining the same vital information needed for investing information. But this information means a great deal more now and investors should use it to examine any bonds they own or anticipate owning.

Another red flag has been raised with the announcement that UBS AG has begun making a market in derivatives tied to municipal bonds and other securities. Also Bank of America, /Merrill Lynch, Citigroup, Goldman Sachs JP Morgan Chase, and Morgan Stanley. Hedge Funds looking for the next sub-prime debacle are buying trying to profit from a muni disaster. When trading is being done in credit default swaps someone at least thinks there is a possibility that some bonds will default.

This is not a sell recommendation for all municipal bonds by any means. The right bonds are still as solid an investment as any security in the market place. But as President Reagan once said – “Trust, but verify”. This is good advice for many actions today and owning municipal bonds has become one of them.

About the Author

As I prepare my “reentry” into the e-world of blogging, I am advised that I should provide my prospective audience with a brief biographical résumé covering my life’s work and future aspirations so that I, and my work, can be properly categorized and thus judged in the proper venue. Since I will be joining a new group in just a few short months, it came to my attention that for a quick summary I can cover my life span in 20 year segments that pretty well sum up the route that I took to get to where I am today. In December, the Lord willing, I will become a member of that esteemed group known as Octogenarians. . Now that may be a disturbing, even scary, pigeonhole for some folks to find themselves assigned to, but I’m beginning to realize some real benefits from being maturity advantaged. The first 20 years I grew up, was educated and began my married life and my career. Second period was about 20 years in the cotton business in Memphis, TN. Trading this commodity in the world’s largest inland cotton market. Third period was spent in the municipal bond industry in Memphis, Houston TX Chicago and finally to my present home in Kansas City, MO. The fourth 20 years I served as a registered investment adviser to a number of individual clients which I continue to do in a semi-retired capacity. In addition to all this, over all these years, I have been blessed with a loving wife of sixty years, four children, four grandchildren, two great grandchildren, and a menagerie of grand horses, dogs, cats and a donkey. Providentially, none of these, except of course my patient wife, are still living in the family home. And now the fifth period will be consumed in my new career. For the first time in all the years I have an opportunity to share my opinions with the world. I can truly express my thoughts without regard to any extenuating conditions. I can just say how I feel about any subject. How liberating. Let the blogging begin!!!! By the way – what I do in the next period remains to be seen and depends on how well I do in the fifth period.

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