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Thread: weekend commentary ... are muni bonds now worth thinking about ?

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    Default weekend commentary ... are muni bonds now worth thinking about ?

    As particular states are beginning to suffer major shortfalls in sales tax, income tax and property tax revenues, many are moving into a situation of deficits. At the same time, states are discovering that their muni bonds are no longer viewed as 'totally secure', and thus are now commanding interest rate premiums. As a resident of New York, which already has a fairly stiff state income tax rate, and with pretty good odds that the state income tax rate must be increased in 2008 in order to balance the state budget (in the absence of cuts in gov't spending of course), the equivalent after-tax rate of return available on new New York muni bonds (which are exempt from federal + state income taxes) is really starting to rival and is likely to exceed available interest rates on fully taxable CD's.

    thoughts ?

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    Default Re: weekend commentary ... are muni bonds now worth thinking about ?

    They'll just pay the higher interest robbing one creditor to pay another until it finally all falls apart.

    If they cut back on food and stuff there will be immediate bitching.

    If they cut back on road repair, etc. people won't notice until bridges start falling down.

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    Default Re: weekend commentary ... are muni bonds now worth thinking about ?

    I see where you are coming from. In theory, it should be a safer investment instrument for a similar return.

    However, in the current climate, are any class of bonds such a good idea. Leave aside the heightened possibility of default from many different types of organisation for this, that would add another level of complexity. And you did mention above that they are no longer considered the safe ground that they once were.

    But, in the current climate - increasing inflation in an era when inflation generally seems to be denied - aren't bonds a tough place to make a living. Even if it index linked, in the current world it will be falling behind real inflation.

    But if it isn't index linked, I'd be concerned that I was about to have the linings torn from my pockets.

    The only part of your description that I liked was that the bonds will be immune from federal and state income taxes. But an investment should never be made if it is relying on tax benefits to justify itself.

    If you have a page that discusses the NY muni bonds in more depth so that I can understand them a little better, I'll be happy to take a look and offer an opinion. If you want...

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    Default Re: weekend commentary ... are muni bonds now worth thinking about ?

    The only part of your description that I liked was that the bonds will be immune from federal and state income taxes. But an investment should never be made if it is relying on tax benefits to justify itself.
    unfortunately, this principle of investment where tax advantages overshadow economic fundamentals is endemic to the American 'uber-rich' ... and is also arguably the only reason that ethanol production / wind power / photovoltaics and a host of other tax favored industries are able to continue to attract investors.

    There is one other point I should mention re muni bonds that has recently minimized the risk to potential muni bond buyers... which was all over the US news but which may not have been covered in European financial media.

    yes I would definitely appreciate further opinions on NY muni bonds. It may be helpful to start with

    I would also interject that the effective combined US federal + NY state income tax rate the muni bonds would be exempt from will be at least 33%. This percentage could increase significantly though if Democrats wind up winning the 2008 elections and use their filibuster proof majorities to pass tax increases on the 'rich' (which arguably affects single Americans earning $75k)

    A small sampling of some of the NY muni bond deals available can be found at . Of course the minimum 'buy in' for a direct bond purchase is typically $5000 sometimes more for the highest yielding munis. There's also a plethora of NY muni bond mutual funds that are also tax free -

    As I said earlier, I'm not particularly looking to buy existing bonds. I am more interested in snapping up new bond issues that will take place when the NY state gov't must 'go to the well' in 2008 in order to balance its budget in the face of rapidly falling tax receipts from wall street businesses and workers ! I would also look towards a NY muni bond mutual fund because of its much greater liquidity, as well as its future ability to boost returns as new NY muni bonds are issued with higher interest rates.

    ~
    Last edited by Melonie; 01-06-2008 at 04:07 PM.

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    Default Re: weekend commentary ... are muni bonds now worth thinking about ?

    Interesting about both Buffett and those bond articles.

    I see now where you are coming from re the equality or better with other bonds already out there.

    The question you need to ask is then simply this. What do you think is going to happen to interest rates? I don't know if you have been a bond investor in the past - knowing you, it is too low risk ;-) - but as far as capital value goes, interest rate movements are very important.

    If rates fall, the capital value of the bond will / should rise. From what I can see, this is a tough time to be making that guess. Oil and food price rises are inflationary and central banks are generally charged with keeping inflation low. To do that they need higher rates - no matter what the housing market may want.

    On the other hand, the world and his wife want interest rate cuts to help them out the financial squeeze they are in.

    Are capital gains on an investment like this taxed? I don't recall reading that in the links you provided...

    So that is issue one. Issue two relates to my above post and inflation relative to the actual return on the bonds. If inflation is much higher than stated - as we believe - then buying a fixed return of below that is going to ensure that your interest payments do not keep up with actual costs. That could be very painful too.

    But you know all this already...

    What is the plan?

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    Default Re: weekend commentary ... are muni bonds now worth thinking about ?

    Are capital gains on an investment like this taxed? I don't recall reading that in the links you provided...
    That's the real attraction of tax free muni bonds. Neither a capital gain nor interest earnings are taxable by the US federal gov't or by the home state. Also. at least so far, income from tax free muni bonds does not contribute to the income basis for Alternative Minimum Tax calculations. This could be important for residents of high tax rate states like my NY because, above a certain threshold (about $75k for a single person), the AMT starts to disallow deductions from federal taxable income for things like state income tax paid, property tax paid, home mortgage interest paid etc. The Democrats fought to not adjust AMT trigger income levels upward this year and were forced to do so as a one year temporary measure. If they carry majority wins in the 2008 election, it is a pretty sure bet that AMT thresholds will not be moved upwards, meaning that inflation will carry more and more middle class Americans into AMT land ! If that happens, an extra say $10k in fully taxable income versus tax exempt income could disallow enough federal income tax deductions to jack the taxpayer's effective federal income tax rate by a few extra percent ! This is a double whammy effect, with first the $10k in additional taxable income being hit with the highest marginal federal and state income tax rate, and with second the (partially) disallowed tax deductions due to AMT also effectively adding to one's taxable income at the highest marginal federal and state income tax rate. In my own case the marginal rate is about 28% federal + 7% NY state - but this could increase if a new gov't increases tax rates to address budget problems.


    Issue two relates to my above post and inflation relative to the actual return on the bonds. If inflation is much higher than stated - as we believe - then buying a fixed return of below that is going to ensure that your interest payments do not keep up with actual costs.
    two issues - as you point out, the first is the direction of future interest rates. Manipulated CPI statistics aside, IMHO there is no option but for muni bond interest rates to continue rising as US states become more and more driven to float new bond issues to 'balance' their budgets. New York is really on the hook because some 20% of state income tax revenues stem directly from Wall St profits and bonuses !! This is why I would tend to hang back a little bit to see how much the 'premium' on muni bonds increases over treasuries. but not too long.

    But the second, which you're not fully taking into account, is the potential negative effects of future federal and state tax increases on ALL investments. If after the 2008 election, plans are followed through on to raise the capital gains tax rate back to 30%, and if federal and state income tax rates are ratcheted up a few percent, and if offshore tax havens become the subject of greater IRS scrutiny as promised by some candidates, then all of a sudden muni bonds become a much more desireable commodity for uber-rich Americans to own more of ! Just as US treasuries have been bid up lately as a result of wall street fears, I would speculate that muni bonds will also be bid up as the accountants of the uber-rich start reviewing their investment options in terms of after-tax returns in a new political climate. So the thought is to buy in when interest rates are at a peak (i.e. over the next few months as states actually see how deep their budget holes are after April 15th turns forecasts / conjecture into cold hard reality), but before a Democratic election victory and the ensuing tax consequences are fully appreciated by the uber-rich and middle class alike !

    ~
    Last edited by Melonie; 01-07-2008 at 04:44 AM.

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    Default Re: weekend commentary ... are muni bonds now worth thinking about ?

    Mel: Given post example of 33% combined bracket, if muni bond (or mutual fund) earns >67% of CD or MM Fund, then its definitely worth considering. Actually, if 1 is in income bracket whereby deductions start getting reduced, and/or AMT becomes a factor, 1 can probably knock 2-5% off that worthwhile 67% of taxable yield(62-65% becomes worthwhile.

    It should be noted that if one is buying fund or bond beyond money market range, there's a risk involved in a scenario of rising interest rates in that bond price/ MF Share Price decline can offset yield/tax advantages. Conversely, a falling interest rate will yield additional gains.

    As Chinese Fortune Cookie says: "may you live in interesting times".

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    Default Re: weekend commentary ... are muni bonds now worth thinking about ?

    To me, the main benefits seem to be tax wise rather than investment wise.

    Still, if a person was in a situation where a majority of their income came from savings, and by using some of these muni's they could actually drop a tax bracket, that would be very appealing too.

    The bit that bothers me is the entire premise that - state govt's are struggling to balance their books and need to borrow lots more. They are meant to be the 'safe' investments. Hardly inspiring is it?

    I shall continue to meditate on this...

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    Default Re: weekend commentary ... are muni bonds now worth thinking about ?

    The bit that bothers me is the entire premise that - state govt's are struggling to balance their books and need to borrow lots more. They are meant to be the 'safe' investments. Hardly inspiring is it?
    in one sense, no. However, in another sense, if states have no choice but to offer whatever interest rate is necessary in order to attract buyers for their new muni bond issues, then the potential taxable-equivalent returns on these new issues could be worth snapping up. As you further observe, the non-taxable nature of muni bond interest, and the fact that muni bond interest earnings do NOT count towards triggering the AMT disallowance of tax deductible expenses, can indeed help a muni bond investor drop into a lower tax bracket / effective tax rate.

    Please meditate, because this will be a long term 'bet'.

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    Default Re: weekend commentary ... are muni bonds now worth thinking about ?

    At one time I figured these might be safe bets. After all, if they need more money to pay it off, they'll just raise taxes right?

    Then Orange County flew the bird at their bond holders in 1994.

    The "full faith and credit" of the Republic of California went in the toilet in my book. I am betting there is something similar around the corner from that state and it's thanks-for-the-free-money citizens too.

    Alaska and the mid-west is the only place I buy muni's these days.

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    Default Re: weekend commentary ... are muni bonds now worth thinking about ?

    ^^^ that's where Warren Buffet's billions worth of muni bond insurance comes in !!!

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    Default Re: weekend commentary ... are muni bonds now worth thinking about ?

    Quote Originally Posted by Melonie View Post
    ^^^ that's where Warren Buffet's billions worth of muni bond insurance comes in !!!

    He has a scam in there someplace. I still can't figure out what he is thinking.

    Must be why I'm not a billionaire.

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    Default Re: weekend commentary ... are muni bonds now worth thinking about ?

    to figure it out, you might want to do some historical research on one Robert Morris and the date January 7th 1782 ...

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    Default Re: weekend commentary ... are muni bonds now worth thinking about ?

    My meditating has lead me to the following question... why?

    And from there:

    1, Mel doesn't understand bonds
    2, Mel doesn't understand economics
    3, Mel doesn't understand politics
    4, Mel is planning to invest A LOT and wants to be sure

    My thoughts are that:

    1, I don't believe
    2, I don't believe
    3, I don't believe
    4, Any thoughts Mel???

    I found my investment textbook last night so that I can refresh my memory about the bond market properly...

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    Default Re: weekend commentary ... are muni bonds now worth thinking about ?

    you're pretty close about 'door number four' !!! And yes if I do this, the $50k minimum buy-in and 30 year term of the new muni bonds do make them a fairly 'serious' investment.

    As to my own thoughts, I've pretty much spewed my speculations ... i.e. that the tax exempt earnings aspect will cause these bonds to become more valuable as state / local gov'ts are forced to raise taxes to balance their budgets against social welfare program spending, and as upcoming new social policies in Washington result in higher future federal tax rates as well.

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    Default Re: weekend commentary ... are muni bonds now worth thinking about ?

    whaddya think ? one step closer to bargain buy-in time ?



    (snip)"A more worrying consideration is that when a bond insurer is downgraded, all the securities it has guaranteed are, in theory, downgraded as well.

    If Ambac and MBIA lose their top ratings, billions of dollars of muni bonds will be downgraded, and the guarantees that have been sold on mortgage-related securities such as collateralized debt obligations, or CDOs, will lose value.
    Bond insurers guarantee roughly $1.4 trillion worth of muni bonds and more than $600 billion of structured finance securities, such as mortgage-backed securities and CDOs, according to Standard & Poor's. Ambac alone has guaranteed about $67 billion of CDOs.
    "The destruction of the bond insurers would likely bring write-downs at major banks and financial institutions that would put current write-downs to shame," Tamara Kravec, an analyst at Banc of America Securities, wrote in a note Friday. "(snip)

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    Default Re: weekend commentary ... are muni bonds now worth thinking about ?

    California will pay Warren good money to guarantee their debt.

    Now I get his play.

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    Default Re: weekend commentary ... are muni bonds now worth thinking about ?

    ^^^ that's why I made historical reference to Robert Morris ... who basically used his own personal creditworthiness to underwrite the bad credit of the post-revolutionary US gov't !!! Of all of the public figures in the country today, perhaps only Warren Buffett has the reputation as well as personal / corporate assets to pull off a modern day Robert Morris role. But yeah he's going to earn a shitload of money from muni bond insurance premiums. Unfortunately, any investors wishing to benefit from Warren's new muni bond insurance business face a very hefty buy-in ... today's stock price for Warren's company Berkshire Hathaway was $131,200 for a single share !

    The flip side of course is that, with the downgrading of muni bond ratings resulting from Ambac's and MBIA's true financial situation becoming public, if state and local gov'ts are forced to go to the bond market with new bond issues in order to cover their budget deficits (which they will be - see California fiscal crisis thread), they are going to have to pay whatever interest rate it takes to attract buyers for their new bond paper. If the Citibank cash crunch is any example, it's conceivable that we could see new 'junk' muni bond issues that carry 8-10-12% interest rates ... TAX FREE 8-10-12% interest rates !!! Of course there is some theoretical risk of loss of principal. However, with Washington DC in an election year 'bailout' mood, it's highly doubtful that any outright bankruptcies of state or local gov'ts would be allowed.

    Personal comment ... ordinarily I absolutely hate investments which rely on gov't tax policies and/or gov't subsidies in order to provide a high rate of return for a select few investors. But hey what the hell, if most people don't see anything wrong in taking advantage of taxpayer financed profits and/or credits against their other tax liabilities when buying AgroBusiness stocks or Alternative Energy stocks, then why should 'junk' muni bonds be any different ? And if things get really bad economically speaking, federal and state gov't funded subsidies / tax credits for ethanol / solar / wind etc. will wind up being cut before state and local gov'ts are allowed to go bankrupt outright thus defaulting on their muni bonds. After all, a bankrupt state / local gov't would also mean the end to social welfare benefit payments as well as the end of police paychecks, which would result in blood in the streets within a month !!!

    !
    Last edited by Melonie; 01-18-2008 at 10:59 PM.

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    Default Re: weekend commentary ... are muni bonds now worth thinking about ?

    I don't mind admitting Mel that I am coming round to your thinking on this matter. Thus far, from what I have read, your logic seems pretty much impeccable.

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    Default Re: weekend commentary ... are muni bonds now worth thinking about ?

    Well the key 'ingredient' that I continue to wait for is some hard evidence out of California / New York / New Jersey etc. that, when push comes to shove about meaningful reductions in state spending levels to balance state budgets, these states will opt to maintain spending on social welfare programs and essential gov't services. This will then confirm that these states must opt to raise state income tax rates and/or go to the muni bond market for additional money before the end of their fiscal year in order to meet their balanced budget mandates. Obviously, the higher that state tax rates rise, the more valuable the tax free status of state muni bonds will become for residents of those states. Also, the more billions in new muni bond paper these states need to sell, the higher the effective interest rate they'll have to offer on new muni bonds in order to continue attracting buyers.

    So far these states have been trying to increase revenue by raising road tolls, by raising fees, by raising excise taxes ... but they have NOT yet talked about income tax rates. However the percentages don't lie, thus any serious amounts of new state tax revenue MUST come from either a sales tax hike (which will piss off the poor, the middle class, and the rich alike) or an income tax hike (which will only piss off the middle class, since the 'poor' don't actually pay state income taxes and the rich have proportionately little earned income to tax as opposed to cap gains and/or dividends). Also, these states are actually coming out with stimulus proposals that will result in INCREASED levels of state spending, which will only increase their budget deficits and provide yet more pressure to increase tax rates or float more muni bond issues !

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    Default Re: weekend commentary ... are muni bonds now worth thinking about ?

    Quote Originally Posted by Melonie View Post
    Obviously, the higher that state tax rates rise, the more valuable the tax free status of state muni bonds will become for residents of those states. Also, the more billions in new muni bond paper these states need to sell, the higher the effective interest rate they'll have to offer on new muni bonds in order to continue attracting buyers.
    2 great points. I can really see why you are becoming keen on this issue.

    I had a read of my old bonds textbook a couple of days ago. Thus far, I really can't find fault in your logic. It upsets me a little... I was hoping to make some incredibly insightful comment that wowed everyone, but I can't.

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    Default Re: weekend commentary ... are muni bonds now worth thinking about ?

    Even in a non-income tax state like mine, munis are a good idea. Most of the super-wealthy people I know have a decent stake in them. I used to be a fan of a couple of muni bond mutual funds (diversification, etc) but they've all been performing so poorly over the last year that I laid off. Perhaps its time to revisit, now that these funds may get some new injections.

    And before anyone goes on a mutual fund assault, Muni M.F. are simply a way for a middle-class investor to get into that sub-asset class without shelling out $50-100K per bond. I brokered one that had double digit returns for over 5 years. And that's NET of fees.

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    Default Re: weekend commentary ... are muni bonds now worth thinking about ?

    ^^^ well it all comes down to avoided taxes ... i.e. if federal income taxes alone are in the 33% bracket, it makes a 5% tax free muni bond the functional equivalent of a 7.5% taxable investment. But if federal plus state income taxes are in the 40% bracket, it makes a 5% tax free muni bond the functional equivalent of almost a 9% taxable investment. But as you have pointed out, in order to get the full 5% tax free return (or whatever it is) the investor has to pony up the full $50k or $100k price of the muni bond. Muni bond mutual funds, or repackaged $5k 'slices' of muni bonds, both wind up having some percentage of their interest rate lost to fees of one sort or another.

    As far as I can see, there are two critical factors that can make or break my little scenario. The first is a commitment by high tax rate states that they are NOT going to significantly cut social welfare benefit spending or public sector employment spending in any meaningful way, which will lead to an inescapable conclusion that they must raise income tax rates and/or go to the bond market with new bond sales. Today New York's governor released a proposed 2008 budget that will do exactly this, i.e. increased year over year spending and zero cutbacks in state employees.

    The second is whether or not US Fed policy will turn inflationary to the point where even a 7.5-9% de-facto rate of return is insufficient to keep up with US dollar denominated inflation. From this standpoint, today's emergency rate cut by the FED put me off a bit.

    Any more thoughts, Stuart ?

    ~
    Last edited by Melonie; 01-22-2008 at 11:03 PM.

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    Default Re: weekend commentary ... are muni bonds now worth thinking about ?

    Quote Originally Posted by Melonie View Post
    The second is whether or not US Fed policy will turn inflationary to the point where even a 7.5-9% de-facto rate of return is insufficient to keep up with US dollar denominated inflation. From this standpoint, today's emergency rate cut by the FED put me off a bit.

    Any more thoughts, Stuart ?

    ~
    Go back up to post 3 in this thread. Looking back at it, my English wasn't so hot but that was my point.

    All of your reasonings make sense - they really do. But, if inflation ticks up and up above what we are told is inflation, most types of bonds are going to be in serious trouble.

    DURING TIMES OF HIGH INFLATION, BOND INVESTORS DO NOT FARE WELL. Returns would fall each month / year in purchasing power.

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    Default Re: weekend commentary ... are muni bonds now worth thinking about ?

    I'd like to quote my own newsletter, quoting someone else. I published this in Feb 2004...

    I'd like to offer a quote (stick with it, there is quite a bit here even though I have removed several sentences for brevity): "For in every country of the world, I believe, the avarice and injustice of princes and sovereign states, abusing the confidence of their subjects, have by degrees dimished the real quantity of metal, which had been originally contained in their coins. By means of those operations the princes and sovereign states which performed them were enabled, in appearance, to pay their debts and to fulfill their engagements with a smaller quantity of silver than would have been requisite. It was indeed in appearance only; for their creditors were really defrauded of a part of what was due to them. All other debtors in the state were allowed the same privilege, and might pay with the same nominal sum of the new and debased coin whatever they had borrowed in the old. Such operations, therefore, have always proved favourable to the debtor, and ruinous to the creditor..."

    That gem is from the superb, The Wealth of Nations (Book 1), which is by Adam Smith. The birth of economics as we know it from 1776. I highly recommend it.


    To recap ---> Such operations, therefore, have always proved favourable to the debtor, and ruinous to the creditor..."

    What more is there to say? This is your risk factor. Not taxation status. Not supply or demand. Not state finances. This is absolutely where your decision making needs to focus.

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