Given the precarious condition of many states and cities, it's worth considering just how safe some of these bonds really are.
1. The same credit rating rating agencies that gave AAA ratings to various mortgage backed securities also rate these state and local bonds.
2. Bonds come in two types- revenue and general obligation. Revenue bonds are backed by a specific revenue source. Usually issued by a public authority, they are repaid by bridge and tunnel tolls, airport fees or transit fares. Some are backed by room and board at universtities- Dormitory Bonds or hospital bills being paid- Hospital Bonds.
General Obligation Bonds are backed by a PROMISE to repay from a state or city.
And they are, so long as those entities have the money. California has just barely avoided default and N.Y. is headed directly for one of its own. In 1975, N.Y.C. defaulted on GOL bonds it issued. Carter stepped in and signed Federal loan guarantees so N.Y.C. and N.Y.S. could restructure their debt. Who says the Feds are going to do it again ?
3. It used to be that bondholders were first on line in any bankruptcy. Even a municipal bankruptcy. Two things to remember- what happened to the holders of Washington Public Power Supply System bonds in the 80's when "WHOOPPS" went bankrupt and defaulted ? That was a government authority. Did the state of Washinton step in and pay off the bonds ? Eventually they did, but a lot of folks depending on their monthly coupon clipping to supplement their Social Security had to wait to get paid and they could never sell those bonds. Today, 15% of every Washington resident's electric bill goes to pay off those bonds. How long would you want to wait until Bloomberg could auction off Gracie Mansion and re-zone Central and Prospect Park for condos and scattered site McMansions ?
Secondly when GM and Chrysler went bankrupt, the bondholders were moved from the front of the line of creditors to the back. That won't happen with a municipal bankruptcy or state financial crisis, why ?
4. Most of these bonds are triple tax free. But they are subject to capital gains taxes if you sell them at a gain. Not very likely if we get inflation but if there is another wave of defaults and another financial crisis, who knows ?
For the foregoing reasons, I'd rather be holding revenue as opposed to GOL type bonds. For a LOT of reasons, I'd prefer Brazilian Olympic Games Bonds or Shanghai Transit Authority.



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