Municipal Bond Returns Shine in Tough Times

Stocks are tanking and Treasury bond yields have dropped so far that interest rates on 10-year paper are lower than what you’ll get in a money-market fund.

So what’s an investor who’s looking for a safe investment and a decent return to do? Maybe its time to think municipal bonds.

Thanks to the subprime mortgage crisis and the financial troubles of muni bond insurers Ambac Financial, MBIA and Financial Guaranty Insurance, muni bond prices have sagged since the middle of last year.

Remember: When prices go down, yields go up. Munis are offering some juicy returns now.

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The typical 10-year triple-A rated muni bond yields about 3.57 percent. As interest payments from muni bonds are tax deductible, that 3.57 percent yield turns into 4.76 percent for middle-class tax payers in the 25 percent bracket.

And that’s before state and local tax deductions. A New York City resident in the 25 percent bracket who bought a 10-year New York issue with a 3.57 percent yield would have a taxable-equivalent yield of about 5.71 percent.

That’s quite a step up from the paltry 3.84 percent yield offered by 10-year Treasuries.

Yes, a New Yorker would be able to deduct interest income from Treasuries on state and local taxes, making the taxable-equivalent yield 4.38 percent for Treasuries. But that still pales compared to 5.71 percent for a muni bond.

"Munis stand out as a relatively attractive area, offering relatively high yields in a relatively safe asset class,” John Derrick, portfolio manager at U.S. Global Investors, told The New York Times.

The financial crisis of the past six months has sent institutional investors scurrying for Treasuries. And the 10-year note yield dropped to a three-year low Friday after the release of weak December employment data.

That means prices for Treasuries have little room to appreciate further.

Munis, on the other hand, were in the doldrums until the past few days, as hedge funds were big sellers and individual investors were looking at sexier opportunities.

Now, however, munis are the place to be. In addition to the attractive yields, they offer safety. The default rate for triple-A corporate bonds is 10 times the rate for single-A muni bonds, Thomas Doe, chief executive of Municipal Market Advisors, tells MoneyNews.

"Investors should take a close at munis,” says Doe. "They are so much more secure than corporate bonds.”

The difficulties faced by the bond insurers worry some investors. But Warren Buffett isn’t worried.

Buffett has set up his own bond insurance unit, seizing the opportunity created by the woes of Ambac, MBIA and Financial Guaranty.

Thanks to their stupidity in insuring subprime mortgage paper, those three companies, currently rated triple-A by Standard & Poor’s, may receive a downgrade soon.

But that ratings change, if it comes, doesn’t imply any risk for munis, which are probably the safest credits available after those of the federal government itself.

Put simply, cities and states don’t default on their debt. Even New York City found a way out of its financial crisis in the 1970s without missing bond payments.

"The degree of safety even with bonds insured by some of the more troubled insures is still pretty high, as the default risk of the underlying credit is minimal,” Doe told The New York Times.

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