Could Municipal Bonds Really Default?
When Warren Buffett speaks, it’s usually worth paying attention. This time, the Oracle of Omaha is voicing concerns about the ability of some battered local and state governments to pay off their debts. The idea of cities and states facing insolvency is alarming for sure, and Buffett isn’t alone. Moody’s recently assigned a “negative outlook” to the creditworthiness of all the nation’s local governments. The agency has rarely made such a sweeping generalization but said the magnitude of this recession warranted the move. The comments are the latest to have shaken the once-staid world of municipal bond investing.
Traditionally, muni bonds offered lower yields — usually about 20% less — than Treasury bonds, since their income isn’t taxed. But the group was crushed last year, sending prices down and yields up. Now bargain hunters have started to emerge, attracted by yields that are as much as 70 basis points, or 0.7%, more than similar 10-year Treasurys, for example. As a result, the S&P Muni index has climbed 7% this year, compared with the nearly 6% decline in the broader stock market.
These low prices reflect investor concerns about possible downgrades, says Daniel Solender, director of municipal bond management at Lord Abbett. The Federal Reserve’s buying spree in other areas of the bond market is also depressing yields of Treasury bonds and making municipal bonds all that more attractive. And then there is the $100 billion fiscal stimulus headed toward the states that should help offset the shortfall in tax revenue, says TD Ameritrade Chief Investment Strategist Stephanie Giroux, who adds that historically there has only been a 1% default rate for muni bonds.
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