Municipal Bond Trap

Quite a few people have asked me about investing in municipal bonds lately. Now that the fiscal cliff is in the rearview mirror and the debt ceiling is dead ahead, more tax increases can’t be too far off. But either way, I don’t like municipal bonds. The downside risk you’re taking for the yield isn’t enough for me.

The few municipal bonds that I might consider would be in states that don’t have any state income tax, so buying them defeats the purpose of tax-free investing at the state level. Then, there are the states that really need the money. They are not what I’d consider a good investment.

A number of states are tapped out. There’s going to be some tough sledding ahead for them. With the exodus of residents from states like Rhode Island, New York, Illinois, and California, there are fewer and fewer people to pick up the tab. Then there are the pensions those states have promised.

I don’t like the dynamics. You’re going to have the bondholder expecting to be paid by the same tapped-out taxpayer who has to pay the pension bill. I can’t imagine there’d be as much sympathy for the investor as for the pension recipient when choices have to be made as to who gets paid. The “evil” capitalist has already been vilified by the government. And remember, states can’t print money as the federal government can. The courts might be able to sort it out, but then again they might not. You can have that mess.