Tags: Sloan | municipal | bonds | crash

Fortune’s Sloan: Muni Bonds Headed for Crash

Thursday, 06 Dec 2012 08:36 AM

By Dan Weil

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The explosive municipal bond rally of the last four years represents a bubble that will burst, writes Allan Sloan, Fortune’s senior editor at large.

“High-grade munis … have become insanely popular and are a train wreck waiting to happen,” he writes.

“I want to warn you — yet again — about the perils of buying bonds at current prices. You should be especially wary of muni bonds trading at fat premiums above face value.”

Editor's Note: Economist Warns: ‘Money From Heaven a Path to Hell.’ See Evidence.

Plenty of munis fall into that category. And a lot of them have redemption clauses, whereby issuers can redeem the bonds for face value at a set future date.

Municipal borrowers have every incentive to redeem the bonds, because rates are likely lower now than when the bonds were issued.

If you paid a 20 percent premium over face value for your bond, you would lose that 20 percent upon redemption. That loss puts a major dent in your total return.

To be sure, not everyone is railing against munis. Wall Street Journal columnist Jason Zweig, for example, recommends neither buying nor selling muni bonds now.

His primary focus is the possibility of a 28 percent limit on the tax exemption for muni bond interest payments.

But existing munis could be exempt from such a limit, and many muni investors are in the 28 percent or lower tax bracket anyway, Zweig says.

Editor's Note: Economist Warns: ‘Money From Heaven a Path to Hell.’ See Evidence.

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