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Buy Insured Municipal Bonds
Many municipalities are having difficulty selling bonds. Many are putting off anticipated offerings. The municipal bond insurance industry may be revitalized as investors decide to only buy insured municipal bonds. Poorly conceived pension obligation bonds have come back to haunt many issuers over the years. It turns out that playing an interest rate game in order to spend more than a city or county can afford is a really bad idea. Now a major US city has gone bankrupt. The US auto industry nearly disappeared in the wake of the 2008 market crash. However, a government bailout saved GM and the company has paid off its bailout debt and is back on its feet. Unfortunately, the same cannot be said for motor city. Now we see in the news that many municipalities, especially in Michigan, are having trouble selling bonds. For the smart long term investors it is probably time to buy insured municipal bonds. Interest rates will be higher because of the perceived risk but if you only buy insured municipal bonds you will be protected. One issue, however, may have to do with timing.
Municipal Bonds and the US Federal Reserve
We recently wrote about how the expected end of the Fed bond buying program is driving stocks down. It will also likely drive interest rates up.
The underlying purpose of the bond purchase stimulus program has been to drive interest rates down and keep them there. As the Fed gives up the job of soaking up all of the Treasury notes interest rates will rise. Fed chairman Bernanke has stated that the Fed will proceed slowly so as not to stifle the recovery.
No matter if you are buying corporate bonds or US Treasuries or municipal bonds, the market value of whatever you buy will go down as interest rates rise. Thus timing may be key even when you buy insured municipal bonds.
Long Term Investing in Municipal Bonds
A key feature of municipal bonds is the tax exempt feature. Both general obligation bonds and revenue bonds provide tax exemption from federal taxes and many state and local taxes, depending on the laws of each state. This feature offsets the fact that when you buy insured municipal bonds or the uninsured variety you get a lower interest rate than for other bond purchases. The tax exempt feature makes these bonds attractive to investors who are in a high income bracket. Not paying taxes on the interest on these bonds more than makes up for the lower interest paid. However, this feature is only useful so long as the person is making a lot of money. Once retirement comes an investor has two choices. He can simply make due with a lower interest rate until maturity or he can sell the bonds he has and invest elsewhere. Obviously if interest rates have gone up he will sell at a loss compared to the purchase price of the bond.