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    Motown’s Blunders Bring You Your Next Fortune

    Detroit drove itself into the ditch. With local and State tax and other policies, it drove away businesses; and much of the residential population left after the businesses did.

    And while the city was heading south, politicos eager to keep their own jobs capitulated to union leaders for city workers and gave them the sun, the moon and the stars — in wages and benefits while they were on the job and in golden parachutes when they decided to retire.

    While they were doling out the pledges for city employees, they took advantage of Government Accounting Standards Board (GASB) loopholes for how they accounted for future pension and health insurance liabilities and on the phantom returns for the pension funds.

    The result was that, for years and years, the city was able to understate the true costs of fulfilling pledges to future retirees. With GASB’s blessing, Detroit was able to use accounting that assumed an annual return of 7 percent to 8 percent each year — even if the stocks, bonds and other investments actually earned nowhere near that return.

    So even with the generous accounting rules, it’s more than $3.5 billion short.

    Overall, the city has debts of some $18 billion or more.

    Although it’s bad, it’s only one of seven or eight municipal bankruptcies that happened over the past six years — which is not far from the average for past decades.

    That’s the point: Municipalities don’t go broke that often. And even for those that do, the buyers of their bonds tend to get paid.

    Muni Safety

    The municipal bond market is one of the safest and most lucrative markets in which you get well paid on a monthly basis and gain capital appreciation while reducing your tax bill from Uncle Sam.

    This is why I’ve been a proponent of muni bond investing in past columns.

    Munis are so safe that the $3.7 trillion worth of muni bonds that make up the market saw only 63 bankruptcies last year by the issuers of bonds. That was down more than 20 percent from the prior year, and the trend is even lower from 2009 through last year.

    Only a handful of cities went through Chapter 9 bankruptcies during the year — hardly a massive surge.

    While some doom-and-gloom pundits have made their prognostication of a tsunami of defaults, the reality has been a drop in the bucket of this vast market.

    Moreover, if you look at the long-term averages, including times of deep recessions, the default rates for munis are much, much better than for most other bond markets — and light-years better than for corporate bonds.

    According to reviews by the leading rating agencies, the average for defaults for muni bonds is very low. In fact, the fail rate for the entire muni market is less than 0.2 percent.

    But just because a muni issue delays or misses a payment doesn’t mean the investors get squat. In fact, for most muni issues that have defaulted, the recovery rate has run for decades at 100 percent. That’s right: 100 percent of principal was paid to investors.

    You know what corporate bond investors have been getting over the decades when their bonds default? The long-term average is running at only 40 percent, or 40 cents on the dollar.

    There’s even more proof that the safety of the muni bond market isn’t just how well it has done, but how well it’s supposed to do in the years to come.

    For institutional investors that participate in this lucrative market, there is a form of insurance that can be bought, sold and even traded in the financial markets against munis failing.

    The insurance comes in the form of credit default swaps (CDSs). A CDS gives the buyer the protection that if a muni bond defaults, the seller of the CDS will pay the interest and principal of the muni bond.

    This is perhaps the best credit barometer of how the market prices potential trouble. The higher the price of CDS on muni bonds, the greater the risk of the munis have trouble. The lower the price, the market is pricing in less risk.

    For the muni bond market, the general CDS market has dropped some 24 percent, meaning that the institutions see a whole lot less risk in the market.

    With taxes coming in greater sums around the Nation, muni bond issuers from coast to coast are better able to keep paying their muni bond interest and principal.

    Uncle Sam likes to keep tabs on how much State and local authorities are raking in via the U.S. Census Bureau. In the most current quarterly report, the overall tax receipts of State and local municipal authorities continue to climb at a rate for the last report showing gains of heading closer to double digits gains.

    Safer And Pay More

    And not only are the bonds safer, but they pay more than the U.S. Treasury. And, in many cases, they are rated higher than the U.S. Treasury.

    So no wonder the muni market is faring well. For the past few years alone, the muni market as tracked by Standard & Poor’s is up more than 12.7 percent, continuing a trend that’s been working well for the past decade with an overall return in excess of 60 percent.

    Muni Bonds Perform Despite Detroit Hoopla:bfmDD66

    The Muni Deals Of The Day

    Because of the negative mania of the financial press and politicos, there are some great muni bond buys that have nothing to do with the few trouble spots. But they’re trading as if they’re doomed.

    This brings me to my favorite collection of three muni bond investment company funds that trade nice and easy on the New York Stock Exchange (NYSE).

    What sets these three apart is that they have well-chosen collections of good, well-paying muni bonds that are chosen for their own merits rather than due to pure ratings or special insured deals. This keeps them out of the trouble of hoping that nothing goes wrong with promises and pledges, as is now plaguing investors in Detroit.

    They have done well over the past decade through thick and thin. I have been following and recommending them for many, many years now.

    First is AllianceBernstein National Municipal Income Fund (AFB). When it comes to bonds, this management company has some of the best muni investment pickers; and the numbers prove out. It has earned investors more than 76 percent for the past 10 years, while paying a monthly dividend that with the recent market mayhem is now yielding about 7 percent. On a taxable basis, assuming a tax rate of 35 percent, that equates to an effective yield of more than 10.8 percent.

    Second is BlackRock Municipal Income Trust II (BLE). The monthly dividend is currently yielding 7.4 percent; adjusted for taxes, that equals a yield of more than 11.4 percent. The return by the fund for the past decade is running at more than 103 percent, giving a 10-year average annual return of 7.4 percent.

    Third is Nuveen Quality Income Muni Fund, Inc. (NQU). This is run by one of the best known in the municipal market management businesses. It yields a current rate of 6.2 percent, giving a tax equivalent yield of more than 9.5 percent.

    Even better, over the past 10 years (including all of the supposed crisis years in credit markets, bond markets and even Detroit), the fund has delivered returns of more than 71 percent for an average annual rate of near 6 percent — again with less tax due on the returns.

    Take advantage of the misplaced doom and gloom, and buy these three for the stability and safety that they bring. Each owns a different mix of muni bonds. AllianceBernstein has the lowest amount of lesser-credit-rated bonds (less than 1 percent of the fund); Blackrock and Nuveen have a bit more.

    As for maturities, the three balance out. AllianceBernstein has the shortest average effective maturity, followed closely by Nuveen; Blackrock’s maturity is a bit longer.

    The effect is that you’ll have less credit risk and less overall bond price risk if market yields go up in the muni market by owning all three together.

    And with the three in your portfolio, you’ll be earning a yield averaging near 7 percent — which on a tax-equivalent basis works out to more than 10.5 percent — paid monthly by the funds.

    — Neil George

    Neil George is the editor of By George, an investment advisory publication. George was the editor of Personal Finance for many years. In addition, he served as editor for a collection of other investment journals published in the United States, Germany and other selected nations. Prior to his career in media, George worked for more than two decades on six continents in senior positions with a select group of financial institutions in investment banking, bond trading, brokerage and asset management. The institutions included Merrill Lynch International Bank in Europe, Asia and the Americas, as well as U.S. Bank and British- and Chinese-based Investec PLC. In addition, George worked to build a collection of independent public and private brokerage and fund-management companies in Los Angeles and New York. He also currently serves as an adjunct professor and board member of Webster University's Walker School of Business and Technology. George earned an MBA in international finance from Webster University in Europe and a bachelor's degree in economics from Kings College.

    | All posts from Neil George

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