Personal Finance Advice

While municipal bonds are becoming an increasingly attractive investment, that’s not really good news for the municipalities themselves.  Their history of low default rates, much lower than even AAA rated corporate bonds, have not stopped municipal bond yields from soaring, causing many communities to pay millions more in increased borrowing costs.

These increased borrowing costs are causing many state treasurers to bring into question the ratings system which has them paying more than their corporate counterparts.  The fact of the matter is though that a government entity is more prone to operate in debt than a corporate entity and thus usually has a lower credit rating.  This also means though that any community that is currently running a budget deficit is going to find it increasingly expensive to finance that debt.

The current credit crunch and the troubles of the bond insurance industry have played havoc with their efforts to borrow money and refinance debt.  Even big time players in the market like the State of California and the New York Port Authority have had their bond auctions fail due to a lack of bidders.  The NYPA has had to raise toll and fare rates to compensate in order to fund their building projects.

The renewed fear of inflation has also helped to drive up interest rates in recent weeks.  It may even be the inflation scare that’s most to blame for driving away bidders as investors are starting to flock to inflation hedges such as commodities.  Coupled with the fact that the dollar is trading at record lows, it is becoming increasingly obvious that no one wants to be tied to fixed rate securities denominated in dollars no matter how attractive the yield.

As it has become increasingly difficult to find investments with positive gains, municipal bonds have begun to surge to the forefront. The yields on muni’s have become comparatively attractive in recent months due to a number of factors.

Although a shaky stock market tends to have investors fleeing into the warm embrace of the bond market, things are a little different this time around. The bond market is having it’s own little crisis at the moment.

Bond insurers are reeling from the fallout of the sub prime mortgage collapse with many firms in that industry having lost or are in danger of losing their AAA ratings. This has in turn added an aspect of volatility to a normally placid market.

This added uncertainty along with renewed fears of inflation, due to the Fed’s recent aggressive moves, have sent bond prices falling recently and yields up. These higher yields coupled with their tax free status have led many financial analysts to extol their virtues.

If anything, the recent troubles in the bond market have made muni’s even more attractive. While the short term risk has grown considerably, the long term risks are negligible.

This is due to the fact that historically, muni’s have a miniscule default rate, less than 0.01%. Even non AAA rated muni bonds have a lower default rate than their AAA rated coporate counterparts. As a long term investment, it’s one of the safest bets around.

The recent news that Bank of America has offered to buyout struggling mortgage giant Countrywide Financial could be signaling a period of consolidation in the banking sector.  As I wrote in a previous article, financial stocks are going through a rough period right now but could be potential bargains when the sector does recover.

Many of the larger financial institutions after suffering large losses last quarter have been re-capitalized with new investment.  This doesn’t mean the credit crunch will end anytime soon though.  Still stung by the mortgage meltdown, companies are still reluctant to lend out funds.

Awash with new money and unwilling to lend it out, larger companies could be seeking to gobble up their smaller brethren while stock prices are still down.  Financial stocks are trading at way below their historical PE ratios currently.  What would be a smart buy for a single investor is even more so for these companies but on a much larger scale in this case.

It may take a few years but the mortgage industry will eventually recover.  People will always need a place to live.  The industry was a solid profit maker before this mortgage mess started and will be again in the future.

Smart investing has always been about taking the long run approach.  If you start seeing more news about mergers and acquisitions, it means it’s time to jump back on the bandwagon.