How Safe Are Municipal Bonds

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People are always asking me how safe municipal bonds are.  The answer is: They’re Safe.

Note that we are talking about BONDS here, NOT Notes, which are a whole different deal.  Unless you are an expert or near-expert bond trader, you should stay away from any and all notes of any kind except those from the US Treasury.

But, that can’t be the end of it.  After all, there are some examples of muni bonds going sour, most notably Orange County’s default on some of its muni bond debt. 

And, of course, various municipal bonds which were pegged to specific projects or revenue streams have gone belly up.  Of course, it is pretty easy to spot which ones have that kind of risk.  Bonds fully backed by the state, county, or city are generally as safe as you can get without investing in a US Treasury.  Also pretty safe are bonds back by utilities (water and sewer especially) since people have to pay for those one way or another. 

The ones you have to watch out for are the ones that are for building a specific project and then funded with the revenues from that project.  Common examples are things like an aquarium, stadium, road, business park, mall, and so on. Those can and do default pretty regularly, so you’ll really want to make sure you know all about the project and all about municipal bonds before you dip a toe in there.

When it comes to regular municipal bonds though, they tend to be as safe as anything can be without being backed by a federal agency like the FDIC or NCUA.

Here is an example.  Today’s CNNMoney site (among others) reports that California is delaying $3.5 billion in payments.  The list includes taxpayer refunds, contractors, counties that get money from the state, and even social service agencies.  Do you notice what is missing from that list? 

Nowhere in any news story in any paper or on any website do you see even a hint that California is considering for one second not making timely interest payments on California Muni Bonds.  In fact, while Fitch was downgrading California Revenue Anticipation Notes, or RANs, (what did I tell you in the second sentence?) it made no moves to lower its A+ rating (with negative watch, from before this news) for California municipal bonds.  That is a pretty good example of how safe most municipal bonds are.

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4 Comments on How Safe Are Municipal Bonds

  1. trad says:

    OHH I am amazed with it. It is a good thing for my search on the net. Thanks. ^_^

  2. Tim McLeer says:

    You sound Like Bernanke in 2008 “the housing market is stable”

    Just because a municipal bond is rated AAA does not mean that
    a municipality is safe. This rating is set by regulators who by
    the way are lobbyist for municipal bonds!!!

    Get real and tell the truth—-Local Municipalities can file chapter
    9 bankruptcy and the bonds become worthless.

    • Update: I came back across this article, and the comments from 2010. It’s 2014 now. I think it’s safe to say I was right :)

      I’m not saying that it cannot happen. I’m saying that the risk is much lower than other investment options. (Bank deposits are not investments.) The ratings are actually set by ratings agencies, not regulators. However, in this case, that isn’t necessarily any more comfort considering these are the same ratings agencies who rated all the now “toxic” mortgage securities AAA right up until they started plummeting.

      All you have to do is look at California. The budget is a mess, the state’s finances are in shambles. They even issued “IOUs” for a while, but they did not default on a single bond. Munis can be defaulted on (see Orange County and New York) however, it is much rarer than people give it credit for. That all adds up to the fact that even a minimally diversified muni bond portfolio can be much safer (from a default risk perspective) than just about anything else.

  3. […] experts didn’t buy Whitney’s prediction. Even I wrote a 2011 article about how safe are muni bonds when people kept asking me about it. Of course, none of those stories was a big, inflammatory […]

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