Are municipal bonds still a safe investment?

U.S. bonds.

TEXT OF STORY

Tess Vigeland: Back in June uber-investor Warren Buffet warned if a "terrible problem" ahead for the municipal bond market. The Oracle spoke and he was right. Shortly thereafter, Pennsylvania's capital city nearly missed a $3 million debt payment. The state came to Harrisburg's rescue with a cash bailout this week, but both events highlighted concerns over what is traditionally thought to be a safe investment.

Peter O'Dowd reports.


Peter O'Dowd: What happened in Harrisburg could have been huge. Analysts say municipal bonds rarely default. But then, these are unprecedented times for American cities. When budgets are flush and your town builds a new playground or incinerator, it often relies on future tax revenues to pay the debt. The problem is tax revenues are not exactly abundant these days.

Robert Keats is a Phoenix-based financial advisor.

Robert Keats: Counties and municipalities haven't been realistic about how to deal with it yet. They really think that somebody's going to come along and bail them out. But I think that's a big mistake.

Here in the suburbs of Phoenix, officials in Queen Creek were left wondering how to make a payment on the town's water-treatment plant when the housing market crashed and development fees dried up. The town manager recently told me that at one point last year, he faced a code-red crisis. So if you're an investor, what do you make of these near-defaults?

Jeffrey Chapman: I think this is a blip on the radar screen. It's very rare. You don't have to worry about it.

Jeffrey Chapman is a public finance professor at Arizona State University.

Chapman: I am not shilling for the bond market, but the straightforward bonds are a perfectly safe investment for individuals.

And here's why, according to analysts and financial advisers. Owning a straight-forward general-obligation bond -- like the one in Harrisburg -- gives the investor a lot of leverage.

Chapman: It's backed by the full-faith and credit of the issuing jurisdiction.

That means you, as the bondholder, can sue a city that defaults on its debt. By doing that, it's forced to raise taxes or sell assets to pay the bill. Of course, the investment isn't risk-free.

Financial adviser Robert Keats says municipal-bond credit ratings have fallen recently. And plenty of bonds are not backed by the government that issues them. Those are much riskier and far more likely to default.

Keats: It's a little bit of a crack in the dam of municipal bonds, but chances are you will avoid most problems if you've got someone that knows the bond industry, that is watching it 24/7 for you.

Keats and others say the bigger risk is the likelihood that interest rates will go up, which will make bond portfolios less competitive. Keats suggests avoiding interest rate fluctuations with short-term municipal bonds. Don't sell them until they're mature. And consider this: Analysts say that despite the Harrisburg dilemma, local government bonds are still one of the safest asset classes available outside of U.S. treasuries.

In Phoenix, I'm Peter O'Dowd for Marketplace Money.

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