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Friday, January 9, 2009

WSJ: "The Golden State's Golden Buying Opportunity?"

Bob Brinker's latest advice on California munis is that they are safe and he is holding them. Some bloggers have asked for advice. From the Wall Street Journal:

* JANUARY 8, 2009, 6:59 P.M. ET


Despite a fiscal crisis and a falling bond rating, California munis could yield respectable returns this year.

Investors are getting used to thinking the unthinkable. From Fannie Mae to Washington Mutual to Bernie Madoff, the impossible -- even the surreal -- has become the new normal.

Yet even by current standards, the fiscal crisis engulfing California looks especially alarming. State revenues have collapsed. Sacramento is paralysed. Some infrastructure projects were put on hold last month. The state comptroller warns he may soon have to start paying bills with IOUs.

No wonder California's bond rating is the lowest of any state. The "general obligation" (or full faith and credit) bonds now yield about three times as much, on one key measure, as equivalent Treasurys. In most markets that would be considered a sign of extreme distress.

Nervous times all round.

I know it seems crazy. But this week, when I spoke to California state treasurer Bill Lockyer, I had to ask: Is California public debt completely safe?

Absolutely, he replied. "The only way we're going to default is if there's a thermonuclear war."

Well, it doesn't get more emphatic than that. Mr. Lockyer calls it a "certainty" that California will pay all its debts, and on time.

"There's a fair amount of bad news coming out of California," he conceded. "So 'perceived risk' like that gets factored into the rates. But the good news for a bond investor is that there's always some money coming in. Debt payments are a very, very high priority." Mr. Lockyer has some of his own money in Fidelity's California municipal bonds fund.
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Analysts, ratings agencies, and fund managers specializing in municipal debt aren't quite as emphatic. But they nonetheless give the state the OK. A default would be highly "unlikely," says Vanguard fund manager Reid Smith.

David Blair, the head of municipal credit research at bond giant Pimco, agrees. "They clearly have the ability to pay," he said. The main risk, he added, is "headline risk": Bad news may wallop prices and try your nerves.

The ratings agencies put the state's bonds on the same rung as Louisiana, or lower. But they consider default risk very small indeed. They still rate the bonds as very solidly investment grade. And that's by the very harsh standards applied to munis.

Other relevant details: Debt service payments make a small political target. They are far less than 10% of the $100 billion budget. Many owners are California voters. Analysts also say that, by law, bondholders get paid after K-12 public education but before everyone else.

So maybe in this crisis the Golden State is offering a golden buying opportunity - especially for the state's higher income taxpayers. Ten-year Treasurys currently yield about 2.5%. California's general obligation bonds: About 4.2%. And that's exempt from federal income tax. On a taxable equivalent basis, that's like 6.3% for top-rate payers. (Both Treasurys and California munis are exempt from state income tax too)

Has the gap ever been this wide? No.

"Not even close," says Vanguard's Mr. Smith.

The picture is similar for municipals across the country. Panicked investors have dumped everything - and blindly stampeded into Treasurys, driving yields down to absurdly low levels. Meanwhile munis are also under pressure because so many states and cities will have to borrow more.

Yet municipals almost never default. A study by Moody's, dating back to 1970, found that non-junk munis were far safer than even the highest rated corporate bonds........."

Read complete article here: Wall Street Journal, California Muni Bonds

PS: The latest "rumor" is that the Brinker's are trying to find a way to get Moneytalk back on Sirius XM Satellite Radio.

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