David Korn has written this complete summary (and editorial comments) of the interview. Posted with David Korn's permission:
On Saturday, Bob had on Jim Lebanthal a well known bond salesman and municipal bond educator.
Brinker: Bob prefaced the discussion by noting the distinction between two classes of municipal bonds. The first is the General Obligation Bonds which are backed by the full, faith and taxing power of the issuer which could be the State of California or the State of Illinois. They have a very low default rate. The second category are revenue bonds which are backed by the proceeds of a specific project, such as the Pennsylvania Turnpike.
[David Korn] EC: The web site, municipal bond.com has an article just published about default rates and risks of municipal bonds. Here is the link:
Jim Lebanthal: Only about 25% of bonds coming to market these days are General Obligation bonds which were always considered the top of the line bonds. Another bond has been invented that can be as good as a GO and some are even rated higher such as the "recovery" bonds in California which have an extra tax behind them that cannot be spent elsewhere until the bond is paid. Other states in the union also have these "asset backed bonds." The trust fund or gas tax or income or sales tax that secures these bonds cannot be diverted until those recovery bonds are paid off.
[Korn] EC: California's $8 billion of economic recovery bonds were actually upgraded by two rating agencies on Thursday after a refinancing lowered the state's debt-servicing costs. Read more about it at this url:
Jim Lebanthal: Bob asked Jim to discuss California's General Obligation Bonds which have come under fire with California¹s budget crises. Bob noted that the money to repay California General Obligations ranks only second to education. Jim said that is a big deal. And the great thing about the GO bond is that it is paid out of the state/city Treasuries. That is what made State General Obligations so attractive second only to USA Treasuries. Jim noted that most States in the union are similar to California in terms of their taking on debt. Jim said that the enormous borrowing power of States only works and can be sustained if what you are borrowing for adds to the economic well being of the community. Deficit financing, plugging holes in a budget is like feeding salt water to a man dying of thirst. Whether it is a first, second or third claim to pay, legislatures go looking to the GO bond to bail themselves out of this spending hole because they know that the bond will raise money plug the hole and postpone facing the music.
[Korn] EC: California's fiscal watchdog will be releasing a report soon which is expected to continue to show grim news in the State.
Jim Lebanthal: Jim said New York learned its lesson back in the 70s when NY City General Obligation Notes defaulted. What cured them was that there was no credit and they had to balance the budget. Bob said he remembers it well because he was on Wall Street working for the Bank of New York. Jim said the culture at the time was deficit financing and New York was just the first to get caught. They went into default for a year which gave the city one year to straighten up. After that, the Court said the notes had to be paid and hardship was no defense. New York got out of it because they had no choice.
[Korn] EC: Read the article Municipal Bonds and Defaults at this url:
Jim Lebanthal: Bob asked Jim his opinion on Build America Bonds. Jim said that he LOVES them! It is a chance for the municipal bond industry to relate to the people. The problem is that the bonds are being gobbled up by big institutions and when they return to the market they return at marked up prices. Jim suggested that individuals should have access to these bonds and not just the fat cats. You can get 5.5% on Build America Bonds (they are taxable), and they have safety similar to state General Obligations. They are wonderful instruments and should be available to the little guy.
[Korn] EC: Sales of Build America Bonds rose 28% in the third quarter. More than $51 billion have been issued since their inception. The federal government pays sellers 35% of their interest cost. Learn more about Build America Bonds at this url:
Jim Lebanthal: Bob asked Jim where the best place for individuals to buy municipal bonds would be. Jim said if you have the patience and fortitude and learn about bonds the best way is to buy individual bonds. That is a lot of work to get 4.5% even tax free. Most people are not willing to do the work. Another option is to go with a mutual fund you get the diversification and professional manager can do. However, if you do that make sure you read the prospectus because mutual funds may do some things that you wouldn't do. The SEC has required that the prospectus be readable in plain English!
[Korn] EC: Fidelity has a good web page exploring the differences and pros/cons on individual bonds vs. bond funds. Check it out at this url:
Jim Lebanthal: Anyone who gets a solicitation at home, usually a cold call at dinner time, to buy a municipal bond should ask for the CUSIP Number and say you will call them back. Then log on to the web site, http://www.investinginbonds.com/. Follow the steps to enter the CUSIP number and find out what that bond has been trading at. Find out the high/low, how many shares trade and make sure you find out what the right price for that bond is. There is the difference between the bid and ask but Lebanthal said that the average spread is about $15 per $1,000. If you can't figure out whether you are paying what others are paying, you can always buy a mutual fund where everyone pays the same price.
[Korn] EC: The CUSIP number is an identification number assigned to all stocks and registered bonds. The Committee on Uniform Securities Identification Procedures overseas the entire CUSIP system. Incidentally, foreign securities have a similar number called the "CINS number." I know, I know, yawn. But hey, someone out there might have been wondering.
Jim Lebanthal: Bob asked Jim to comment on purchasing new issues. Jim said new bonds and old bonds should be priced competitively. Bob told Jim that the seller pays the commission on new issues, but Jim seemed to question that premise. The issuer is the one who gets $99.25 and if you never sell the bond you will never feel that three quarters of a point if you hold to maturity. That is the beauty of yield-to-maturity. Bob said that narrow amount on a new issue would compare favorably compared to a principal trade. Jim said he wants a bond on the secondary market to be similar but usually the seller knows more than the individual investor buyer does.
EC: A good article on purchasing municipal bonds can be found at this url:
Caller: This caller is seeking safe tax exempt income. If you buy into a mutual fund of tax exempt mutual fund, won't the net asset value drop if and when interest rates rise? Jim said yes. The same thing will happen in your holdings of individual bonds. Bob said if you hold a quality bond to maturity, however, you will get your principle back. Jim acknowledged that, but noted that you can't always hold onto an individual bond until maturity. Jim recalled a time during the 1970s when most long term bonds lost 40% of their market value because of inflation and if you had to sell a bond you got 60 cents on the dollar.
Jim Lebanthal: Jim noted that if you buy bonds of inflationary expectations there is a tendency for the market to price that inflation into the bond. If inflation abates while you are holding that bond, then you will see that bond value go up ‹ just as they are today where you are seeing bonds trading at a premium to your purchase. Always remember that it is the "real" rate of return and after taxes. While municipal bonds can take taxes out of the equation, every investor must recognize and realize that they have to account for inflation. If we goof in the tightening of the money supply which right now is flooding the country and the globe, than the bond that I sell you today will reflect that bungling and depreciate in market value. Jim said he hopes Ben Bernanke has those qualities so that when he tightens, he does it right.
Caller: This caller has over a million to invest in General Obligations, particularly California. How does an individual investor buy those bonds without going through various people who are going to tack on commissions and fees. Where is the easiest and safest way. Jim said he goes through this in his book where he spells out who to deal with and who not to deal with. To avoid the fees is a tough question because you have to pay something. Even if you were an institution with hundreds of millions to invest, the fee would be 50 cents per thousand or even more. For the investor even with a few million to invest, you have to find someone you like and can trust.
Caller: Should a caller from one state compare a general obligation of another state? Jim said he thinks all people should diversify their bond holdings to other states, even though you might lose the state tax exemption. Bob said people tend not to do that because in a state like California where the top state income tax bracket is 10.5% it is hard to write those tax checks to other states. Jim added that he believes in preaching diversification even though it is hard to practice and 10.5% is hard to swallow but that is the price sometime for diversification.
Caller: This caller owns a closed-end mutual bond fund of common shares and it is insured and he is trying to understand what that means. Jim said the insurance is not worth that much anymore. Jim said he was on the board of a major bond insurer and was on the audit committee and he hangs his head in shame over what happened. It was a beautiful model that insured what didn't need insurance and tried to apply that model to credit default swaps and mortgage backed securities and all the leveraged junk that the culture loosed upon the world. Jim said overall he thinks the insurance is worthless because the liabilities have reduced their reserves so much that they are rated junk. That said the bonds that have insurance today are probably good enough to stand on their own two feet.
[Korn] EC: Wow. This guy is a trip! I like learning about municipal bonds. Generally it is not a topic that is covered too much and so this guest made some good points.
David Korn's Stock Market Commentary, Interpretation of Moneytalk (Bob Brinker Host), Financial Education, Helpful Links, Guest Editorials, and Special Alert E-Mail Service. Copyright David Korn, L.L.C. 2009
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If you want to listen to the Jim Lebanthal interview, it will be available on KGO810 for downloading until next Saturday. It is in the 3-4pm time slot. Here is the [LINK]
Here is the last of SJ_Al's beautiful San Francisco photos. This is a lighthouse overlooking the Pacific Ocean (click photos to enlarge):
Dixiegeezer took this picture of wild parakeets. How beautiful, and how unusual (and nice) to see them free: