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Subject:  Municipal bonds: A train wreck waiting to happen Date:  12/6/2012  12:29 AM
Author:  yodaorange Number:  410598 of 481794

Every financial writer or blogger has a certain style and characteristic that you pick up on after a while. Many METARites are the same. If you read a METAR posting without knowing the author, you would probably be able to correctly guess the author in many cases.

When you read a blog or article, it helps to keep in mind the style and biases that the author has. And yes, try as we may, everyone has biases, including Yoda. Your goal might be Switzerland, but you end up being Russia.

When you read an “alarmist” article from a normally reserved author, you probably pay more attention to it. I read just such an article today from Allan Sloan. Allan has been around the block many times over his 30+ year career in finance. He is currently senior editor at Fortune. I have been reading his articles for a long time. He is NOT prone to hyperbole. If anything, he tends to err on the understated, reserved side. If Allan screams “fire” I am heading out of the theater ASAP.

Today Allan screamed fire about the muni bond market with an article: Municipal bonds: A train wreck waiting to happen. [1]

The essence of Allan’s argument is that muni bond buyers often ignore the call provisions in muni bonds. In many cases, they see a high yield and think it will persist until the bond matures. What they do not understand is how many bonds are being called early and/or “sunk” early. I can independently verify Allan’s concern. I see individual’s buying bonds where they clearly do NOT understand what the risks are. For example, they buy a bond that has a 2/3 chance of LOSING MONEY and only a 1/3 chance of achieving the yield to maturity. Allan documents a single bond that illustrates this risk:

You should be especially wary of muni bonds trading at fat premiums above face value.

Here's the deal. Unlike U.S. Treasury securities and many corporate bonds, lots of investment-grade muni bonds can be -- and will be -- called in for early redemption by their issuers. That means that muni bonds' apparent interest yields are way above the actual yield that