Municipal-bond tax breaks face court challenge
US Supreme Court weighs whether states can give residents who buy munis preferential tax treatment.
from the November 5, 2007 edition
Page 3 of 3
Those who already own muni bonds should hold them, to avoid trading costs. "I wouldn't sell anything based on what's happening now," Mr. Fabian says.
But a more gung-ho John Mousseau, portfolio manager at Cumberland Advisors in Vineland, N.J., recommends buying now before typically heavier year-end buying sets in. Part of his rationale centers on the ample supply of these bonds, due to more issuances this year versus in 2006. That comparatively abundant supply is one factor keeping munis' prices relatively low now, while their yields currently hover not far from those of comparable US Treasury securities – whose interest payments are taxed at the federal level, he says.
As for the Davis case: "In the end, that case talks about relative yields of munis to each other," Mr. Mousseau says. But to him, investors should be more focused on the bigger economic picture. "If you believe that interest rates [generally] are high and the economy is slowing down, you should own bonds now. Any effects of the Davis case are secondary to interest-rate levels and movements now."
It's wise to be wary of these bonds
Although experts disagree about the climate for buying municipal bonds now, some issues don't look like surefire buys regardless of one's broad market view.
Among the issues that could be stung by a Davis victory in the Supreme Court: Munis of Puerto Rico, whose interest payments are currently tax-free at all government levels in all US states. The prices of these bonds are comparatively high, says Matt Fabian of Municipal Market Advisors, because their interest is tax-free to investors across the United States, giving them wide appeal. But if the Davises win their case in the Supreme Court, that broad tax advantage could be jeopardized, making those bonds vulnerable to a sell-off, he says.
But those bonds so far haven't been hurt, a factor some market pros link to doubts about a Davis victory.
Bonds with ties to the housing market could also be a concern.
According to Mr. Fabian, these housing-related bonds include: Land-secured bonds based on future housing development, whose credit quality has been hurt by the subprime lending woes; multifamily housing project bonds, backed by revenue from apartment projects – a problem because of the surplus of rental properties now on the market; and bonds that help finance nursing homes. In the last case, Fabian says, such "bonds are backed partly by the entry fees people pay when admitted to a nursing home. The ability to pay these fees depends on people being able to sell their homes, which is a problem in the current housing market."
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