5 Reasons Not to Panic Over California Bankruptcies

Municipal bond investors quake out west.

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Here's why: California is different from other states, since it froze the property tax increases under Proposition 13 in 1978. Since then, the state's property tax cap is a political sacred cow. State politicians in both parties are loathe to raise the state's property tax.

Still, the California economy is starting to improve, and real estate is steadying. That could help in the long term, but there will likely be more bankruptcies in the state before economic recovery comes to the state's rescue.

4. Muni prices may fall—but they are too high anyway. Through all of the credit upheavals of recent history, muni prices have behaved much like the debt issued by Uncle Sam. Their prices are at all-time highs, with yields at all-time lows. Summer is when the largest number of municipal bonds mature and municipalities need to issue more debt. The flood of new issues could put more supply in the market—and yields might have to rise to attract investors.

"June and July are slow (for investors)," says Petek. While many issuers will be bringing offers to market, buyers may be off at the beach. "You may see some elevation in yields."

Advisers say it might not be a bad idea to hold off muni buying until September.

5. Over the long haul, more people will want tax-free and fixed income. Munis are no longer the domain of the wealthy. The market will be boosted over time as demand from investors continues to grow. As Boomers start to tap the trillions they have in IRAs and 401(k)s, they will buy munis for their steady income and to avoid giving up too much for taxes. In addition, the expectation is that the Bush tax breaks will disappear and taxes will rise for upper-income people, creating still more demand for tax-free income. Some retirees are starting to worry about Medicare income caps as well, and munis help reduce taxable income.

But in the search for yield, don't get greedy.

[See Preparing for a Bond Bubble: 6 Investing Tips.]

Munis are considered a "can't miss" investment if a tax-free yield rises above Treasuries, which is the case now. The long-term yield for munis at 3.5 percent is slightly better than the Treasury yield. The tax-free yield equivalent is a full percentage point higher. But conventional wisdom may not hold, especially if the squeeze on local governments becomes too much for more and more municipalities to bear. The oracle of Omaha, Warren Buffett, said in a recent Bloomberg television interview that it appears municipalities are more willing to take the bankruptcy option.

That could boost bankruptcy filings, he said. But this will not augur the disaster some have forecast. "I don't think we're at the precipice," Buffett said.