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Continued: Know your way around muni bonds in a post-Detroit world; an opaque but largely stable market

  • Article by: CHRISTINA REXRODE , AP Business Writers
  • Last update: August 2, 2013 - 4:10 PM

Dealers are supposed to offer "fair and reasonable" prices. They make money from the difference between what they paid and what they get from a sale.

What kind of return can you expect?

When there's little risk, there's little reward. Thanks to their solid credit history, municipalities pay very low rates to borrow money.

A type of muni called a "general obligation" bond is considered especially safe. They're backed by a city's full faith and credit, which essentially means a city will take extreme steps to repay them — even if it has to cut police and fire protection for its citizens or raise taxes.

The average yield on a top-rated, 10-year general-obligation muni bond is 2.71 percent, according to Thomson Reuters data. For a 30-year muni, it's 4.22 percent.

That's a bit more than the payout on U.S. government debt, and the tax break makes the benefit bigger for investors. The 10-year Treasury note yields 2.62 percent. The 30-year bond yields 3.70 percent.

What's going on in Detroit?

Detroit owes billions to bondholders and billions more in pensions to retired city workers. In its bankruptcy filing, the city proposed trimming pension benefits and paying bondholders a fraction of what they're owed. It also wants to treat retired city workers and bond investors as equals.

Both groups plan to fight the city's proposal, for very different reasons. The retirees argue that Michigan's state constitution protects their pensions. Investors who hold the city's general-obligation bonds expect not only to rank first in the lineup of creditors but also to be paid in full. Laws often require local governments to pay bondholders before they pay anybody else.

Government borrowers generally stick to their promised interest payments as long as residents keep paying taxes. Even when trouble strikes, bondholders usually get all their money back. In 1994, for example, the bankruptcy of Orange County, Calif., shook financial markets, raising fears that bond investors would spurn local government borrowers. But Orange County's bondholders eventually got all of their money back, according to the rating agency Moody's.

One of Detroit's problems, though, is that its population and property values have plunged, shrinking the city's tax base.

Bond investors worry that if Detroit manages to pay them less than the full amount they're owed, it would set a precedent for other cities to follow.

"This fight could last for years," said Richard Larkin, director of research at Herbert J. Sims & Co. "Bond investors ain't going to sit back quietly."

Will it affect me?

Probably not, unless you worked for the city of Detroit or own its bonds.

Even if you blindly stashed most of your savings in muni-bond funds, it's unlikely that you loaned much to Detroit. Mutual funds tracked by the investor service Morningstar have $2.5 billion in bonds tied to the city. That's 0.003 percent of their muni-bond holdings, according to the Fed.

So I don't need to worry about losing my money?

Despite the high-profile problems of cities like Detroit, municipalities rarely miss an interest payment. The rating agency Moody's counted five defaults last year. Cities were behind three of them: Stockton, Calif., Oakdale, Calif. and Wenatchee, Wash.

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