As we enter 2013, it's a good time to see where munis stand after avoiding most of the threats posed during fiscal cliff negotiations, notes Marilyn Cohen of Bond Smart Investor.
The sacred cow avoided being gored. President Obama's desire to limit the income tax deduction on municipal debt to 28% appears to have been shelved-for now.
Still, the President has four years in which to chip away at the tax benefits munis provide investors. We know his intentions and we know that he is no quitter. Still, our tax-free munis seem to have emerged unscathed from the tax changes just enacted.
As you read this, check to be sure none of the names mentioned here appear in your own bond portfolio. If you're watching one or more holdings that appear to be in trouble, take advantage of the MSRB's Web site, EMMA (www.EMMA. MSRB.org). This site identifies your particular bonds suffering material events.
Such events seldom foretell good news for bondholders. The problems that Material Events usually foretell are significant-like fraud, criminal charges against city officials, and credit downgrades. If you discover such material events on EMMA, consider heading for the exits.
Pennsylvania Pension Payouts
A large number of Pennsylvania municipalities are showing an alarming disregard for statutory pension payouts to public employees-in the employees' favor.
Certainly our city employees are valued and appreciated. Police and firefighters deserve their well-earned pensions. But not to the point where their payment forces the very cities they worked for into bankruptcy.
Allentown, PA is such a city. For some time, Allentown has been grossly overpaying its retired city employees' benefits their contracts say they are not entitled to. Greg Scheirer, a retired 26-year veteran of the Allentown Fire Department, received an annual pension benefit of $99,289-more than 150% of what the Pennsylvania state law says was actually owed. As a result of this and other unnecessary (and illegal) generosity, Allentown must now lease its water system in order to pay for these hugely inflated pension costs.
Allentown isn't the only case. Indeed, Bloomberg News reports that 26% of all Pennsylvania municipalities have policies of paying pensions well beyond statutory guidelines. This has added an extra $1 billion in unfunded pension liabilities, boosting the unfunded total to $8.5 billion. Pennsylvania taxpayers will have to foot that bill eventually.
Why would an already cash-strapped city do such a stupid thing? The answer lies in form over substance-another way of saying the elected officials kicked the can down the road.
Rather than give city employees a raise that immediately increases the city's budget deficit, why not just promise them a greater pension benefit sometime in the future? The pension benefits have such a large unfunded component that a little more unplanned expenditure won't make much difference anyway.
Now we see these chickens have come home to roost. However, apparently Pennsylvania bond investors agree with this strategy. They demanded just 0.28 percentage points of extra yield to own the state's and its municipalities' debt.