Are California Muni Bonds Safe?

by: Investor Nirav

California is running out of cash. Yields on California Municipal Bonds are therefore pretty high right now. But is it safe to buy them?

According to the Wall Street Journal, it would appear that it is. They asked the California state treasurer Bill Lockyer whether the California public debt was completely safe. “Absolutely, the only way we’re going to default is if there’s a thermonuclear war.”

David Blair, the head of municipal credit research at bond giant Pimco, agrees. “They clearly have the ability to pay,” he said. But he added that the main risk is headline risk, where bad news smacks prices.

The ten-year Treasurys currently yield about 2.5%. California’s bonds yield about 4.2%. And that’s also exempt from federal income tax.

According to Vanguard’s Mr. Smith, the gap between the two has never been so high. The picture is similar for municipals across the country. Panicked investors have dumped everything - and blindly jumped into Treasurys, driving yields down to incredibly low levels. Meanwhile munis are also under pressure because so many states and cities will have to borrow more.

So there’s no doubt that California will pay back the debt. In the worst case, the Federal Reserve would just bail the state out. If they’re willing to bail out car companies, I’m sure they’ll step in for California.

But if there’s more bad news, the yields could go higher still, and the prices of the bonds could fall in value.