Yields entice in muni sell-off

It's a great time to be a buyer of high-quality tax-free municipal bonds.

Except that it might be an even better time in a week or so. Or several months from now.

When the state of California tries to raise $1.75 billion early next week in one of its periodic sales of general-obligation bonds, it is likely to have to pay the highest interest rates in four years, at least on securities maturing in 20 years or more.

California taxpayers, who ultimately foot the interest bill on the state's bonds, can thank the credit-market mess that Wall Street has brought on itself and the rest of us.

Muni bond prices have plunged in recent weeks, driving yields way up, in part because investors are fleeing certain muni securities that were marketed as super-safe, short-term debt when in fact they were long-term securities.

Chalk up another brilliant stroke by the financial industry's alchemists -- the same group of people who assured investors that AAA-rated bonds really could be created from a rank vat of sub-prime mortgages.

We'll come back to the scene of the crime, but first let's look at what may be an opportunity for investors who have cash to put to work and are hungry for a decent return on their money.

The plain-vanilla bonds the state will offer for sale Monday through Wednesday will finance voter-approved infrastructure improvements such as new schools, libraries and clean-water projects.

The bonds, as usual in such sales, will be offered in maturities of one year to 30 years.

Here's the hook: Based on what the market was demanding Friday, California may have to pay north of 4.5% on 10-year bonds and north of 5.2% on 20-year issues.

Because the interest is exempt from state and federal income tax, those yields are equivalent to much higher rates on taxable bonds.

A married couple with taxable income between $131,451 and $200,300 this year would be in a combined federal and state tax bracket of 34.7%, according to the California Municipal Bond Advisor newsletter. In that bracket, a 5.2% tax-free yield is the same as earning nearly 8% on a fully taxable bond.

By contrast, a 20-year U.S. Treasury bond now pays 4.4%, which is subject to federal income tax but not state tax.

Mike Dawson, co-manager of the MFS California Municipal Bond mutual fund in Boston, says muni yields at these levels offer "absolutely tremendous value."