Detroit Bankruptcy on Munis

Friday’s big news in the markets (outside of the concerns over MSFT and GOOG) was the bankruptcy of the City of Detroit.

This Chapter 9 filing was a long time coming, in my opinion, and should not be a surprise. But some investors might be wondering–will the effects  spill over to the municipal bond sector overall?

In a word, no.

Detroit is a very unique situation (and not in a good sense). It has very little tax revenues, infrastructure is depleted, and its population is near-poverty level. That’s a toxic mix for any municipality.

But it does underscore the importance of due diligence. Investors who own muni bonds must be very selective:

1. pay attention to credit rating

2. think about the macro and micro–economic factors around the country

3. look up the local economy–is business booming? What’s the tax revenue outlook?

4. consider the overall debt load of the municipality

If those are a bit more work than you bargained for, consider a muni bond fund if you’re looking for current income and capital preservation. Some decent ones include SWNTX (Schwab Tax-Free Bond Fund) and PRINX (T. Rowe Price Summit Municipal Income Fund).

Personal Finance: the Housing Question

Legendary hedge fund manager John Paulson had a message on CNBC yesterday: he’s bullish on housing.

Pressed further, Paulson said that one of the best investments a person can get into, right now, is to buy a house. And if one already has a house, buy a second house.

OK, so you may not think that Paulson is to be trusted as his long gold calls are down 30% YTD (although, life-to-date, the gold fund is still up 100%). BUT… does he have a point on housing?

There’s a couple things to consider here (and each person’s situation is different):

1. Assuming the status quo is in place, paying a mortgage makes infinitely more sense than paying rent. Excluding interest, mortgage payments build equity–think of it as a transfer of value from cash to the form of real estate (from the left pocket to the right pocket). On the other hand, paying rent destroys value. It’s cash going into someone else’s pocket.

2. Since mortgage interest rate can be deducted for tax purposes (assuming one itemizes on the tax return), you’re looking at a ~30% savings in dollars paid on a mortgage vs. rent.

3. Right now, mortgage rates are still at historical lows. But that may change in the next year or so. If the Federal Reserve thinks that the economy is growing at a fast-enough pace and feels the need to control inflation, it will raise rates.

4. Congress is considering changing the tax code around mortgage interest deductions, specifically barring the deduction on second homes (e.g. vacation homes) and homes exceeding a certain price.

Conclusion: buy a house, and do it soon.