Philip Fischer, a Wall Street veteran, was head of Municipal Research and the Global Index System at Bank of America Merrill Lynch before co-founding eBooleant Consulting. He draws on years of study and practice in Investing in Municipal Bonds: How to Balance Risk and Reward for Success in Today’s Bond Market (McGraw-Hill, 2013), a book aimed at high net worth investors, financial advisors, and trust departments.
Fischer first offers what he calls “a little history.” One of the more interesting tidbits was a paragraph on mandamus suits during the Reconstruction period. “[T]he administrators from the North were often highly unscrupulous in their issuance of municipal debt. The citizens were so incensed that they refused to make payments on the bonds. They didn’t just default; they repudiated the bonds, saying that their issuance was null and void in the first case. Mandamus suits by out-of-state bondholders were of limited value when the court sought to compel local officials to pay and a different mayor showed up each day.” (p. 11) Even though there are municipal defaults today and even though our current political dysfunction is often compared to the Reconstruction period, this example exposes the hyperbole of that comparison.
Fischer’s account of municipal bonds is thorough but not dense. He explains the various kinds of bonds—from general obligation bonds where the funds for the payment of interest and the repayment of principal come from the general taxing power of the issuer to revenue bonds that rely on a specific revenue source (water, sewer, power) to moral obligation bonds where “the state is not required by statute to help the issuer, but the legislature has the moral obligation to do so.” (p. 56) Then there are conduit bonds. Here the proceeds of a tax-exempt municipal bond issue go to a private entity. For instance, an issue sold by the Arizona Health Facilities Authority raised money for Banner Health, a nonprofit corporation.
Most people assume that all municipal bonds are tax-exempt, but Fischer explains that even so-called tax-exempt bonds are not always tax-exempt in reality: “whether and how municipal bonds are taxed varies depending on whether they are bought in the primary or the secondary market and whether they are bought at par, a premium, or a discount.” (p. 110) If this sounds complicated, it is. Fischer writes that “the market discount tax rules are some of the most befuddling in the tax code for investors.” (p. 113) Moreover, some municipal bonds, such as pension bonds, are taxable.
Municipal bonds can be a tricky lot, but Fischer’s book goes a long way toward making them understandable. Anyone who is thinking about investing in this area or who is advising those who do owes it to himself to become better informed about both the basic principles and the quirks of the municipal bond market. Investing in Municipal Bonds is the perfect place to start.