Municipal bonds: Safety depends on the municipality

ByABC News
July 15, 2009, 4:38 AM

— -- Q: Is it safe to buy New York and New Jersey municipal bonds?

A: Municipal bonds have been among some of the safest bets investors can make.

With few exceptions, when you lend money to a city, state or local government you can figure you'll get your money back.

But lately investors are worried about things they never worried about before. Just the fact that you're asking whether the debt issued by two of the states with the largest economies shows just how widespread worry has become.

To answer your question, I'd first say that no investment is 100% safe. Not to go too far, but any time you let someone borrow your money, there's a chance you'll get back less than what you loaned. Not acknowledging that would be folly.

Now, we've established that all investments are risky. But what's more important is understanding how risky the investment is and whether that amount of risk if right for you.

Municipal bond investments as a group are among the least risky investments available.

But don't make the mistake of putting all municipal bonds in one basket. There are different types of munis, some of which are riskier than others.

If you're concerned with safety, you want to stick with what are called general obligation bonds. These are bonds that draw on the borrowers' general taxing power. There have been almost no defaults of general obligation bonds in the past 30 years, says Matt Fabian of Municipal Market Advisors.

There are other types of bonds, such as revenue bonds, which depend for repayment on revenue from the specific project they are sold to finance, such as a toll bridge or sports stadium. These are considered more risky.

What if the state is in financial trouble? Many states, notably including California, are struggling with enormous budget shortfalls. So far, the states have been protecting the interests of lenders and instead, are trying to cut costs to balance their budgets. If that trend continues, muni bonds will continue to be a safe investment, Fabian says.