FMSbonds, Inc.’s Municipal Bond Forum is an exclusive opportunity for investors to submit questions and comments on the bond market or to respond to one of our articles.
To participate, just send us an e-mail. Be sure to include your name or initials and your state of residence. Posted e-mails may be edited for length and clarity. If you prefer a private response, please note that in your e-mail. Responses are provided by James A. Klotz, president and co-founder of FMSbonds, Inc., a municipal bond specialist for more than 35 years, and other members of the firm as noted.
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We have a family trust that is 100% invested in New Jersey municipal bonds, with a face amount of $1 million. The current market value of the bonds is way down and is fluctuating between $965,000 and $975,000. I am trying to understand the market conditions that are responsible for this, and my inquiries to our ML broker are not providing me with anything that I can readily understand or explain to my father.
R.K., New Jersey
In light of the subprime mortgage problems, what would happen if an insurer were to go bankrupt? Is it like other insurance, where there are insurance pools that would step in and take over?
D.W., California
How will the potential hedging of the tender-option-bond-programs, or unraveling of these trades, affect the value of AAA-rated insured bonds? Will this seriously harm bond values and is it a transitory effect?
D.M., New Jersey
I am deeply concerned about what’s going on in the market. I find it hard to believe that “the bond insurers have mostly insured only the mid to higher levels of CDOs,” as you say, since it’s become clear that most holders of CDOs don’t really understand the risk profile. Furthermore, you say “a large segment of the CDOs would need to be in default before the insured layers would be impacted. This is not anticipated.” Well, I don’t think any of the experts anticipated we’d be in the turmoil we’re experiencing today, so I’m not convinced their judgment is credible. I, too, am concerned about what would happen to the insurers if we truly had a meltdown. I’ve never understood how the insurers could cover the potential calamity that could arrive. How could insurers protect us in a crisis?
A.S., New Jersey
I am a client of yours who has purchased several insured bonds. Could you explain whether and, if so, to what extent, these insurers will be negatively impacted by the collapse of the sub-prime market where, apparently, several of them provided insurance on junk paper? Will they remain capable of handling any muni defaults individually or as a group?
T.B., Georgia
I’m having trouble following your logic. Would you make clearer what is happening to the markets?
How do you determine which bonds that are at depressed levels? It seems to me that it would take a team of experts led by Bill Gross to determine the truth from the trash.
D.J., New York M.G., California
Great information on your site, especially the laddering truths, which most people don’t understand. I have a few questions: 1) Capital losses, for example: Buying zeros (at a bit of a premium over accreted value) and a short time later they are called at accreted value. Is there a capital loss to report on one’s 1040 schedule D? If yes, do you accrete them up to expected value based on your purchase price, then subtract for the loss? 2) Zero munis accrete, as we know. Does one report the accretion on the 1040 with other exempt interest? If yes, does one figure the accretion from one’s purchase price to maturity (not the bond’s original accretion)? If the bond was bought at a discount or premium to accreted value at the time of purchase, one would create a new schedule on a spreadsheet. 3) Similar to the first question above: Do zeros, if sold before maturity, ever create a cap gain or loss? If yes, is it based on one’s own accretion table (as in question two above)?
R.H., Kansas
Am I missing something? By purchasing a bond as an individual investor, you say that I am helping the states, not the tobacco industry. Wouldn’t it be more accurate to state that I am helping the investment banks, who bought the stream-of-payments from the states, so that those banks spread their risk of loss to individuals like me? If no individual bought a bond, wouldn’t the investment banks a) get all the income, but also b) incur all the risk of default?
K.K., West Virginia
I just discovered your site and find it very interesting. But with regard to your “Lessons in Laddering” article, my understanding is that accreted market discount is taxable at ordinary income rates when a bond is sold, even for municipal bonds. In your example, when the discounted bonds bought in the swap at 50 mature at 100, ordinary income tax will be owed on the $100,000 gain. Therefore the tax loss of $100,000 resulting from the swap will be offset by $100,000 of accreted market discount at maturity. If the tax loss is used to offset capital gains, then the investor is only saving 15% ($15,000) in taxes at the time of the swap, but will owe anywhere up to 35% ($35,000) taxes on the accreted market discount at maturity, presumably 20-plus years after the swap. You state: “Best of all, the investor’s new bonds regained all of their lost market value in the following years,” but you don’t mention this tax liability. Admittedly, if the investor reinvested the $15,000 tax savings, and his tax rate were less than the maximum 35%, he might still come out ahead, but it pretty much seems a wash. Am I missing something?
H.B.
In your article “Hidden Gems in the Muni Market”, you state that a premium bond will produce about 50 basis points more yield than a comparable par bond maturing in the same year. However, as I see it, and what you don’t say, is that the 50 extra basis points comes from the premium that was paid in that, when the bond is called (at par or for less than the premium paid) or matures, the premium disappears or dissipates. In other words, I am merely trading some return of capital for more current income. It’s like taking the premium from the right hand and putting it in the left hand and calling it “additional yield.” Please convince me that I am making money by collecting less than I paid when I sell a bond or when it is called or matures at 100 when I paid, say, 105. As I see it, I am merely increasing my own current income with my own money taken from (by reducing) the premium part of the price that I paid for the bond. Is that why, as I understand it, the IRS does not allow a capital loss (of the lessened premium) to be deducted on my income tax because the so-called “loss” is really transformed into “current income” and, therefore, merely changes its nomenclature – not its value?
L.K., Maryland
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