How to Earn Almost 10% From a Treasury Bond
By Tom Dyson
November 17, 2008
"Soap is set to run out before Thanksgiving!"
My friend is a schoolteacher in Clark County, Nevada. He teaches third grade at a public school. We spoke last week. He told me his school is having a budget crisis. They're running out of all the basic supplies they need to run the school... like soap, paper, and toner for the printers.
"It's ridiculous. How do they think we can teach without printer paper and toner? I asked for pencils last week. They gave me 12 pencils. But I have 16 kids. How can I teach them to write without pencils?"
The trouble is, the state of Nevada is broke, and there isn't enough funding for the school system. My friend says they've already cancelled all the new projects and programs his school was hoping to start next year. And they don't have enough money for immediate expenses.
The problem is so bad, that this week, Nevada Governor Jim Gibbons said he'd take a pay cut to help ease the situation. Nevada pays Gibbons $141,000 per year.
California has the same problem as my friend's school. They are fighting against an $11.2 billion budget deficit this year. But the cash shortage is so severe right now, there's a probability schools will shut down, garbage trucks will stop running, and hospitals won't open.
Last month, Governor Arnold Schwarzenegger wrote a letter to Treasury Secretary Hank Paulson asking for an urgent loan of $7 billion to keep the state running. Schwarzenegger said he's increasing California's sales tax by 1.5% to raise revenue for the state.
Last week, Connecticut Governor Jodi Rell called an emergency press conference and told reporters Connecticut was facing a $6 billion deficit over the next few years. "Cuts have to be made," she said.
Meanwhile, Wisconsin Governor Jim Doyle said his state's budget deficit would exceed $5 billion through 2011. This is by far the largest deficit in Wisconsin's history.
The Economist reports that state tax revenues have fallen in 31 states this year. It's a result of the recession. People earn less, so they pay less income tax. Their houses have fallen in value, so they pay less property tax. Companies cut back, earn fewer profits, and pay less corporate tax. And consumers buy fewer goods and service and pay less sales tax.
Meanwhile, people demand more money from the state. They want new public works projects to increase employment, better health care, and more benefits for the unemployed.
In short, state governments are broke right now... and it's about to get worse.
Unlike the federal government, state and local governments can't print money to fix their problems. The municipal bond market is where state and local government go to borrow money from investors. California, for example, is the largest issuer of municipal bonds in the country. So when California runs out of money, it's either going to default on its loans in the municipal bond market or the federal government will have to bail it out with a huge loan.
The market has pushed up yields on municipal bonds to account for this risk. And I've heard many fund managers and professional investors say municipal bonds are a great deal right now because you can get after-tax yields approaching 10% for the next 30 years by buying AAA-rated municipal bonds.
There's one type of municipal bond safer than any other. It's called a "prerefunded municipal bond." These bonds are a great deal right now...
Let's say a state government needs $100 million to build a hospital. It issues bonds to raise the money. Interest rates are high. So the state must pay 8% interest.
But then let's say interest rates fall to 4%, and the state decides to refinance. It issues a new bond with 4% interest and uses the money it raises to pay off its debt on the first bond. Except you can't just pay off a bond anytime you like. You have to wait until the bond becomes "callable," or eligible to be paid back. So the state government invests the proceeds in Treasury bonds – the safest place in the market – until it can pay off the first bond.
The first bond is now a "prerefunded bond" because the state has already paid back the principal. It might sound complicated, but here's the point: There's no possible chance of default.
Because you're buying a risk-free Treasury bond in disguise, the yields on prerefunded muni bonds are lower than yields on regular muni bonds. But the income is still tax-free and yields are much higher than Treasury bond yields.
For example, in a recent Barron's issue, I noticed a 20-year California prerefunded bond trading at 5.85%. In a high-tax state like California, that's a true after-tax yield of almost 10%.
If you'd like to buy a prerefunded muni bond, call up your broker and ask to speak to the bond expert. Every major brokerage house has one...
Good investing,
Tom
Editor's note: Tom Dyson is a regular contributor to DailyWealth, a free investment newsletter focused on the world's best contrarian opportunities. We write with a simple belief in mind: You don't have to take big risks to make big money with your investments.
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Just a month ago, $700 billion sounded like a lot of money.
Not anymore. Half the money is spent, and while it's hard to prove that cash has not helped to avoid a much more serious situation, say, the closure of thousands of banks, it's equally hard to keep corporate lobbyists from crashing the gates at Treasury for a shot at what's left.
Worse still, it seems very likely that the incoming Obama administration will be forced to either expand the program or tack on a new one as automakers, credit card companies, regional banks, and insurers – even auto dealers and boat sellers – line up, hat in hand.
"By the time they get to the community banks, there may not be enough money left," Edward L. Yingling, president of the American Bankers Association, told The New York Times.
Perhaps the most controversial funding so far has been to insurance giant AIG, which the media has typed as a "zombie" company that isn't really functioning at all and now depends on taxpayer cash to exist.
Taxpayers are "keeping the zombie alive," Robert Eisenbeis, chief monetary economist at hedge fund Cumberland Advisors, told Bloomberg News. |
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Silver will outperform gold as a hedge against inflation, investor Jim Rogers said in an interview on Nov. 3. Silver is down 33 percent this year, while gold has fallen 12 percent.
"It's been beaten down horribly," said Rogers, the chairman of Singapore-based Rogers Holdings.
"If you put a gun to my head and said you have to buy one, I would buy silver rather than gold." |
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