The popping of Champagne corks can doubtless be heard clear across Naples, Florida, during the pre-dinner cocktail hour—which, down there, is probably around 2 in the afternoon.
Rich retirees—in Naples and elsewhere—are enjoying a windfall this year on their favorite tax dodge, municipal bonds.
Those are bonds, or IOUs, issued by states, cities and towns (as well as some semi-public institutions such as hospitals).
Muni bond prices have risen, even as taxable bonds have slumped, and it’s all thanks to Washington.
It’s not just because of President Biden’s plan to hike taxes on the better heeled, which make tax-exempt bonds more appealing.
But, more important, it’s because of the unprecedented money tsunami pouring out from Washington, D.C. to America’s cities and towns.
Total aid to states, cities, counties and towns in the American Rescue Plan Act of 2021 passed in March comes to about $330 billion.
That was way more than the amount of revenues they actually lost during the pandemic, argues Craig Brandon, co-director of municipal bond investments at Boston money manager Eaton Vance. As a result, he says, “Some of the small towns and cities we talk to, they don’t know what to do with the money. They just don’t know what to spend it on.”
Lucky them. It means that hardly anyone is worrying any more about the risk that municipalities might default. Even places like debt-riddled Illinois seem much safer bets.
Uncle Sam, it seems, will provide. (By “Uncle Sam,” of course, we mean the Federal Reserve, “millionaires and billionaires,” or lots working stiffs paying taxes, depending on whom you ask.)
Bonds are like seesaws. When the “yield” or interest rate falls, the price rises. And vice versa.
So the prices of riskier “high yield” muni bonds have risen even more than that of safer bonds. If you want to see what’s going on look no further than the Eaton Vance National Municipal Opportunities Trust EOT,
Thanks to the boom, there aren’t even enough muni bonds to go around. New bond issues are typically 20 times oversubscribed.
The net result? Muni bonds are doing so well now, compared to taxable bonds, that in many cases it no longer makes as much sense for taxable investors to keep buying them.
Five year AAA-rated muni bonds are now paying barely half the interest of five year Treasury bonds. Among 10 year bonds, AAA-rated munis are paying less than two-thirds of the interest of Treasury bonds.
These are historic lows, Brandon reports.
It means that even a high earner paying President Biden’s proposed 40% top rate of income tax could end up better off in a taxable Treasury or corporate bond than a muni. There again, people who live in New York or California, where the proposed top rates of federal, state and in some cases city tax could take more than 50 cents on the dollar, may still be better off in munis.
The higher the taxes, and the more the federal spending, the more the demand for munis. So the price goes up, the interest rate goes down, and it becomes cheaper and cheaper for cities and states to borrow more money. What could possibly go wrong?