After several sessions of declines, municipal bonds and the exchange traded funds (ETFs) that track the sector seem to be attractive and might be a great bargain.

  • Yields on AAA-rated general obligation muni bonds are about 1.5% higher than those of Treasuries and these tools are generally tax-exempt.
  • Another reason muni bonds have appeal is that rising deficits, especially in states such as California, Minnesota and Ohio, will keep yields high. Muni bonds will eventually deviate back to their normal prices, may give you a gain, but will not translate into quick riches.

Although muni bonds are tempting, they aren’t foolproof. The bond market has been hit by leveraged investors fleeing causing a severe lack of liquidity and credit downgrades to bond insurers, states Mina Kimes of Fortune Magazine. This raises the issue of default in these bonds – in tough times like these, many cities are nearing bankruptcy.

Another issue coming up in the bond market is a new nationwide inquiry that’s been launched. Federal agencies and some state attorneys general have been gathering evidence of what might be collusions among banks and companies that have helped state and local governments take about $400 billion worth of municipal notes and bonds to market every year, reports Mary Williams Walsh for The New York Times.

The issue is concerning now, because the incoming administration is preparing a stimulus package that would spawn projects carried out and financed at the state and local level. Some estimates have as much as $4 billion a year vanishing into the system.

If interested in this market, a sampling of the many funds are: PowerShares Insured National Muni Bond (PZA) has a yield of 5.11% , with a taxable equivalent of about 7.8% ; iShares S&P National Municipal Bond Fund (MUB) has a yield of 3.7%, with a taxable equivalent of about 5.6%; SPDR Lehman Municipal Bond ETF (TFI) has a yield of 3.9%, with a taxable equivalent of about 6%.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.