Bond Insomnia's Cure Awaits Readers of Fine Print: Joe Mysak

Commentary by Joe Mysak

Oct. 14 (Bloomberg) -- Investors don't want to know what to look for in buying municipal bonds.

They want to know what they bought.

Oh, dear.

I can't blame them. They bought municipal bonds at a time this kind of security was almost becoming commoditized. More than half the market in recent years was insured and so rated AAA, so why bother researching exactly what you were buying?

And municipal bonds never default, right? Isn't the default rate less than 1 percent? Bonds are by their very nature safe, boring investments, and these also provide tax-free income, so that's all you need to know.

Combine this kind of thinking with the fact that most municipal bonds were sold rather than bought, and you have a formula for buyer's remorse years later.

When I say municipal bonds were sold rather than bought, all I mean is that individual investors rarely call up their brokers and ask for specific bond issues, coupons, maturities. They buy what their brokers sell them.

Now that the credit crunch has reached the state and local level, investors are nervous, afraid that they might have dropped a few bombs into the same basket with their nest-egg money.

Who Sold Them?

Saying you bought a municipal bond is very much like saying you bought a black car. There is such an infinite variety, it almost makes no sense.

Is that what you were sold, ``a municipal bond''? Think about this. Say you own a bond issued by city X. Well, city X may be printed on the cover of the official statement, or offering documents, describing the bond issue, but maybe it also says ``City of X authority.''



So city X sold the bonds, all right, but otherwise may not have any responsibility for them at all.

Maybe city X sold the bonds on behalf of an organization that wanted to build a tourist attraction of some sort. The bonds are solely the responsibility of the organization, and will be repaid only from the money paid by tourists and local sponsors, and gift-shop revenue.

If that money doesn't cover debt service, the bond issue's trustee has to dip into reserve funds to make the payments that go to you. If those run out and the attraction still isn't drawing enough visitors, then you are out of luck.

Willingness to Pay

That's just one example of a ``municipal bond.'' That model has been replicated probably hundreds of times, thousands of times if you substitute ``company'' for ``tourist attraction.''

Safest of all municipal bonds are those backed by the promise of the issuer to raise taxes to an amount sufficient to pay debt service, so-called general obligation bonds.

For a brief period, after Orange County, California, declared bankruptcy in 1994, people started having their doubts, even about these kinds of securities. Maybe, they thought, you are safer with a bond that is repaid by a dedicated source of revenue -- water fees, say, or tolls.

That takes politics, the political willingness to raise taxes, out of the equation.

I have a feeling people are going to start wondering about this willingness to pay, versus ability to pay, again.

If you don't know what kind of bonds you own, you've got to go back to school. Have your broker get you the final official statement for the bonds.

`Plan of Financing'

Then sit down at a table with a strong light, a pen, and a little packet of those sticky notes and read the O.S. to figure out what you own. Make sure you have plenty of quiet.

There's no short-cut to this method. These documents aren't written in the most graceful language. They are repetitive. You have to read carefully to distinguish all the parties involved. You need to be patient.

Read all about the ``Plan of Financing,'' and find out exactly who ``The Borrower'' is. Make sure to read the ``Security and Sources of Payment for the Bonds.'' And you might even begin with the section on ``Risk Factors,'' usually found at about Page 35 or 40. If your bond is financing some sort of project, there will usually be a big appendix containing a feasibility study, and what's more, it will be written in pretty straight English, unlike the rest of the document.

Then you can decide whether you still want the bonds, or are doomed to sleepless nights ahead.

Maybe it's not too late.

(Joe Mysak is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: Joe Mysak in New York at jmysakjr@bloomberg.net