The Crumbling Muni Bond Market Monolith
Is the municipal bond market a safe place for clients to put their money? Actually, a new study suggests that the question itself may be flawed – because the municipal market is far from monolithic, and municipal defaults are more common than ratings agencies have indicated. The study was authored in August by three Federal Reserve experts on the subject – Jason Appleson, Eric Parsons and Andrew Haughwout.
Moody's and S&P have each published default studies on muni bonds that they rate, indicating there have been 71 and 47 defaults, respectively, from 1970 through 2011. But when unrated bonds are included, muni defaults increase to 2,521, say the authors.
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"What causes such markedly different default frequencies between rated and unrated municipal bonds? Our answer: Not all municipal bonds are created equal. Different types of municipal bonds are secured by very different revenue sources with varying levels of predictability and stability." Specifically, the authors say industrial development bonds (IDBs) make up a majority of unrated IDB defaults. This is noteworthy, they add, because IDBs have accounted for two-thirds of municipal new issuance since the mid-1990s.
Help your clients evaluate the underlying economics of every municipal bond and tax-exempt fund, before investing. Don't assume all munis (or historic default statistics) are equal.
Federal Direct College Loan Costs Increase
Most parents of college-age children fill out a Free Application for Federal Student Aid (FAFSA). For middle-income households that qualify for aid, chances are good that Federal Direct loans will account for the bulk of the financial assistance package. But are these loans really the best way to go? Financial advisors should help clients evaluate three types of Federal Direct loans vs. other alternatives.
Subsidized Direct Loans are the best deal, and Unsubsidized Direct Loans also can be viable – even though the Department of Education has begun charging a 1 percent origination fee on both types since 7/1/12. The fixed interest rate on both currently is 6.8 percent. There are three main differences between them: 1) Subsidized loans are based on financial need, while unsubsidized are not; 2) In subsidized loans, no payments are due and no interest accrue during a "grace period" that lasts until six months after the student graduates or leaves school. There is no period in unsubsidized loans; and 3) Graduate students are no longer eligible for unsubsidized loans.
The most expensive type of Federal Direct Loan is a PLUS loan made to parents of dependent children and graduate students. The interest rate currently is fixed at 7.9 percent, plus a hefty 4 percent origination fee. Financial advisors should help parents evaluate lower-cost alternatives, including home equity lines of credit, life insurance cash value loans, and 401(k) plan loans. To learn more about Federal Direct Loans, click here.
The "Sure Loser" Asset Class – Cash Held in Dollars
Americans keep piling up cash dollars in banks and money market funds. Since the start of this year, the Fed reports that total savings deposits have increased by $430 billion, to $6.5 trillion. But in launching "QE3," Fed Chairman Ben Bernanke has heralded a "weak-dollar" policy that may continue for years. At the same time, other leading governments and central banks around the world are moving in the opposite direction – toward more fiscal austerity and monetary discipline.
Investors should know that the dollar has been sinking steadily against a trade-weighted basket of foreign currencies since 1985. In fact, the trade weighted U.S. Dollar Index touched an all-time low of 71.8 in September – less than half its peak 1985 value. Read this link for more details.
What's changed recently is the opportunity to hold cash in currencies other than the dollar, via ETFs and mutual funds. In addition to many single-currency ETFs, PowerShares offer DB US Dollar Bearish Fund (UDN) and Merk offers a Hard Currency mutual fund (MERKX). Gold is a time-tested form of hard-currency, accessible via bullion-based ETFs such as SPDR Gold Shares (GLD) and futures-based ETFs such as PowerShares DB Gold Fund (DGL).
Ask your clients: "Are you holding cash because you anticipate better opportunities in the next 6-12 months, or because you just don't know what else to do?" If the answer is the latter, remind them that holding cash in dollars is a sure loser (after devaluation/inflation), as long as QE3 continues.
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