It used to be that municipal bonds were one of the safest investments that a financial advisor could recommend to a client, and were often utilized by retired investors looking for a safe way to generate income in retirement. Unfortunately, the heyday of muni bonds appears over and any financial advisor not adequately disclosing the risks of municipal bonds is doing so negligently. There is simply too much information out there in the media and too many negative warning signs for a financial advisor to continue to tout these investments as super low risk.
One significant factor that impacts whether these investments will perform in the future is the status of the tax-exempt status of municipal bonds. This status is up in the air as Congress wrestles with the fiscal cliff.
Any changes to the tax status of the bonds could send notoriously fickle municipal bond fund investors fleeing for the exits, and as with any outflow of capital, this could cause an enormous decline in municipal bond values.
As has been reported in numerous other places, municipal bond investors have shown already that they’re susceptible to factors that have nothing to do with the underlying fundamentals of the market. In late 2010, for example, a massive sell-off in the municipal bond market was triggered by analyst Meredith Whitney who predicted a near-apocalyptic scenario for the asset class. Although the raft of defaults predicted by Ms. Whitney has failed to materialize, many municipal bonds have defaulted and the underlying concern for the sector still exists.
Another risk of this sector is liquidity risk. Because of the illiquid nature of municipal bonds, the performance of municipal bonds is largely tied to flows into and out of the funds. That illiquidity could get even worse if the tax exemption is threatened, as it would make the narrow investor base even narrower and retail customers could be stuck in these investments similar to way investors were stuck in auction rate securities in 2008.
Although the form is uncertain, most analysts agree that some kind of a change to the tax exemption seems fairly likely, given the fiscal challenges the government faces.
For these reasons it appears that municipal bonds could be facing a fiscal cliff of their own, and if it occurs, financial advisors that glossed over the risks of such an event could be left holding the bag.
The foregoing information has been provided by The White Law Group. The White Law Group is a national securities fraud, securities arbitration, and investor protection law firm with offices in Chicago, Illinois and Boca Raton, Florida.
For more information on The White Law Group visit http://www.whitesecuritieslaw.com. For a free consultation with a securities attorney, please call the firm’s Chicago office at 312/238-9650.