One of Last Shelters Left : Tax Plan Starts Stampede to Buy Municipal Bonds
Tax revision has worked wonders for Andrew Geller’s popularity. The Los Angeles bond dealer said he cannot pull into his driveway without being besieged by neighbors wanting tips on buying municipal bonds.
At his office, too, “we are being bombarded with calls,” Geller, senior vice president of the tax-free bond specialist MuniciCorp, said. “There is a frantic, frantic craze to buy municipal bonds right now.”
Since congressional tax conferees Saturday night approved the most sweeping reform of tax laws in the nation’s history, municipal bond sales have surged as much as 40% at firms specializing in these investments, which are exempt from federal taxes and, in the state of issuance, from state taxes also.
Over the last two weeks, as investors saw how the final bill was shaping up, deposits in funds that invest in municipal bonds have risen even more dramatically--to a monthly equivalent of $1.2 billion from $750 million in July.
“We have seen a tremendous rush into municipal bonds” since the bill emerged from the House-Senate conference committee last weekend, said George Bernard, senior vice president of Moseley Securities Corp., a New York tax-free securities specialist. “And because real interest rates will fall because of tax reform, tax-free (bond) issues can only become more and more attractive.”
The specter of lower interest rates is only one factor spawning the buying euphoria. The bonds emerge from the new tax bill as one of the last remaining tax-favored investments.
Investments having huge tax advantages under the current laws, such as stocks and limited partnerships in real estate, lose their luster under the new tax bill. And the popular individual retirement accounts and 401(k) tax-deferred retirement investments will be sharply curtailed.
So, even though the legislation is not yet law and the changes will have no impact on 1986 tax bills, securities dealers are advising their clients to switch out of such investments and into municipal bonds as soon as possible. It is advice that thousands of investors, principally individuals with as little as $5,000 to salt away, apparently are heeding.
Also fueling the buying spree is the new tax bill’s elimination of many popular deductions, such as those for consumer interest and sales taxes. Investors who lose those deductions will have higher taxable income and, thus, brokers say, a greater need for income that is tax free. That is particularly true, they say, for investors paying high state tax rates, such as Californians and New Yorkers.
Even though municipal bonds are considered a safe investment, if interest rates fall, they can be called in early by the issuer; and, if interest rates rise, the prices at which bonds trade decline, meaning that the bondholder might lose money if he sells the bonds before they mature.
Help From Tax Crusade
In a perverse way, tax revision has been a friend to municipal bonds ever since the crusade for a fairer and simpler tax system began well over a year ago.
Uncertainty over how those revising the tax code would treat tax-exempt investments sent bond prices tumbling. Thus, bond yields rose and kept rising--to a level higher than any other government or commercial investment available.
“Because of the uncertainty, investors were wary of this market for a while, which gave us this tremendous yield opportunity,” Carolyn J. Cole, a first vice president at the brokerage firm of Paine Webber, said.
With the buying spree of the last few days, bond prices are now rising again, which means that yields are falling slightly. But a high quality 10-year municipal bond is still yielding between 7% and 7.75%, tax free, far better than any government investment or certificate of deposit now available.
Even under the new tax bill, which reduces the top individual tax rate to 28% for most people--and 33% for the affluent--from the current 50%, an investor would have to find a taxable investment of nearly 10% to do better than a 7% tax-free instrument.
Particularly popular with investors are bonds issued before Aug. 7. That is the cutoff date for so-called private-purpose municipal bonds, which are debt securities issued for such things as single-family housing and student housing. Any issued after that date are no longer tax-exempt.
Because there is still some doubt about which bonds will remain tax free and which will become taxable under the bill, brokers are advising customers to invest only in bonds issued before Aug. 7 or in those that specify that they are “essential purpose” bonds.
This planned taxation of some types of bonds will slow the number of new bond issues, brokers say, which in turn will tend to push bond prices up.
Too Few Bonds
That prospect worries bond traders because there already are too few bonds to satisfy the demand for these newly popular investments.
Individuals already dominate the market for tax-free investments. According to the investment banking firm of Goldman, Sachs, they made 84% of all the tax-free investment purchases in 1984.
Tax revision is expected to further that trend because the supply of other types of tax-advantaged investments will be sharply reduced.
At present, only an estimated 2% of all households now own tax-exempt securities.
George Frey, of New York’s Long Island is typical. The 68-year-old retired firefighter said that he and his wife had always invested their money in certificates of deposit until three years ago.
‘Build Big Bridges’
“Our kids married and moved out and my wife and I were making money faster than we were using it. Our tax bracket was building up to the point that it wasn’t worthwhile to have those CDs anymore,” he said. “So I heard about these municipals. All I knew was they help people build big bridges and buildings and so forth.
“We bought some. And then we bought some more. And, a few days ago, I started reading in the papers that this tax reform is going to make them look even better. So, I’m going out and buying more. A lot more.”
