Investors have fled to the safest investments they can find. Yet while supposedly safe blue chips like AT&T
The once-quiet world of money market mutual funds has turned upside down. Once relied upon as a no-risk safe haven, money market funds have hit the headlines, as the credit crisis has revealed that some funds have more risk than others. Although returns for various money market funds used to track each other pretty closely, you can now see huge differences in yields, depending on which type of fund you own.
As with stocks and other investments, rates in the money market world tend to rise as risk increases. So ultra-safe money market funds that hold only Treasury debt have extremely low yields -- around 1.5% to 1.7%. Higher-yielding money market funds that hold corporate debt pay a bit more -- around 2.3%.
Those small differences in rates make plenty of sense -- in a tight credit environment, corporate issuers have to pay a premium to get investors to own their debt. But where traditional rate relationships have broken down is in the tax-exempt municipal money market. Although you might consider state and local governments to be no riskier than corporate issuers, the rates governments are having to pay for short-term borrowing have gone sky-high -- above 5% as of yesterday.
When you consider that interest on tax-exempt municipals is free from federal income tax, making that 5% equivalent to nearly 7.7% in a taxable investment for someone in the 35% tax bracket, you can see that things don't make sense right now. Are munis a great opportunity, or the latest value trap?
Clearly, some investors are concerned about the financial condition of state and local governments. California governor Arnold Schwarzenegger's recent request for $7 billion in emergency aid from the federal government is just one extreme example of the financial difficulties many states and municipalities are suffering. As property values drop, tax bases are falling, thereby resulting in lower revenue. A slowing economy reduces spending, causing sales tax revenue to decline. And with unemployment rising, state and local income tax revenue may start to disappear as well -- especially in areas like New York City, which will be hit hard by Wall Street's woes.
Yet at least in the money-market realm, municipal investors' concerns are overblown. For one thing, many municipal obligations are insured by firms like MBIA
Although there are similarities, the problem isn't the same as the one earlier this year in the auction-rate securities market, which cost millions for companies such as Palm
Several experts believe that once the financial system returns to more normal functioning, muni money market yields will return to lower levels -- likely within the next month or so. Therefore, it's probably not worth going to a lot of trouble to move money into these funds to take advantage of a very short-term anomaly.
If you're lucky enough to be an investor in these funds, however, enjoy the great yields while they last. It's an opportunity you may never see again.
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Fool contributor Dan Caplinger loves not paying taxes on muni bond income, but he doesn't own shares of the companies mentioned in this article. The Fool owns shares of Bed Bath & Beyond, which is a Motley Fool Inside Value recommendation and a Motley Fool Stock Advisor selection. Try any of our Foolish newsletters today free for 30 days. The Fool's disclosure policy never gets mad at you.