And since the start of July -- since the state began issuing IOUs -- California munis have beaten national municipals, investment-grade and corporate bonds, along with Treasurys, the stock market, and most commodities, too.
The worse the news, it seems, the better the bonds' performance.
"California's bonds are holding up very well through this," says Dan Solender, director of municipal bond management at fund firm Lord Abbett. He notes that since the state actually began issuing IOUs its bonds have risen in relation to Treasury bonds. "It's gone the opposite way to what you'd expect," he says.
The state's bonds have done well because they started the year seriously undervalued. Treasurys, conversely, have done poorly because they were expensive at the beginning of the year. It's a timely reminder for investors: The "risk" of an asset class is heavily dependent on the price you pay for it.
California munis aren't a great opportunity right now, but if you are already an investor in these bonds, here's the good news: The state is highly unlikely to default on its debt. State Treasurer Bill Lockyer, in an interview Monday, said the threat of default is "infinitesimally small." California won't default on debt payments "short of a thermonuclear war."
By law, bondholders get paid second in the state budget, just after schools but before everything -- and everyone -- else. "Even in a bad year we'll have about $80 billion in tax revenues, 40% of which is dedicated to schools and then the next priority is debt," Mr. Lockyear says.
Most California munis are owned by California voters, and the state's politicians know that. So owning the bonds is like being a member of the syndicate. You enjoy a lot of protection.
The budget crisis in Sacramento is more of a political crisis than a structural economic crisis. Despite the gloomy headlines about malaise and taxes, California's growth has been pretty good; the state's per-capita growth over the last ten years has been ahead of neighboring states and the U.S. economy overall.
Investors have stayed cool. According to Financial Research Corp., which tracks industry data, through the first five months of the year about as much new money came into California muni funds as went out. The funds missed out on the strong net sales seen by municipal bond funds elsewhere, but they missed an outgoing stampede too. John Carbone, manager of Vanguard's California muni funds, says the firm has seen only "modest" outflows.
The state has issued about $470 million in IOUs, called Registered Warrants. So far, they've been used to pay some contractors and some individual tax refunds. State controller John Chiang says he may issue as much as $2.9 billion in IOUs this month.
If you are paid in these warrants, you should consider holding them if you can do without the ready cash. They pay tax-free annualized interest of 3.75% and will be redeemed on Oct. 2. That's not a lot, but by comparison, money markets are paying zip.
Warrant holders who need cash immediately should consider opening an account at a California credit union -- many are honoring the warrants. (The California Credit Union League has details.)
As for the state's bonds, they're still cheaper than national munis, but not by much. Vanguard'sCalifornia Intermediate Term Tax Exempt fund (CVAIX) yields 3.81% today. The equivalent national muni fund (Vanguard Intermediate-Term Tax Exempt, VWITX) yields 3.4%.
The picture is slightly more attractive for very long term California municipals -- those lasting twenty or thirty years. Lord Abbett's Mr. Solender notes that some 2037 California "general obligation" municipals, which are backed by state taxes, yield about 5.9% per annum, tax free, compared to barely 4.5% for national equivalents.
But anyone buying bonds of that length is taking a gamble that inflation will stay low. Even if it does, in many cases you may only get those yields for five or ten years anyway. Many of California's long-term municipals, also have a "call" provision, meaning the state can choose to buy them back early at par. Buyer beware.
Write to Brett Arends at brett.arends@wsj.com
