Some "municipal" bonds are debts of busted housing developments. Beware.

[The Straight Story]

Potemkin Villages


Some "municipal" bonds are debts of busted housing developments. Beware.

Municipal bonds are enjoying a renaissance. Nervous investors craving tax-free income and the safety normally associated with state and local governments are gobbling up bonds. Municipal bond funds enjoyed $47 billion in net inflows in the first eight months of 2009. But not all municipals are created equal. A quiet epidemic of municipal bond defaults is already under way, another victim of the housing bust fed by eager builders and Wall Street.

The defaults are hitting what's known as community development districts. Developers, using so-called dirt bonds, join with investment bankers and consultants to create these districts as quasi-governmental entities. They assess homeowners for the costs of roads, sewers, electric lines, clubhouses and tennis courts. These "municipalities" enjoy tax-free funding the same way cities, states, schools and hospitals do. They're supposed to be self-sustaining, but when homes don't get built, the whole scheme collapses.

The biggest concentration is in Florida. At least 109 issues of Florida community development bonds, worth $2.8 billion when issued from 2004 through 2008, have defaulted. So says Distressed Debt Securities, a newsletter published in Miami Lakes by FORBES contributor Richard Lehmann. Some have stopped paying interest, and others have been paying interest and principal from reserve accounts, which aren't supposed to be tapped when projects are completed and homeowner fees kick in. Many investors have yet to feel the brunt of the damage, but the day of reckoning is coming. Standing behind the IOUs: tracts of land with pipes ending in empty, weed-strewn lots.

The Tern Bay Golf Community consists of 1,780 acres a few miles south of Punta Gorda, Fla. in Charlotte County. In September 2005 this self-proclaimed municipality issued $58 million in tax-exempt bonds yielding from 5% to 5.4%. Home builder Lennar Corp. ( LEN - news - people ) planned to build a luxurious golf, tennis and spa country club community with 1,800 houses, townhomes and condos to be priced as high as $450,000. Also planned were a 250-room hotel, eight tennis courts and 140,000 square feet of commercial space. The proceeds of the bonds were to go toward roads, water and sewer pipes and other amenities, including wetland preservation and a golf course.

Two years ago Lennar stopped building homes, and today all that is left are partially built roads, some two dozen homes and 18 of 27 holes of a golf course designed by Chip Powell.....

http://www.forbes.com/forbes/2009/1005/outfront-housing-goldman-prager-potemkin-villages.html