Muni-Fund Yields May Point to Big Problems

It is a basic principle of finance that yields rise when risk is increased. In the last few days, look at the rise in the yield on the Vanguard Tax-Free Money Market Fund.

09/10/2008 1.65%
09/11/2008 1.68%
09/12/2008 1.71%
09/15/2008 1.80%
09/16/2008 1.83%
09/17/2008 2.00%
09/18/2008 2.39%
09/19/2008 2.80%
09/22/2008 4.05%
09/23/2008 4.46%
09/24/2008 4.83%

In one week, the yield has more than doubled. Municipalities are apparently stuggling to keep their paper financed and are having to accept higher yields to do so. For someone in the 28% bracket, this is a 6.71% return. It is a 7.21% return for someone in the 33% bracket. Folks, this is a very high return for cash when bank yields are so low. This return does not come without risk. This is strong evidence of the strain on our credit markets and the ripple effect that this crisis is having on our economy. In a matter of days, municipalities are paying more than twice as much on their short term paper.

Disclosure: I own Vanguard Tax-Free Money Market Fund.