The good old American standby, the municipal bond, is paying big yields thanks to budget surpluses in many states and localities. By Jeffrey R. Kosnett, Senior Editor March 6, 2006 My mortgage lender is HSBC, the worldwide bank. In my last statement, HSBC inserted a promotion for the bank's online savings account. The rate recently was 4.8%. Curious to see how that stacks up against other rates, I looked up the yield on Vanguard Total Bond Market fund (VBMFX), a combination of corporate, Treasury, mortgage and government-agency bonds that serves as a one-stop solution to the bond allocation in any portfolio. The fund yields 4.5%. As for Treasuries themselves, the ten-year is at 4.7%, and the 30-year T-bond, back in action, pays the same. You might expect a lot more from the Pimco Emerging Markets Bond fund (PAEMX), which owns bonds issued by richer middle-income nations such as Russia, Brazil and Mexico. But it yields only 4.8%. No, I didn't miss something: An insured bank deposit and a fund full of Russian bonds are tied. None of this sounds like much of a reason to buy bonds or bond funds, and I'd have to agree. But there's an exception. The best story in bonds now is all too easy to overlook. It's that good old American standby, the municipal bond. Not only are yields excellent, with plenty of highly rated or insured tax-exempt bonds priced to pay more than 5%, but states, cities and local instrumentalities of all kinds are honestly sharing in the nation's current economic prosperity. Some state governments are running big surpluses. Plus, Moody's Investors Service says there were two credit-rating upgrades for every downgrade in 2005 and that the positives will again outweigh the negatives in 2006. Advertisement Stuart Bromberg, managing director of municipal research for Samuel Ramirez & Co., a New York City bond firm, says the times are also good for state and local revenue bonds. A revenue bond is backed by money from a particular project or revenue-generating facility, such as a bridge, hospital or water system. A general obligation (GO) bond is backed by -- you guessed it -- general revenues. Bromberg says the good trends in New York City sales-tax revenue, for example, tell him that there's plenty of money sloshing about the city and its region. Bonds issued by, say, the New York City-area transit authority and other city entities are often yielding more than 5% and are sound. (If you live in New York, with its state and city income taxes as well as the federal tax, that 5% can be the equivalent of an 8% taxable investment. The interest earned from municipal bonds is exempt from federal income tax and, in most cases, from income taxes of the issuing state as well.) Bill Fitzgerald, chief investment officer and managing director for Nuveen Asset Management, a major sponsor of tax-exempt bonds funds, calls the market "stable." If he were talking about the stock market, that would be uninspiring. But stable in bonds is a good thing, especially if it also means that you can expect these high relative yields in comparison with Treasuries and other taxable bonds. Fitzgerald and Bromberg are watching to see how hedge funds, foreign speculators and other unusual parties are starting to get more involved with municipal bonds. If trading gets to be more frequent and aggressive, you'll see more ups and downs on a daily basis, and bond-fund prices will show more variance. But none of this will overwhelm what Fitzgerald sees as a market that's well priced for investors, full of opportunities and underwritten by thousands of issuers that are able to meet their obligations. I continue to marvel that you can get 4.8% on a fund that owns credits from Panama and Tunisia and the equivalent of more than one and a half times that from Chicago or New York. You should, too.