The greatest part of income for most municipalities is from local real estate taxes. Commercial real estate pays a big portion, but residential, unless it is a city, pays the larger amount.

Everyone knows the housing bubble is leaking badly. It hasn’t burst yet, but the consequences will be severely felt when it does. Why?

According to the National Ass’n of Realtors (NAR) home sales are down 22% nationwide, 28% in both Florida and Arizona and 24% in California. Actually another 6 to 10 percentage points may be added to these figures. Cancellations for previously purchased homes are running 40% to 50% which is not reported.

The inventory backlog for existing homes has risen to 8.4 months and new home permit applications are making new lows. Home prices have tripled in price since 1980. Each time a home is sold at a higher price the real estate tax assessment is reappraised to that higher amount. A home bought for $100,000 in 1987 had an original county tax (Brevard County, Florida) of $1200 that slowly increased to $1600 when it was sold for $455,000. The new tax assessment is $5,400 that the new owner will pay. Since 2006 home prices in that same area have declined 15% to 20% in 2007 and are continuing to decline. The problem is that local politicians have increased their spending to the 2006 levels and made long term commitments based on 2006 projected income that they will not be able to pay without drastic cuts in many services.

Many of the long term commitments were in the form of municipal bonds that seemed very safe when issued as the debt forecast was based upon real estate tax income remaining forever high. If home prices continue to fall these bonds could be in jeopardy.

According to economic theory there is something called Regression to the Mean. It means that over a period of time there is an average price that will be generated for any commodity (steel, houses, corn, etc.) and if that price works too low or too high the price will come back to that average.

If this is accurate of current housing prices many economist and real estate analysts predict a further 40% to 50% price decrease for residential homes.

If that is true it is easy to understand why many municipalities will have trouble paying their debts. Some may default.

The wise investor may protect his money by only buying insured bonds. And be sure to check out the strength of the insurer.

At this time there are few municipalities in trouble, but bond buyers must look to the future.

Al Thomas' book, "If It Doesn't Go Up, Don't Buy It!" has helped thousands of people make money and keep their profits with his simple 2-step method. Read the first chapter at http://www.mutualfundmagic.com and discover why he's the man that Wall Street does not want you to know. Copyright 2006 All rights reserved.

Copyright 2007 Albert W. Thomas All rights reserved. Author of "IF IT DOESN'T GO UP, DON'T BUY IT!"