Putting The Muni Bond Panic Into Perspective

I thought these were some pretty good notes from an analyst at First Trust.  It puts the muni bond panic into the proper perspective and helps to resolve a few of the current myths that are circulating:

“One trigger to the bond market weakness came on December 19, 2010 when an analyst went on a popular prime time news program suggesting that this year there could be “50-100 sizeable defaults worth hundreds of billions of dollars.” The problem with this assertion is that according to a December 21, 2010 Citigroup report, the top 50-100 municipalities in this country do not even have “hundreds of billions of dollars” of debt outstanding. By the way, according to Marketwatch.com, there has only been one municipal bond default since the week of December 19th, which was valued at only $6 million.

It has been argued that budget issues confronting states are as bad as budget issues confronting countries such as Greece or Ireland. According to the International Monetary Fund, Greece’s debt as a percent of its gross domestic product (GDP) is estimated at over 100%, while Ireland’s is around 55%. To put that in perspective, the median for all 50 states is only 2.2%, according to MarketWatch.

According to Bloomberg, municipal bond defaults hit a record of $8.15 billion in 2008. That same year, $157.7 billion worth of corporate bonds defaulted, according to Forbes. Municipal bond defaults have since declined to just $2.52 billion in 2010. Part of the reason defaults have been declining is because revenues have been increasing for many states and municipalities the past year. Rockefeller Institute data shows that for the most recent quarter where data is available (3Q 2010), local and state revenue has increased for the third straight quarter.  Additionally, many states, cities and towns have raised taxes significantly, cut services and cut budgets in order to get their
balance sheets healthier.

The muni market is enormous with a size of over $2.9 trillion and over 55,000 different issuers, according to the Municipal Securities Rulemaking Board.

In a Moody’s study that covered 1970-2009, only 54 of the 18,400 municipal bonds they rated had defaulted. Of those, only 5 involved general obligation debt.

In a Fitch study covering the period from 1999-2009, only 10 entities defaulted, which equates to an average annual default rate of 0.04% over those 10 years.

Even during the Great Depression the default rate for municipal bonds only reached 1.7%.”

I am not attempting to downplay the very serious budget issues that many states and localities are currently suffering, however, it is important to keep things in perspective and not blow this problem well out of proportion.  This is not to say that we won’t see localities default, but I think fears of a state ever being allowed to fail are beyond stretched.  First of all, if the USA is willing to save banks and let states fail then the purpose of this country has failed and we should just fold up shop and thank everyone for being a citizen for all these years.  Second, we’re far more likely to see increased austerity measures (such as the tax increases in Illinois) as opposed to defaults.  The credit crisis is still causing ripples across the world, but one thing it is not doing is turning the USA into Europe.

Post Footer automatically generated by Add Post Footer Plugin for wordpress.

by Andrew Wilkinson, Senior Market Analyst at Interactive Brokers

Read more at The Pragmatic Capitalist