Investors Exit Municipal Bonds as Congress Explores Bankruptcy for States

 

Municipal bond funds are hemorrhaging. Investors removed $4 billion from municipal-bond funds in the week ended January 19, the largest outflow since Lipper began measuring muni fund flows in 1992, said Kelly Nolan and John Kell in their Wall Street Journal article, “Record $4 Billion Exits Muni Funds.” The previous record was a $3.1 billion outflow last November. $1.5 billion. It was the 10th consecutive week of outflows, which total approximately $20.6 billion. The four-week moving average was an outflow of $2.2 billion, up from $1.9 billion in the previous four-week period.

The mass exodus may intensify as reports surface that some members of Congress are quietly discussing bankruptcy for state governments. See “A Path Is Sought for States to Escape Their Debt Burdens,” by Mary Williams Walsh, The New York Times, Jan. 20, 2011.

The reality is that states are faced with crushing debts, including the pensions they have promised to retired public workers. But states, unlike cities, are considered sovereign, and cannot file for bankruptcy. Changing that would present constitutional issues.

House Republicans, and Senators from both parties, are reportedly interested. Senator John Cornyn asked Federal Reserve chairman Ben Bernanke about the possibility of bankruptcy for states in a hearing this month. Newt Gingrich is a vocal proponent.

The key for proponents of state bankruptcy is that states could abrogate existing contracts, including those affecting huge unfunded pensions. Naturally, public employee unions are up in arms about this.

General obligation bond holders could be treated as unsecured creditors of the bankruptcy estate, subject to reduction or wipeout.

The mere introduction of a state bankruptcy bill could lead to “some kind of market penalty,” even if it never passed, according to the article. That could mean higher borrowing costs for a state and lower bond prices. Institutional investors might not make additional investments. Some states could be priced out of the capital markets.

No bill has been circulated, nor has any member of Congress yet come forward as a sponsor, according to the article. But even discussing the possibility may give governors and others some leverage in bargaining with unionized public workers to reduce states’ unfunded pension liability.

Such discussion could also further destabilize the municipal bond market.
A potential alternative to bankruptcy that has been mentioned is an oversight panel for distressed states, similar to the Municipal Assistance Corporation, which assisted New York City during its fiscal crisis of 1975, according to the article.

Page Perry is an Atlanta-based law firm with over 125 years collective experience representing institutional and individual investors in securities-related litigation and arbitration all over the country. While past results are not indicative of future success, Page Perry’s attorneys have recovered over $1,000,000 for clients on more than 40 occasions.