Municipal Bankruptcies Rattle the Municipal Bond Market


There is concern growing within the municipal bond market as a result of the recent high profile bankruptcy filings by the California cities of Stockton, Mammoth Lakes, Compton, and San Bernardino. The concern is that bond payments will not be treated as a priority obligation. Municipal bonds have historically had the reputation for safety and dependability. The Internal Revenue Service grants most of them tax-free status to further encourage investment. It has always been assumed that the municipalities would make good on their promise to pay interest and principal even if it meant raising taxes or doing without other expenditures.

Michael Corkery writing for, quoted analysts at Moody’s Investors Service who questioned whether “distressed municipalities will begin to view debt service as a discretionary item on their budgets and whether defaults will increase”. Many of these city officials see bankruptcy as the best way to restructure their debt. They cite GM and Chrysler successes achieved through bankruptcy and relate their situations to such corporate restructurings. Investors, monoline insurers and credit-rating agencies see it much differently. Credit agencies are considering lower ratings on the municipal sector while monoline insurers and investors question the intentions of city managers.

The case of Stockton, California, provides an example of the controversy. There the City Council filed 800 pages of documents detailing the measures taken to avoid bankruptcy including cuts in city wages of 22% and cuts in the police force of 25%. Connie Cochran, Stockton’s public information officer, stated that the council was unable to raise taxes due to the high unemployment. But the insurance carrier behind Stockton’s municipal bonds, Assured Guaranty, contends the city has not done enough especially since city employees contributed nothing for their health-care or for pension costs until just last year. The insurance company is not convinced that the city officers are making the necessary tough decisions.

California is not the only state with municipal bankruptcies. Other states notable for municipalities considering skipping bond payments are Washington State, Pennsylvania, and Missouri. The seriousness of the 2008 Great Recession and the lag in job creation put all government entities at risk of finding creative ways to make budget numbers without the fallout from tough political decisions, even if it erodes future sources of credit.

Page Perry is an Atlanta-based law firm with over 170 years of collective experience maintaining integrity in the investment markets and protecting investor rights.