The Risk of Municipal Bonds Continues to Rise


State and local issuers of municipal bonds are in trouble, but most municipal bond holders are not ? at least not yet. While waves of default predicted by analyst Meredith Whitney several years ago have not yet materialized, lower revenues and unfunded liabilities are creating a slow-motion train wreck for many state and local governments. (See “Munis may take it in the teeth after all,” by Andrew Osterland, InvestmentNews).

Moody’s has a negative credit outlook on municipal bond issuers in general. The pressures on state and local governments are becoming worse. Income taxes, property taxes and federal subsidies ? the lifeblood of municipalities ? have all declined as a result of the weak economy, the collapse in real estate prices, and trillion dollar federal budget deficits. Huge obligations like Medicaid, employee health care, and pension payouts are harder than ever to meet.

“Everything flows downhill to the local level,” Naomi Richman, a managing director in public finance at Moody’s Investors Service, was quoted as saying, adding: “The trade-offs are getting tougher, and the cuts are now really starting to hit.”

There have been few bankruptcy filings by municipal bond issuers to date, but if the ones that have filed come out of it in better shape, others may follow suit. “If some of these entities are successful in restructuring collective-bargaining agreements and paring their debt, it may become more acceptable for others to try ? and we’ll see more bankruptcy filings,” one bankruptcy attorney was quoted as saying.

Central Falls, Rhode Island is a case in point. It filed a Chapter 9 bankruptcy last July to get out from under $80 million in unfunded pension and retiree health benefit obligations it was unable to meet. In that case, pensioners got whacked (they suffered a 50% reduction in benefits), not the bondholders. But that could change. “Few states are going as far as Rhode Island to shield [municipal bond holders].”

In these local government debt crises, like the European debt crisis, something has to give ? either the pensions and benefits, or bond holders, or both.

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.