Crying Wolf about Municipal Defaults
‘Tis the season of white elephant gifts, a popular holiday game where participants exchange gifts whose value exceeds their usefulness. Unfortunately, it is also the season of Wall Street analysts crying wolf about the municipal bond market – warning of white elephant projects and near-bankruptcy state and local governments.
Wall Street analyst Meredith Whitney leads the way, saying most recently on CBS’ 60 Minutes that “There’s not a doubt in my mind that you will see a spate of municipal bond defaults…You could see 50 sizeable defaults. 50 to 100 sizeable defaults. More.”
So, which is it Ms. Whitney? 50? 100? More? One wonders if the interview had gone longer just how many municipal defaults she might have predicted.
Beyond the Hyperbole
To be sure, local and state governments continue to confront declining or slow growth in revenues as a result of the Great Recession and 2011-2012 will present many general purpose governments with difficult choices. But, the overwhelming majority of local and state governments are balancing their budgets and meeting their debt obligations. The careless statements of Ms. Whitney and the sky-is-falling media coverage are painting an inaccurate and misleading picture of municipal sector.
Let’s put 50-100 municipal defaults in perspective. As of November 2010, there were 72 defaults totaling $2.5 billion, down from 204 defaults ($7.3 billion) in 2009 and 162 ($8.2 billion) in 2008. These seem like big numbers until you look at the entire sector. Total outstanding municipal debt is estimated at $2.7 trillion and potential debt issuances number in the thousands, coming from 50 states, 19,000 cities and towns, 4,000 counties, 15,000 school districts and an untold number of special purpose entities and enterprises.
Not all municipal bonds are the same. Some municipal bonds are backed by a General Obligation (GO) pledge that all of the revenue-producing power of a general purpose government can be used to service the debt. But, a considerable amount of municipal debt is non-GO debt, sold to special purpose entities like hospitals and housing projects where revenues raised from the projects secure and service the debt.
Historically, the annual default rates for municipal debt are miniscule, less than 1/3 of one percent across the three rating agencies. Moody’s Investors Service reports only 54 defaults from 1970-2009, with the majority of these defaults (78%) coming in health care and housing-related projects. Only four of these defaults came from cities and counties.
What does all of this tell us about the municipal bond market? First, 50-100 defaults, while not ideal, aren’t much in context of the total activity in the sector. Second, any increase in municipal default will most likely come from special purpose entitles, often backed by non-GO debt, where individual projects have gone awry.
The Wall Street Journal’s David Wessel concluded, “Most municipal defaults and bankruptcies so far involve either behind-schedule, over-budget constructions projects that didn’t yield promised revenue or overstretched hospitals, not cities or counties.” Wells Fargo’s Municipal Securities Research unit noted “These projects failed not because of the recession, but because they did not work, weren’t completed, or failed to produce expected revenue.”
The Muni Market Remains Strong
1. Local and state debt levels are low, about 16 percent of GDP, and usually representing a relatively small portion of local and state budgets;
2. Nearly all local and state borrowing is longer-term (20 or 30 years) and debt service payments are predictable (usually the same amount each year);
3. All but one state and a few local governments have balanced budget requirements; and,
4. Many state and local governments have provisions that require steps to be taken to address problems before defaults can occur, or prioritize debt payments over spending for other government services.
Those who understand the municipal bond market and the fiscal structure of local and state governments – including the rating agencies, analysts at the nation’s leading think tanks, and private sector research firms, tend to agree with the assessment of Bloomberg News’ Joe Mysak: “The governmental entities that make up most of the market are doing everything they can to repay their debts. Their ability to pay may have been compromised by the recession. Their willingness to pay is as strong as ever…That should be reassuring to bondholders and all those investors who have been thinking about buying municipals, and who have been barraged by speculation over the past two years that the market is on the verge of collapse.”
The Missing Story
Sky-is-falling reports about the municipal bond market are a distraction from a much more common and economically significant story about cuts in other arenas – cuts in services that impact the quality of life in communities; job losses in the public sector; cuts in pension and health care benefits for employees and retirees as local and state governments seek to rein in liabilities.
Unfortunately, crying wolf about defaults is the latest attack on infrastructure financing. Declining revenues have many local governments canceling or delaying infrastructure projects. Tight credit markets coming out of the recession have resulted in many governments having difficulty issuing municipal bonds. Build America Bonds (BABs) provided a temporary reprieve, but the U.S. Congress failed to re-up BABs just weeks ago. And now there are proposals to revoke the tax-exempt status of state and municipal bonds.
The attack on infrastructure financing couldn’t come at a worse time for the country. Local and state governments comprise three quarters of U.S. infrastructure spending and debt financing has been the primary mechanism for funding the nation’s system of public works – nearly four million miles of roadways, 500,000 bridges, 1,000 mass transit systems, 16,000 airports, 25,000 miles of intercoastal waterways, 70,000 dams, 900,000 miles of pipe in water systems, and 15,000 waste water treatment plants.
At a time when the country needs these jobs-producing projects more than ever, why are we wasting time focusing on the potential for a few, idiosyncratic municipal defaults? Unfortunately, the answer to that question is that news about local and state insolvency makes for good headlines and, in the case of Wall Street, generates attention and sales for a few analysts who are looking to profit by crying wolf about municipal defaults.