The History of Municipal Bond Defaults

Why and When?

BA543 PresentationKen True

What’s a Municipal Bond?

Issued by a state, municipality or county to finance capital expenditures.

Exempt from federal taxes and from most state and local taxes.

May be used to fund construction of highways, bridges or schools.

Popular with people in high income tax brackets.

Types of “Munis”

General Obligation Bonds

Revenue Bonds

What is a Default?Interest or principal not paid on time.

Often just a suspension of payments.

Most issuers resume paying debt service

Risk of Default = Credit Risk

Credit Risk Ratings:Most popular scale is AAA, AA, A, BBB, BB, B, CCC, CC, C, and rating D for bonds in arrears

Five major bond rating agencies are Standard and Poor's, Moody's, Fitch Ratings, Dominion Bond Rating Service and A.M. Best

Why?

General Obligation BondsTaxing authority unable to raise sufficient revenue to meet debt obligations

Revenue Bonds Revenue stream is inadequate to meet debt obligation

When?

Following downswings in economy

High growth areas / heavy borrowing

Bond Defaults Can be Entertaining!

Baby Bonds

Wait . . . There’s More!

Whorehouse Bonds

But That Doesn’t Happen Anymore . . .

Does It?Orange County, 1994, went bankrupt instead!

Deadbeat voters refused to honor their debts.

Bob Citron: County Treasurer, Financial Wizard“Borrow short, lend long!”“If the post-hole is too deep, keep digging ‘till it’s not!”

Lost $1.6B in 1994, almost defaulted on $1B more in 1995

What Made Citron’s Reign of Error Possible?

Political FragmentationNobody driving the bus.

Voter Distrust“Cut fat, not spending!”

Fiscal Austerity. Revenues < Expenditures

Strike any chords?

SourcesInvestopedia. Series 6- Investment Securities, Section 3.9 - Municipal Bonds. 2011. 16 04 2011 <http://www.investopedia.com/exam-guide/finra-series-6/investment-securities/municipal-bonds.asp >.

McDonnell Investment Management, LLC. "Municipal Default History - McDonnell Investmnet Management." 14 April 2008. Goggle. 16 April 2011 <http://www.google.com/url?sa=t&source=web&cd=3&ved=0CCkQFjAC&url=http%3A%2F%2Fwww.mcdonnellinvestments.com%2FFIFIles%2FMunicipal%2520Default%2520History%2520Commentary%2520-%252041408%2520-%2520REVISED.pdf&rct=j&q=The%20History%20of%20Defaults%20on%20Municipal%20Bonds&ei=_-WpTYXJB6jXiALp-czvDA&usg=AFQjCNEpwJ9XwYUuoSwIvDKrmC7etRxWLA&sig2=yIwVP9YoHPr7HrrH1tCfQg&cad=rja>.

Public Bonds. "Municipal Bonds and Defaults." June 2004. Public Bonds. 16 04 2011 <http://www.publicbonds.org/public_fin/default.htm>.

Sources (con’t)Public Policy Institute of California. "When Government Fails: The Orange County Bankruptcy A Policy Summary." The Second Annual California Issues Forum After the Fall: Learning from the Orange County Bankruptcy Sacramento, California . Sacramento: University of California Press, 18 March 1998.

Sylvan G. Feldstein, Frank J. Fabozzi. The Dow Jones-Irwin Guide to Municipal Bonds. Homewood: Dow Jones-Irwin, 1987.

Wikipedia. Municipal bond. 9 April 2011. 16 April 2011 <http://en.wikipedia.org/wiki/Municipal_bond>.