Wall Street pros and the credit rating agencies are saying that talk of an imminent, widespread collapse of states and towns across the country is overblown.
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Reason: Because these municipalities can still afford to pay the interest costs on their bonds. That’s what Fitch Ratings says.
A municipal default only happens if a borrower can’t make its principal and interest payments. Same as if you can’t pay your mortgage.
And it would be calamitous if Congress changed constitutional law to let states declare bankruptcy. Not only would that state then get locked out of the muni-bond market, it would drag down other teetering states over the brink, too, causing them to be locked out of the muni-bond market as well, causing their borrowing costs to soar.
And a bankruptcy would hurt investors, many of whom are senior citizens, who own muni bonds. They wouldn’t get their investment back. This would be a dreadful policy decision with deep and profoundly harmful affects on the markets and the US economy. There is no serious discussion in DC of allowing state bankruptcies to happen.
I’ve already told you that former Clinton Administration officials, including former Treasury Secretary Robert Rubin and economic advisor Laura Tyson, conducted a simulation of what would happen if a state were locked out of the muni-bond market. The fictional state being modeled after California.
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The consensus was that the Treasury could arrange for a temporary loan sluiced through the Federal Home Loan Banking system.
But giving taxpayer-funded bailouts to fiscally reckless local governments would be disastrous. Putting states on the iron lung of a government bailout would cross the Rubicon of moral hazard. Already states have received tens of billions in stimulus money and interest reductions on Build America Bonds.
Yes, all of that’s going away now. But companies that issue debt can’t raise taxes or print money. States can. And they have, just as they’ve cut spending. Just as New York City did when it stared into the abyss in the ‘70s, after the Daily News famously ran a front page headline: “[Gerald] Ford to New York: Drop Dead.”
Yes, the states are turning again to the muni-bond market as stimulus money vanishes. Yes, the bond market, where nerves are already shredded, will feel the heat. But state and local government tax revenue rose 5.2% during the third quarter, says the Census Bureau, and that’s the fourth consecutive quarterly increase. Deutsche Bank (DB) analysts issued a January 14 report that said that spending by U.S. states and localities during the third quarter showed a trend toward fiscal austerity.
Wall Street is taking a hard look at this, and several bond experts and credit rating agency sources say this idea of massive default may be exaggerated.
Fitch says that this idea is overplayed and it does not see widespread default. It says: "While the incidence of default may increase from exceedingly low historical levels, defaults will continue to be isolated situations."
When it comes to such defaults being extremely rare, Fitch specifically says that from 1999 to 2009 only 10 rated entities failed to make debt-service payments, resulting in an average annual default rate of 0.04%. Fitch isn’t seeing widespread fiscal collapse as a problem for now; it’s saying that states and towns are still paying interest on their debt — which is about 4% interest on $2.5 trillion.
The National League of Cities in Washington says only four cities and counties have defaulted on bonds since 1970, and those bonds were usually for infrastructure spending like schools or bridges.
And Bill Gross, who manages the world's biggest bond fund, Pimco Total Return, told Bloomberg Television on Jan. 12 that he doubted there will be many municipal bankruptcies.