Government Bankruptcies, Defaults Heading Higher: Moody's

By Markets FOXBusiness

Government bankruptcies and defaults are rising in the United States, according to a just-released report from Moody’s Investors Service.   

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The report, entitled, “US Municipal Bond Defaults and Recoveries 1970-2013,” is an annual review of Moody’s rated municipal securities. It shows the number of defaults on traditional municipal funding securities like general obligations bonds has increased since the financial crisis started in 2007 but concludes, “…municipal default rates remain very low.”  

There were seven (Moody’s rated) defaults last year; 30 since the recession began in early 2008.  Among the defaults in 2013 were securities issued by the City of Detroit, Jefferson County Alabama and the Pontiac City School District in Michigan.   

Since 1970, most defaults, 65%, have occurred among government financed healthcare and local multi-family housing projects.  But Moody’s highlights a growing trend: governments like Detroit defaulting on general obligation bonds.

Moody’s Managing Director and Chief Credit Officer for Public Finance, Anne Van Praagh, says, “Most local governments have proven they can adjust to new realities of sluggish economic recovery, limited revenue growth and continued spending pressure.  A few won’t be able to adjust because of large pension and other fixed costs.”

The vast majority of local governments have been able to manage their finances despite the sluggish economic recovery and growing spending pressure according to the report. But rising pension costs, declining population and stagnant local economies continue to menace municipal and state governments.  

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Moody’s issues a dire warning for Chicago, “…which has the largest relative unfunded pension liabilities of any Moody’s rated US municipality and faces the potential insolvency of its pension plans within approximately ten years.”  Without substantial pension reform and funding, the report predicts Chicago will spend half its operating budget paying retiree benefits in the near future.

Conservative investors have often bought government debt because it carried less risk than corporate debt even in default.  Not anymore. The gap between recovery on defaulted municipal and corporate debt is shrinking according to Moody’s. 

In 1970 investors recovered 100% of their money after the Chesapeake Bay Bridge and Tunnel District  defaulted on its revenue bonds. Recovery rates on defaulted municipal debt remained near 100% until the beginning of this century. But Moody’s says it now averages around 64%, not much higher than the 48% recovery rate on defaulted corporate debt.  

Still, Moody’s expects municipal defaults to remain few in number despite the increased default activity and says, “We believe that risks are stabilizing as public finance issuers adjust to new realities.”

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