Panel Tells Congress Sky is Not Falling On Muni-Bond Market

The sky is apparently not falling on the municipal bond market.

A panel of muni-bond experts testified as much Wednesday at a Congressional hearing called to address concerns that many state and local governments across the U.S. are teetering on the brink of insolvency.

The fear is that if a rash of these governments default on their municipal debt payments, as at least one prominent analyst has predicted, the fallout will spread like wildfire through the economy and the impact will be a replay of the subprime mortgage crisis.

According to a Wall Street Journal blog account, no one at the hearing disputed that many states and local governments are in a financial bind due in large part to rising health-care costs and ever-growing pension obligations.

But defaults and bankruptcies are unlikely, let alone in large numbers, said several experts who testified before the House Oversight and Government Reform subcommittee.

Iris Lav, an analyst with Center on Budget and Policy Priorities, predicted that no major large city or county will default. Instead, defaults will likely be limited for the most part to special zones such as sewer districts.

Late in 2010, well-known banking analyst Meredith Whitney predicted 50 to 100 government defaults leading to hundreds of billions of dollars in losses to muni-bond investors. The prediction by Whitney, who accurately forecasted the demise of several big banks in the early stages of the recent financial crisis, has led to something of a run in the muni-bond market.

There has been considerable backlash to her prediction, however. And although she was invited to participate in Wednesday’s hearing, she did not attend.

Instead, the experts who testified played down any notion of a sub-prime-type panic in the muni-bond market.

Committee members used the hearing as an opportunity to draw attention to the fiscal disarray at the state and local levels, and to reiterate their opposition to federal bailouts of state and municipal governments.

Rep. Patrick McHenry (R-N.C), who chaired the committee, urged more transparency for public pension systems so that muni-bond investors know what they’re facing when they invest in local government bonds.

Panel members noted that the muni-bond market is very different from the subprime mortgage market, and that it’s extremely unlikely vast numbers of bad muni bonds would make their way into the financial system the way bad subprime mortgages did a decade ago.

Committee members also voiced opposition to allowing states to file for bankruptcy. As it stands, only cities can file for bankruptcy and very few have taken that drastic step, the most notable being Vallejo, Calif., in 2008.

Critics of Whitney’s prediction have noted that state -- and municipal governments, for that matter -- can always raise taxes in order to increase revenues and meet their debt obligations. Illinois did just that a month ago, raising the state income tax 66% in order to help fill a budget deficit expected to hit $15 billion in 2011.