Municipal bond investors beware!
On June 14, it was announced that Detroit will not make a $39.7-million payment on unsecured municipal bonds worth $2.0 billion. This makes Detroit the most populated city to default on its debt, after Cleveland, since 1978.
The Emergency Manager, Kevyn Orr, who was sent by Michigan state to look over Detroit’s budget deficit told reporters in a news conference on June 14, “We have to strike a balance between the legacy obligation to our creditors, our employees and our retirees, and the duty we have as a city to 700,000 residents to give them lights, police, fire, emergency management, clean streets.” (Source: “‘We’re Tapped Out’: Detroit Emergency Manager Proposes Plan to Creditors,” CBS Detroit web site, June 14, 2013.)
As horrific as this news may be to the mainstream media and the politicians who say the U.S. economy is getting better, it shouldn’t be a surprise to Profit Confidential readers in any way. I have been harping on about the growing problem of cities and municipalities in financial trouble in the U.S. economy, and their effects on the municipal bond market, for some time now.
The “Motor City” defaulting on its debt obligation is certainly a big issue, but it isn’t the only place where municipal bond holders are facing losses. Cities like Stockton, California have already filed for bankruptcy due to their inability to control their budget deficits.
Jefferson County, Alabama, which previously filed for bankruptcy, recently came to a decision with its municipal bond holders. It has decided that the largest creditors will only receive 60% of what the city owed.
Gone are the days when municipal bonds were considered a great investment with significant tax advantages. The $3.7-trillion U.S. municipal bond market is facing threats. Detroit defaulting on its debt obligations is just adding fuel to the fire.
Dear reader, as it stands, cities across the U.S. economy are posting higher budget deficits. Remember: the main source of a city’s income is usually property taxes. With the housing market still depressed, I doubt many troubled cities will be able to get out of their rut anytime soon. The impacts of this on municipal bonds will be harsh.
I am looking at this situation from a different level.
Moody’s Investors Services has downgraded the general obligation debt issued by Illinois to A3 from A2—a lower investment grade—and maintained a negative outlook. (Source: Moody’s Investors Services, June 6, 2013.) The reason for the downgrade: staggering pension liabilities.
Now, consider what happens if some major city in Illinois runs into troubles. Will the already struggling state come to help? My take is that as more and more cities run deeper budget deficits and states continue their struggle, the federal government will eventually be asked to step in to save them. If the federal government helps them, the budget deficit of the U.S. government will obviously increase and any hopes of getting its annual deficit under a trillion dollars will be crushed.
An official national debt in excess of $20.0 trillion could happen a lot sooner than the end of this decade, as was originally forecast.