What are the chances of Muni Bonds defaulting?
Now we have 60% bonds and 40% cash and we're getting worried about the municipal bond market. Where hearing very mixed things including:
Bad: 95% of municipalities are facing budget crisis
Good: There is strong demand for bonds.
Bad: The Federal Government doesn't have enough money to bail out municipalities which means possible defaults.
Good: Muni default rate is historically < 1%
Bad: Historical averages are going out the window in today's crisis.
1. What do the experts think will happen with Municipal bonds in the coming years?
2. What are the chances of a municipal bonds defaulting during this crisis?
3. What the most reliable sources for information on municipal bonds?
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M$4 Answers
The bonds are backed by the full faith and credit of the California government. If the bonds ever defaulted, it would destroy investors' confidence in California indefinitely, sending interest rates sky high. It would also shake the foundations of muni bonds nationwide, because if CA can default, who else can?
States use bonds to pay for projects that run the gamut, from highways to water and sewer infrastructure to schools to high speed rail. If they were to default, it would put at risk their ability to build those projects in the future.
There are so many downsides to default, I just can't imagine it happening. Obviously there is some risk, which is why you get an interest rate. But these bonds are the second safest investment you can make, besides US government bonds.
City bonds are a little shakier, but for the same reasons listed above, it would be a terrible idea for any of them to default on their obligations.
So, long story short, for the most part no, I don't see them defaulting.
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M$
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M$
"I just can't imagine it happening."
I wouldn't put too much faith in the above statements.
Everyone was astounded when Russia defaulted in 98. No one (in the mainstream financial advising business) could imagine the current crisis happening.
If you stick to high quality muni bonds, you lower your risk. The risk is still there. In addition to default risk, you face price risk (the chance that the bond prices will fall when you need to sell them if you aren't holding to maturity), inflation risk (depends on how long you're holding), as well as potential diversification risk. If you live in CA and own a bunch of CA muni bonds for the tax benefits -- you have no diversification.
Note that some of these risks are different with individual bonds versus mutual funds that hold bonds.
Municipal bonds will be fine if the economy is steady or improves from here. If that is the scenario that unfolds, there are probably other asset classes that will do better, even on a risk adjusted basis.
If the economy isn't stead but rather continues downward, then municipal bonds are at risk, especially those of lower quality (Michigan/Detroit, areas that busted in real estate, etc.).
At the end of the day, muni bonds are on the conservative side of the risk spectrum. You could do much worse. But there are still risks.
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M$
From David Fessler:
A great place to start is municipalbond.com. Here you can learn about municipal bonds in general, and the ones available for sale in your state. If you're interested in checking out municipal bond funds, Morningstar.com has a great fund screener that you can use to sort munis.
Default rates on municipal bonds are historically very low. Be aware that not all municipal bonds are created equal nor or they issued in the same manner.
You should review every bond you hold for these points. If you find some that you don't feel comfortable with, now is the best opportunity you will ever have to sell them.
1) Is it a revenue bond? Revenue bonds are much like a secured loan. The revenue from the project the bond financed is pledged to pay the bond. The bond holders have a claim on thet revenue stream but nothing else. This does not mean the bond will default if the project fails - but it might.
2) Is it a "General Obligation" bond. General obligations bonds are backed by the "full faith and credit" of the issuing entity. When they are issued by entities with the power to assess taxes, they commit the issuer to raise the tax rates without limit, as necessary, to meet the bond payments. In this case, the state/city is "betting the farm" on the ability to repay.
3) There are also "Moral Obligations" bonds. The nearest loan equivalent is a non-recourse unsecured loan. There is no legal obligation to pay.
4) Some bonds are insured as to interest and principal payments. This used to make people feel really comfortable. Today I would be more afraid of the insurance company than the issuer of a general obligation bond.
Personal experience.
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M$
However, year after year California puts more bond issues on the ballots, and almost every single one offers NO PLAN -ZERO, NADA, ZILCH- to actually provide funding for the bond payments. It's no surprise at all that California faces an emergency budget gap every year when they tack on the sale of Billions in bonds with no extra taxes to raise money to fund the bond payments. I wonder how prevalent that practice is in other states?