(August 16th, 2012) Yesterday the NY Fed’s Libertystreet Economics blog published a piece entitled “The Untold Story of Municipal Bond Defaults”. The post starts out with the question of whether the recent problems in places like Stockton CA, Jefferson County AL, and Harrisburg PA point to an increase in future municipal bond defaults. To that point the authors state:
History—at least the history that most of us know—would seem to say no. But the municipal bond market is complex and defaults happen much more frequently than most casual observers are aware.
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Later in the paper they go on to show that while the rating agencies report 71 municipal bond defaults in the period from 1970 to 2011, the data the NY Fed compiled for its study (which also includes unrated bonds) shows 2521 defaults during that same time period. To help drive home that point they include the following chart:
Now, questions surrounding the safety of the muni market have been a sensitive topic since Meredith Whitney scared investors out of the market with her incorrect predictions of $100’s of billions in defaults. With that debacle still fresh in the minds of muni market participants, the reaction to the Fed’s piece was quick and severe. It started with asset manager, CFA, and popular blogger David Merkel, who left the following comment on the Fed’s blog:
- Unrated bonds default more.
- Bonds funding projects that are not economic necessities to municipalities default more.
- Bonds default more during times of economic stress.
- These are trivial insights that anyone with the least connection to the muni market already knows. Tell us something we didn’t already know in your next piece.
Next it was Twitter’s turn, with everyone from professionals that sit on municipal bond trading desks, to muni market reporters, to casual observers chiming in with tweets such as the below from popular Reuters Muniland Blogger Cate long:
— Cate Long (@cate_long) August 15, 2012
At the end of the day however, it was public finance analyst, former bond fund manager and blogger (who writes under the psuedonym Bond Girl) that threw the knockout punch. In a post entitled “The Well Known Story of Municipal Bond Defaults” she methodically picks apart the report explaining that the “more comprehensive data” and default rates the NY Fed says it has discovered are in fact already “widely cited in research notes from investment banks and independent advisory firms”.s
She then goes on to talk about another gripe that industry participants have with the Fed’s report, which is that it does not talk about the dollar amount represented by the defaulted bonds. As most defaults occur among small non rated issuers, it seems irresponsible to quote only the number of issuers, without showing the small percentage of the $3.9 Trillion market those issuers comprise. To further drive home the point that the writers involved in the post may need to spend a little more time on their research next time, she points out that:
I also thought the remarks at the end about how the near-demise of the bond insurance industry has only complicated matters for investors were rather humorous … in a post about unrated bonds. Perhaps someone should explain to the NY Fed what types of bonds are insurable?
Much of what has been written about this by industry experts was likely done to try and get out in front of the mainstream media’s coverage of the report. Unfortunately however, if recent articles by Businessweek and Reuters are any indication, they have not gotten the message.
What’s the bottom Line?
There’s no need to panic as its no surprise that the default rate is higher on non-rated municipal bonds. While 2521 defaults may seem like a lot, as most non rated bonds are small in terms of dollar amount, this still represents only a small percentage of the $3.9 Trillion market. Retail investors generally only buy, and only should be buying, rated bonds. With this in mind the much lower default rate of rated bonds is the number that is important.
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