There are lots of reasons why munis are safe.
Moody’s Investor Services just published a report on municipal credit. In it they noted that all the states are rated Aaa to A1, while only 4 percent of non-financial corporations are rated that highly.
Why does Moody’s consider the states better credits? First, states enjoy numerous financial advantages. They are essentially monopolies, able to raise the prices of their services at will. They can also cut spending without worrying about lower service levels hitting revenues in the short run, kind of like the local cable company.
Second, bondholders enjoy especially strong credit protections. Often debt service obligations are protected by state law. So recoveries tend to be quite high in the event of a default. And if you own a bond secured by specific revenues like water charges, you effectively have a secured claim on that asset. Even if the town defaults, these "subsidiaries" are still obligated.
Finally, states and towns provide truly essential services–education, police and fire, and the legal system. It’s not like citizens can decide to opt out.
These reasons all help explain why munis are likely to remain the most boring of bonds. And that should help us all sleep better.
Douglas R. Tengdin, CFA
Chief Investment Officer
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