NY Fed Flacks

Is “Munigeddon” upon us and we just didn’t know it?

A recent New York Fed article examined the difference between defaults on rated municipal bonds and unrated bonds. They found, unsurprisingly, that unrated bonds default at a higher rate than rated bonds. But the level of defaults was alarming—in fact, so alarming that the New York Times discussed the Fed’s obscure blog post in recent story. Instead of there being only a few dozen defaults over the past 30 years, as Moody’s and S&P reported, the Fed found over 2500. Since half of the $3.6 trillion muni market is held by individuals, a lot of individual investors are worried that their bonds may be in trouble.

But they shouldn’t be. The vast majority of defaults of unrated bonds are by special revenue districts and “industrial revenue bonds,” (IDRs) where State governments issue bonds backed by special projects that may or may not work out. For example, if Intel wants to build a plant in the State of New Mexico, the State can set up a special trust solely backed by Intel’s credit that borrows at a tax-exempt rate and funds the construction of that plant. If Intel goes bust, those bonds default.

Those bonds aren’t government debt any more than race car drivers are daily commuters. Lumping IDR defaults in with government bankruptcies like Jefferson County, Alabama or Stockton, California is like aggregating race-car crashes in with normal traffic accidents and saying that driving is a lot more dangerous than previously reported.

It’s frustrating to read posts like these because the average person is likely to say, “Wow, muni bonds are a lot more risky than I thought; look at all these defaults the so-called experts missed!” But in fact they didn’t miss them—unrated bonds are unrated for a reason, and doing a little digging isn’t very hard. Contra some analysts, disclosure in the muni market is pretty good. Unrated bonds sold for private purposes by an issuer without the ability to raise taxes or rates and mainly sold to institutions may involve credit risk. Did that really merit the New York Fed’s attention?

We have yet to see the “hundreds of billions” in defaults so recently predicted. We’re not likely to see them, either.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

Follow me on Twitter @GlobalMarketUpd

direct: 603-252-6509
reception: 603-224-1350

www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net
By |2017-07-17T12:34:47+00:00August 23rd, 2012|Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. - Leave a comment if you have any questions—I read them all! - And Follow me on Twitter @GlobalMarketUpd

Leave A Comment