The History of Municipal Bond Defaults Why and When? BA543 Presentation Ken True.

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Presentation transcript:

The History of Municipal Bond Defaults Why and When? BA543 Presentation Ken True

What’s a Municipal Bond? Issued by a state, municipality or county to finance capital expenditures. Exempt from federal taxes and from most state and local taxes. May be used to fund construction of highways, bridges or schools. Popular with people in high income tax brackets.

Types of “Munis” General Obligation Bonds Revenue Bonds

What is a Default? Interest or principal not paid on time. Often just a suspension of payments. Most issuers resume paying debt service

Risk of Default = Credit Risk Credit Risk Ratings: Most popular scale is AAA, AA, A, BBB, BB, B, CCC, CC, C, and rating D for bonds in arrears Five major bond rating agencies are Standard and Poor's, Moody's, Fitch Ratings, Dominion Bond Rating Service and A.M. Best Standard and Poor'sMoody'sFitch RatingsDominion Bond Rating ServiceA.M. Best

Why? General Obligation Bonds Taxing authority unable to raise sufficient revenue to meet debt obligations Revenue Bonds Revenue stream is inadequate to meet debt obligation

When? Following downswings in economy High growth areas / heavy borrowing

Bond Defaults Can be Entertaining! Baby Bonds

Wait... There’s More! Whorehouse Bonds

But That Doesn’t Happen Anymore... Does It? Orange County, 1994, went bankrupt instead! Deadbeat voters refused to honor their debts. Bob Citron: County Treasurer, Financial Wizard “ Borrow short, lend long! ” “ If the post-hole is too deep, keep digging ‘till it’s not!” Lost $1.6B in 1994, almost defaulted on $1B more in 1995

What Made Citron’s Reign of Error Possible? Political Fragmentation Nobody driving the bus. Voter Distrust “ Cut fat, not spending!” Fiscal Austerity. Revenues < Expenditures Strike any chords?

Sources Investopedia. Series 6- Investment Securities, Section Municipal Bonds McDonnell Investment Management, LLC. "Municipal Default History - McDonnell Investmnet Management." 14 April Goggle. 16 April Public Bonds. "Municipal Bonds and Defaults." June Public Bonds

Sources (con’t) Public Policy Institute of California. "When Government Fails: The Orange County Bankruptcy A Policy Summary." The Second Annual California Issues Forum After the Fall: Learning from the Orange County Bankruptcy Sacramento, California. Sacramento: University of California Press, 18 March Sylvan G. Feldstein, Frank J. Fabozzi. The Dow Jones-Irwin Guide to Municipal Bonds. Homewood: Dow Jones-Irwin, Wikipedia. Municipal bond. 9 April April 2011.