There was a time not long ago that the municipal bond market was all but ignored by the media. We used to lament the lack of attention given to a critical financing tool for state and local governments and a proven winner for investors.
Judging by the recent coverage of our market, however, we prefer the old days.
An article Friday in The New York Times is the latest report that has us dumbfounded. According to the Times, “Policy makers are working behind the scenes to let states declare bankruptcy,” though no reliable sources were named.
The article states, “No draft bill is in circulation yet, and no member of Congress has come forward as a sponsor,” and goes on to say that Sen. John Cornyn asked Fed Chairman Ben Bernanke at a Senate Banking Committee hearing about the possibility of this type of law being enacted.
But that’s not quite correct.
According to a transcript from the hearing, Cornyn asked Bernanke if the Fed would consider buying state or local debt. Bernanke responded, “We do have the authority to buy very short-term municipal debt that is within certain categories.”
That’s a long way from asking whether such a law would be enacted.
‘Governments have the tools’
Although Bernanke acknowledged that state and local governments are under a lot of pressure, when asked about the possibility of hundreds of billions of dollars of municipal bonds defaulting, he said, “We don’t at this point see anything of that magnitude happening. State and local governments have the tools to deal with their fiscal problems and debt, and the municipal bond market currently seems to be functioning reasonably well.”
As the author points out, The Center on Budget and Policy Priorities released a report this week suggesting “states have adequate tools and revenue to meet their obligations.”
Once again, common sense will trump sensationalism.
According to the Times, the motivation for Congress to pass such a law would be to enable the federal government to avoid having to bail out a municipal entity if it couldn’t pay its bills. Sounds reasonable until you actually think about it: How would future municipal improvements be funded?
There are good reasons why bankruptcy is a last resort for cities and states, and for why the municipal bond market exists at all. How will municipalities acquire financing for long-term capital improvements designed to last for generations, such as sewers, roads, schools, etc.?
Investors became comfortable loaning money to municipal entities because of the protection current laws afford.
Where will these funds come from if borrowers are provided an easy path to wash their hands of their debt? The federal government? Sounds ridiculous, doesn’t it? Isn’t this exactly what the author says Congress wants to avoid?
For years the media all but ignored the muni bond market for the same reason investors appreciate it: It’s boring. The vast majority of issues have simply provided investors with a reliable, steady stream of tax-free income year after year.
While local governments have certainly been challenged, the headlines bear little resemblance to reality. Ironically, the media’s misguided attempts to cover this market have created a significant number of outstanding opportunities for muni bond investors.