Municipal Bond Forum
Important differences in todays muni market
Q
Prior to the credit crisis, Nouriel Roubini predicted a muni market meltdown due to expected plunging revenues for muni issuers from reduced property, sales, income and capital gains taxes. This has occurred, and continues to occur, yet defaults are still minimal. Don’t you expect weak counties, cities’ lack of access to the markets and reduced income to be the next shoe to drop? Defaults were common in the 1930s when circumstances were similiar. It seems to be a “head in the sand” approach you are advocating in the face of potential massive deterioration in muni revenues. Where will debt service and principle payment come from?
A
James A. Klotz responds:
Prof. Roubini has been a leading bear during the recent market turmoil, but we believe his negativity on the municipal market is misplaced. There are numerous differences between the municipal market of the 1930s and that of today. For one, investors had fewer tools at their disposal in the 1930s by which to gauge credit risk. Few muni issuers produced adequate financial statements for either internal or external use. So, judging the health of a muni issuer was far more difficult in the age of “cash” accounting. Second, sophistication in the management of public and non-profit entities was far behind modern practice. Today, better accounting systems, revenue and expense measurement techniques and the availability of outside financial advisors has provided a much stronger hand to those who must manage public organizations.
As a result of these and other changes, muni issuers (for the most part) are more experienced at managing cash flows, establishing “rainy day” funds and preparing for financial downturns. Finally, many issuers, such as California, require the payment of debt service as a priority in managing their budgets. These and other reforms since the 1930s have served to improve the state of public financial management and debt repayment administrations yielding the very low default rates the municipal market has seen over the last half century.
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