Big Muni Default Could Rock The Credit Markets

Uh oh. Jefferson County Alabama, famous for getting deeply tied up in auction-rate securities, is close to filing for Chapter 9 bankruptcy.

According to WSJ, the county has has been advised to default on its $4 billion in muni loans currently held by JPMorgan (JPM), Citigroup (C) and Bank of America (BAC). In isolation, this isn’t a huge deal, but if this is the beginning of a wave of muni defaults, then it is.

Now recall what Warren Buffett said in his annual shareholder letter last month. Historically, muni default rates mean nothing because, historically, public entities haven’t been insured by a third party. Now that they are insured, more cities are likely to decide to default, rather than foist tax increases and lower public services on their citizens.

And if Jefferson County gets away with default with only a minimum negative effect on its residents, then watch out monolines.

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