On Thursday afternoon, Detroit announced it would file for Chapter 9 bankruptcy, the largest municipal bankruptcy filing in history.
Ever since the financial crisis, there has been some concern that municipal bonds across the U.S. were at elevated risk of defaulting.
However, those concerns have proven to be largely overblown.
And the Detroit bankruptcy should not worry holders of other municipal bonds as Detroit’s financial and economic woes are very particular to its local economy.
Here’s Capital Economics’ Paul Dales:
…Detroit is unlikely to be the first of a string of cities to fall in bankruptcy. Admittedly, the recent spike in municipal bond yields, which was triggered by the Fed’s signal that it is edging towards tapering QE3, has led to an outflow of funds from the market. But while this may have pushed Detroit over the edge, most of the City’s problems are structural and can be traced back to the long-term decline of the auto sector that has substantially reduced Detroit’s taxable base. Of course, the budgets of most cities have been under pressure since the recession. But thanks to the boost to tax receipts generated by the economic recovery, most cities are now on a much firmer footing.
The upshot is that we don’t expect the bankruptcy of Detroit to send many shockwaves though the financial markets or the wider economy. Nor do we expect it to prompt municipal bond spreads to break out of their recent range.
Of course, this is not to take away from the fact that there will be losers in this ordeal.
“The news that Detroit has applied for Chapter 9 bankruptcy could have big ramifications for the citizens of Detroit, particularly retired workers, and anyone invested in the City’s debt,” said Dales.
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