A new post at the New York Fed’s Liberty Street Economics blog presents some statistics on municipal bond defaults that suggest their true default rate is higher than ratings agencies report.
The commonly cited rate of municipal default comes from the rated universe, and consists only of those bonds tracked and rated by the major agencies. Jason Appleson, Eric Parsons, and Andrew Haughwout put together a broader database that combines the three rating agencies default listings with unrated listings.
In Moody’s universe, there were 71 defaults from 1970 to 2011. The new broader database had 2,521 defaults over the same period. It’s a massive disparity:
Photo: Liberty Street Economics
The easy way to interpret this is that the municipal bond market is more risky than it appears.
First, the Fed is not citing any sort of new information in their post. Default statistics for unrated bonds are commonly available and frequently cited. Secondly, the Fed does not provide any information on the relative size of these defaults. From her blog post:
As I mentioned at the end of my post on California bankruptcies (quoting JP Morgan research), there have been 47 first-time monetary defaults totaling $889 million YTD (with Stockton expected to default on $230 million of debt next month), of which 58% is unrated. If you exclude insured bonds, the total amount is $725 million across 42 issuers. If you exclude a handful of cases where debt service payments were late due to administrative errors and oversights, the total is $549 million across 33 issuers. This is for a $3.7 trillion market.
The bonds the Federal Reserve refers to are unrated for a reason. The ones that default the most are actually issued by states on behalf of private enterprises, like hospitals and colleges. As @munilass puts it, “Literally the only thing these bonds have in common with government debt is their tax status, and yet they are lumped in with “municipal” bonds for statistical purposes.”
This is not to say that the writers of the Liberty Street post intended it to be misleading, but the presentation lends itself to a broad interpretation about municipal bond markets that is not correct.
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