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Greece and Spain both suffered S&P downgrades this week — Greece to junk — as bondholders realized the obvious. The nations cannot raise taxes and cut spending fast enough to pay their debt without killing off economic recovery.
But nothing has shaken another massive debt market: American municipal bonds.
You might think that investors would pause before pouring money into obligations of muni debt, particularly obligations of California, New York or Illinois. Like mid-2000s homeowners, state and local governments spent boom years using illusory gains to justify ever-higher spending and borrowing.
By 2008, state and local debt rose to $2.2 trillion — 49% higher, after inflation, than in 2000. The biggest partners in profligacy also promised more benefits to public workers in the future.
As the recession's severity became apparent, officials kept borrowing: States have already borrowed another $15 billion for operating costs over the past two years.
Yet gatekeepers consider municipal bonds low-risk. "We do not expect that states will default on general-obligation debt, even under the most stressed economic conditions," analysts at Moody's wrote in a February 2010 report.
Higher Taxes
As for cities and towns, "we expect very few defaults in this sector given the tools that local governments have at their disposal." Standard and Poor's agrees.
The investment advisers and managers who allocate credit assume that states and cities will do anything to avoid default. The assumed incentive, of course, is their desire to borrow more.
The analysts also think that lending to state and local governments isn't risky because they — unlike private firms — have a captive source of funds. State and local governments can always tax their residents and businesses more.
There's further reassurance in the law. State governments can't declare bankruptcy to escape debt. Cities, towns and counties can file for bankruptcy only if their state allows it, and more than half don't.
The analysts take comfort in financial engineering too. The underwriters who help governments raise money have found creative ways to dodge obstacles that theoretically constrain borrowing. States issue debt through structures that depend on taxes for repayment, even as repayment isn't an official state obligation because such a promise would require voter approval.
Another theory is that the federal government regards the biggest debtors "too big to fail."
Finally, observers point to the past. Between 1970 and 2000, no investor took a loss on a state's or a city's general-obligation debt. Even Orange County, Calif., which declared insolvency in 1994 in a one-off meltdown, repaid its lenders with interest.
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Posted By: Serfdumb(1695) on 4/29/2010 | 9:27 PM ET
States will be bailed out just like GM, Chrysler, FFM, AIG, etc. Power is never turned down by socialists, would end states rights and constitution, such as it is.
Posted By: Serfdumb(1695) on 4/29/2010 | 9:17 PM ET
We didn't realize the obvious, the US is still all in, bond vigelantes got out of greece, spain, UK and portugal. I guess socialists must stick together-'for the collective good'
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