While most serious municipal bond investors are clinging to the hope that the asset class is not building momentum toward a wave of defaults and bankruptcies, there apparently are those who support the notion of local governments' just walking away from debt obligations.
In a report by The Wall Street Journal on Thursday, business owners in some of the most troubled California towns reportedly are vocally supporting bankruptcy as a way to manage the local fiscal mess.
Comparisons are even being made to the trend started by homeowners after the financial crisis of just walking away from mortgage debt by mailing the house keys to the bank.
With four California towns now officially in or near bankruptcy, some are suggesting the bankruptcy trend is now supported by a lessening of the stigma associated with dealing with debt by abandoning it.
But the stigma might not be the biggest issue here.
“It is in the self-interest of these municipalities to preserve what is a very effective means of funding projects, and they have a marketplace and a tool to finance projects by issuing bonds that they should not so lightly jeopardize,” said Tom Dalpiaz, who manages $310 million worth of bond portfolios for Advisors Asset Management Inc.
Muni bond investors and portfolio managers such as Mr. Dalpiaz have been downplaying some of the muni market troubles by pointing out that muni default levels around the country are only at about 0.5%.
Even if that default level is up from 0.4% a year ago, it is still seen as a tiny piece of the $3.7 trillion muni bond market, which includes more than 60,000 issuers of about 1.5 million individual bonds.
But even while putting the muni market challenges in context of the overall market, Mr. Dalpiaz can get somewhat agitated by suggestions that bankruptcy could become the new strategy for managing municipal budgets.
“These are certainly tough economic times, but the word 'bankruptcy' is being tossed around pretty casually here,” he said. “I don't really agree that bondholders should have to take a haircut, even though it is an idea that is gaining appeal. Those municipalities are borrowing money for a public purpose, and the money is being lent with the notion that this is a serious promise that will be honored.”
Clearly, Mr. Dalpiaz, as the manager of muni bond portfolios, has a vested interested in shunning the bankruptcy option.
But he does make some excellent points about the relationship between lenders and borrowers, and how that relationship is unique from both mortgage debt and corporate debt.
Walking away from a mortgage certainly has consequences involving lower credit scores and challenges related to future borrowing. But the person abandoning the mortgage can always rent.
The mortgage lender, usually facing some kind of loss, is at least left with the property to help recoup some of the loss.
A corporate bankruptcy also hurts bondholders, who might have to settle for a reduced return, and if the corporation survives, it likely will suffer lower credit ratings.
But while businesses can come and go, it is difficult to imagine a town of 200,000 people, such as San Bernardino, Calif., which is the latest municipality to threaten bankruptcy, just going out of business.
“A corporation can disappear and you can always break up the company, but nobody is going to give you the bricks from town hall and put them on your front lawn and say, 'This is what you got,'” Mr. Dalpiaz said.
Regardless of whether the increased number of bankruptcies lessens the stigma associated with walking away from debt obligations, the municipalities must and will live on. Thus they are only making it more difficult to raise money and manage budgets by opting for bankruptcy, assuming there are other options.
“I'm saddened by the fact there are some municipalities that feel bankruptcy is their best alternative, because they are mistaken,” Mr. Dalpiaz said. “A municipal bankruptcy can be long and costly, and it's not a neat and simple answer.”
In terms of the local business communities' supporting bankruptcy as a way to fix a broken municipal balance sheet, one can only wonder what the longer-term strategy involves.
Whatever temporary advantages that might come from walking away from debt obligations will most likely be wiped out during the next round of budget talks when the new reality involves even higher debt payments coupled with higher taxes.
/images/newsletters src="/wp-content/uploads2012/08/twitter-bullet.png" Follow Jeff Benjamin
