Moody’s Says ‘Strategic’ Muni Defaults Seen as Less Taboo

The number of defaults from U.S. municipal issuers rated by Moody’s Investors Service has more than tripled to an annual average of 4.6 since 2007, showing willingness to pay can’t be taken for granted, the company said in a report.

Five municipalities rated by Moody’s defaulted last year, including Stockton, California, which became the biggest U.S. city to seek Chapter 9 bankruptcy protection in June. Wenatchee, Washington, failed to honor a guarantee on an interest payment for a sports arena. The figure doesn’t include issuers such as Vadnais Heights, Minnesota, which “selectively defaulted” on contingent liabilities, the report said.

Last year’s local-government defaults are more examples of political unwillingness to place payments to bondholders ahead of essential governmental services amid dwindling cash, New York-based Moody’s said. The trend hasn’t halted a rally in the $3.7 trillion municipal market, which has earned about 35 percent since the end of 2007, compared with 24 percent on the Standard & Poor’s 500 (SPX) index of stocks.

“Attitudes toward debt and repayment appear to have changed; ‘strategic default’ may become more acceptable as a viable government strategy and no longer taboo,” the company said.

“These factors could contribute to significantly different credit performance if we were to slip into a second deep recession or protracted slow recovery,” Moody’s said.

Moody’s has “actively lowered” municipal ratings because credit risk has increased, the company said. The economic recovery from the recession that ended in June 2009 may be uneven because of demographic shifts and different policies toward taxation and energy development, according to the report.

About 1.3 Moody’s-rated entities failed to pay from 1970-2007, increasing to 4.6 per year from 2008-2012. The jump represents just a 0.03 percent default rate, according to the report.

To contact the reporter on this story: Brian Chappatta in New York at bchappatta1@bloomberg.net

To contact the editor responsible for this story: Stephen Merelman at smerelman@bloomberg.net

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