Editorial Board

Meredith Whitney’s Muni Prediction Gets No Boost From Fed

The municipal bond market has been taking a few hits lately. To its reputation, at least.

The latest is an Aug. 15 study from the Federal Reserve Bank of New York asserting that municipal-bond defaults occur more often than investors might realize. Thirty-six times more often, to be exact.

Coming on top of high-profile bankruptcies and defaults -- in Jefferson County, Alabama; Stockton, California; and elsewhere -- average investors could be forgiven for getting antsy, and for perhaps wondering if banking analyst Meredith Whitney’s 2010 of “hundreds of billions of dollars” in municipal defaults might finally be upon us.

That is far from the case. Despite those bankruptcies, and even though fewer muni bonds are now insured than before the financial crisis, investor demand points to unshaken confidence: The yield on top-rated 10-year benchmark municipals was 1.861 percent on Aug. 20, according to data compiled by Bloomberg, down 15 percent from a year ago. And as Bloomberg News recently reported, investors are directing the most cash to tax-exempt bonds since 2009.

Safe Investments

There’s good reason demand is so strong. State tax collections are rising, suggesting a return to fiscal health and an increased ability to service debt. Tax-exempt municipal securities are still cheap, with a 10-year yield at 102.82 percent of comparable Treasury debt, well above the 93.14 percent average over the past decade.

And those securities are a relatively safe investment. To understand why that still holds, in spite of the Fed report, consider the methodology used by the study’s authors. They argue that although ratings companies show default rates of less than 1 percent, the actual rate may be much higher. Moody’s Corp., for instance, identified 71 municipal defaults between 1970 and 2011. The Fed tallies 2,521 in that period.

To arrive at that figure, the Fed includes defaults on unrated debt, which are far more numerous. There’s a reason such defaults aren’t usually counted by ratings companies. Municipalities that don’t seek ratings for their debt are almost axiomatically less creditworthy than those that do. That’s why the average investor is much less likely to be exposed to them.

Further, the most common type of defaults the Fed found were for industrial-development bonds, which governments issue on behalf of private companies -- and which usually aren’t backed by taxpayers. Vast defaults on government debt, in other words, aren’t somehow being covered up by ratings companies -- and Whitney’s default apocalypse is as improbable as ever.

The $3.7 trillion municipal-debt market is a critical destination for American investors. It’s also a fundamentally safe one. Regardless of scare stories in the news media, muni investors have no reason to panic.

    To contact the senior editor responsible for Bloomberg View’s editorials: David Shipley at davidshipley@bloomberg.net.

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