Will there be a wave of municipal defaults?

April 23, 2009

So that went quite well, I thought — in any case I’ve pretty much guaranteed myself an invite back next year if there turns out to be a wave of municipal defaults between now and then.

I got a little pushback, in the Q&A, about my assertion that once municipalities start defaulting in any serious number, the cost of default to a municipality drops sharply — perhaps even below zero. One questioner came back with the obvious response: OK, in that situation the market for all municipalities might end up closing, for a while. But at some point, the market will reopen. And when that happens, municipalities with no history of default will find it much easier to raise funds than those who did default.

My answer to that was “not really”. I gave the example of Colombia and Peru to show that entities which have avoided default in the past don’t necessarily have more or cheaper access to debt capital markets in the present — in fact, they often have worse and more expensive access, just because they have more debt as a result.

Another questioner responded that municipalities weren’t like Latin sovereigns — you can’t really argue with that, since it’s impossible to imagine any municipal issuer behaving like, say, Ecuador. All the same, I said, if the muni market closes, it will close for all borrowers, whether they have defaulted or not. And if and when it opens again, it will open for all borrowers, whether they have defaulted or not. Lenders only really care about future defaults, not past ones, and past default is not necessarily a good guide to future default, especially in the municipal context where default decisions are made by elected officials who will almost certainly not be in power the next time the do-we-default question arises.

Of course, the balance of probabilities is still that there won’t be a wave of municipal defaults. But bondholders generally want more than a balance of probabilities: they want near-certainty. And I don’t think they’ve got that, right now.


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