If you’re bad, you pay

July 13, 2011

If you’re bad, you pay

Ever wonder why fixed-income investors are often called “bond vigilantes?” Just as a banker charges a homeowner with a bad credit history a higher mortgage rate, bond investors make borrowers pay more if they have a heavy debt load and weak revenue sources. Investors use higher interest rates to crack down on borrowers; the interest rate is higher because there is more risk.

I thought it would be helpful to visualize the credit quality data that Thomson Reuters Municipal Market Data regularly publishes for states and large cities. The higher the interest rate, the greater the perceived risk in lending to these public entities.

The chart above shows the additional interest rate that a public entity pays over the benchmark AAA interest rate. As you can see, Puerto Rico is far and away the riskiest borrower.

This chart shows the inverse relationship between the size of the debt load and unfunded pension liabilities on the one hand, and the credit rating on the other. The higher the credit rating, the better the credit quality; more debt equals lower credit quality. That is how it works.

Dekalb County, Georgia skips layoffs, raises taxes

There are many ways for municipal and state governments to get on sound fiscal footing and improve their credit ratings, but the main tools are to cut expenses, mainly through layoffs, or to raise taxes. Dekalb County, Georgia, made national headlines in April when Standard & Poors gave them a five-notch rating downgrade. The norm in muniland is a one- or two-notch rating downgrade, so these were major events. Dekalb is now taking steps to get its fiscal house in order.

Bloomberg reports:

In a meeting today in Decatur, Georgia, the [Dekalb County] commission agreed to increase its tax rate by 26 percent, which will bring in an estimated $50 million in new revenue per year.

And the Atlanta Journal-Constitution breaks down what it means for homeowners:

The new incorporated tax rate is 21.21 mills. The tax hike adds $93 a year to the tax bill on the average home, which dropped in value since last year.

But tax bills increase far more where home values have remained the same, with a $420 increase, for instance, on a home that remained at $300,000.

Good links

MSRB: Testimony on Enhanced Investor Protection After the Financial Crisis—MSRB’s Implementation of the Dodd-Frank Act

Reuters: US muni board could increase derivatives oversight

Wall Street Journal: A Stadium’s Costly Legacy Throws Taxpayers for a Loss

Bloomberg: California Schools Suffer in Prop. 13 Tax-Cap Chaos

AP: California Secession Proposal Endorsed By Riverside County Officials

Bloomberg: Amazon Relies on Tax-Averse Californians in ‘Unusual’ Plan to Repeal Law

Reuters: Florida outlook improves to stable with budget: S&P

Reuters: Six New Jersey cities on watch for downgrade: Moody’s

Star-Tribune: One by one, bars get tapped out

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