There has been so much talk in muniland about massive defaults, but so far there has been very little discussion about the actual mechanism of default and municipal bankruptcy. Public entities generally try everything before resorting to default or bankruptcy. The video above is an excellent primer on the many choices that can be made leading up to the end game.
Bond defaults can happen with or without a bankruptcy. Here is Wikipedia’s definition of default:
In finance, default occurs when a debtor has not met his or her legal obligations according to the debt contract, e.g. has not made a scheduled payment, or has violated a loan covenant (condition) of the debt contract. A default is the failure to pay back a loan. Default may occur if the debtor is either unwilling or unable to pay their debt.
If a bond issuer doesn’t make a scheduled interest or principal payment on time (though there is usually a thirty-day grace period), then the bonds are considered in default.
The most common investor concern you hear in muniland is “willingness to pay.” One way to think of this would be if you managed the family budget and had to make a choice between feeding your children or paying your credit card bills. For a muniland bond issuer like a city, the comparable choice is between paying your bondholders before your employees.