In May the financial advisory firm Alex Partners LLP reported that 90 percent of the restructuring experts it polled believed a major U.S. municipality would default on its debt in 2010…But even in the best-case scenario, a municipal debt crisis looms in the near future.
The parallels with the housing bubble are worrisome. Prior to the meltdown, mortgages were perceived as very low-risk investments. Banks were encouraged through government policies to lend large amounts to people, whether they could afford it or not, and borrowers were encouraged to spend more than they should. Both lenders and borrowers had faith that nothing would go wrong—and that if anything did go wrong, Washington would save the day.
That is my colleague, Veronique de Rugy, writing about the muni bond market over at Reason.
Meredith Whitney, a well-respected banking analyst, was recently on 60 Minutes talking about the high probability of a “spate of municipal bond market defaults.”
Felix Salmon, a financial journalist at Reuters, largely disagrees with her. His bottom line:
So my feeling is that Whitney is probably wrong, and that we won’t see a lot of municipal defaults next year. But at the same time, the tail risk here is significant. If it gets bad, it could get very bad.
Here is one thing to keep in mind: Though a muni debt crisis — whatever its odds — would undoubtedly be terrible, the alternative isn’t so pleasant either. Though Orange County didn’t default in 1994, its bankruptcy forced painful tax increases and service cuts. So far, Illinois hasn’t defaulted and its fiscal woes have already forced similarly painful actions. Throughout the U.S., in fact, state and local governments are grappling with extremely painful choices.
As with the housing bubble, it would have been far better to have restrained spending in the first place than to have ever let it grow so fast.