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If Muni Bond Defaults Spike, It Won't Be for Lack of Trying to Fix Problems

New York Among States Addressing Budget IssuesAs has been discussed on this blog before, Meredith Whitney sent a lot of investors into a panic when she predicted widespread defaults on municipal debt in 2011. While her prediction has (thankfully) yet to occur, I still get plenty of notes from investors worried about defaults occurring. I asked Jared Kizer, my firm's director of investment strategy and my co-author on The Only Guide to Alternative Investments You'll Ever Need, to address one of their biggest concerns: that municipalities aren't doing enough to stave off potential defaults. Here's his response.

One misperception that we have spent significant energy countering is the belief that states and municipalities aren't doing anything to improve the condition of their finances. The reality could not be further from the truth. As the New York Times shows, state pension plans are one of the latest areas of reform. A number of states are starting to require (or are considering requiring) substantially higher pension contributions from their employees to reduce the amount of contributions that the state needs to make. One example is New York, where a proposal has been put forth to have all new state and New York city employees contribute six percent of pay up from the current level of three percent.

In addition to pension plan reform, states have closed substantial budget deficits over the past three fiscal years by either cutting spending or raising revenue. This is largely due to the fact that (unlike the federal government) almost all states are required to balance their budgets each fiscal budgeting period. The Center on Budget and Policy Priorities notes that states closed approximately $80 billion of budget deficits in 2009, $120 billion in 2010, $100 billion in 2011 and were expected to close around $140 billion in 2012. Looking at the numbers from a different perspective:

  • 30 states have raised taxes.
  • 31 have reduced health care service funding.
  • 29 states and the District of Columbia have reduced service funding to the elderly and disabled.
  • 34 and the District of Columbia have reduced funding for K-12 education.
  • 43 have reduced funding for higher education.
  • 44 states have made cuts that have affected their state work force (for example, layoffs, furloughs and reductions in pay).
These examples show that many states and municipalities have made and continue to make very difficult decisions when it comes to their finances. As painful as some of these decisions may be for residents and workers, they certainly help protect bondholders. While there's certainly more left to do, all the above shows that municipalities are moving in the right direction.

More on MoneyWatch:
Setting the Record Straight on Municipal Bonds Municipal Bonds: Was Meredith Whitney Right? Municipal Bonds: Why We Likely Won't See Armageddon 3 Reasons to Avoid Corporate Bonds What the Greek Crisis Means for Your Portfolio
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