As highlighted in the WSJ "Heard on the Street" column above, a Moody's study found muni credit loss rates across 1970 - 2000 were lower than for triple A rated corporate bonds. Among general obligation and essential-service bonds - 60% of issuers surveyed - the default rate was exactly zero.
However, we should go back to the Great Depression to obtain a deeper perspective. When we do that the data still look very good.
The above WSJ piece highlights a study by Professor George Hempel who found that the default rate on municipal bonds across the period from 1929-37 was 16.2% of outstanding debt, but the estimated loss rate was just 0.5%. Further, using a recent example in Orange County, CA from 1994, bond holders recovered 100% of principal and interest.
There are counterpoints to this arguement. In a recent Forbes article the same issue was handled somewhat less optimistically. The article notes that creditors who hung in there during the Great Depression by and large received their principal and interest. However, the legal rights of municipal bond investors are not entirely clear according to Georgetown Law Professor, noted bankruptcy expert, and Dartmouth College Trustee Todd Zywicki. In one specific example, however, it is noted that the General Obligation bonds of the State of California enjoy a lien on state revenue second only to education spending.
Where is the investment opportunity? If the favorable risk profile, and attractive relative valuation creates increased demand for munis, there is room for the relative outperformance versus treasury bonds. In 1988 munis peaked at 4.5% of household and non profit organization assets while today they are just 2%. According to the WSJ, if they were to grow to 4.5% of holdings again, that would imply an extra $1.15 trillion of demand, equivalent to 43% of the total amount of muni debt outstanding and well over double the likely issuance this year.
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