Sep 28, 2012

The Budget Deficits and Municipal Bankruptcies

The financial markets today no longer look safe for investing in municipal bonds. With the present U.S. economy assailed with a growth in municipal bankruptcies, the problems that continue to plague America are forever on the rise.

Budget deficits should be controlled by the local governments. In addition, further spats with creditors have to be avoided and so there is need for the deficit cuts by the municipalities. When the local government takes the regular steps in order to survive, the municipal bond investors and their invested amount of the tune of $3.7-trillion will be very much affected. The municipal bond defaulters are the cities in California; viz. Vallejo, Mammoth Lakes, Stockton, and San Bernardino. Compton is the next most likely town to follow suit; the reason being that all theses towns are facing the problem of big budget deficits.

During days of healthy financial markets, there is substantial consumer spending. Like for example if one considers Bell, which is a city outside of Los Angles; it is said that in the year 2010, it paid an amount of $800,000 a year to the city managers. (Source: Wall Street Journal, July 18, 2012). Municipalities land in trouble because of cases like this.

On account of being burdened with enormous budget deficits, cities filed for bankruptcy. The chief resources of revenue of the municipal governments are the property taxes, but when such sources are blocked, cities need to search for different means to make revenue for the payment of dues or just show their helplessness in being able to pay the municipal bond investors. Though the plan looks clever enough, i.e. defaulting on the municipal bonds and starting again, it simply does not work. Examples of cities that have already defaulted as mentioned above are Stockton, California and Jefferson County in Alabama.

Stockton, California has pensions to the tune of $26.0 million each year, which it must pay; as a result of which its municipal bond insurers may be badly hit by an amount above $100 million. (Source: The Examiner, September 17, 2012). In 2011, Jefferson County; not being successful in planning its finances to control the budget deficit, had filed for chapter-nine bankruptcy (which gives protection from creditors to municipalities comprising cities, counties, townships and school districts that are financially in doldrums by working towards a plan between them to resolve the outstanding debt). The municipal bond insurers now remain restless that they may stand to lose an amount near about $709 million.

As per reports from Bloomberg, September 10, 2012, Wenatchee, Washington, Scranton, Pennsylvania, and Moberly, Missouri have also defaulted on their municipal bonds payments as they did not have the requisite available cash.

Thus it can be clearly seen that there will be bound to be an increase in the number of municipal bankruptcies, which will in turn, hit the municipal bond investor to a large extent. It would be advisable for bond investors to exercise caution while purchasing bonds and not get hooked by endorsements of exemption from taxes.

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