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Detroit's 'name is mud,' but fallout likely limited

Detroit street scene
Jeff Kowalsky | Bloomberg | Getty Images
Detroit street scene

Detroit has become a pariah of the municipal finance world, but analysts are holding out hope that the nation's largest government bankruptcy isn't contagious.

The Motor City's "name is mud," said Dick Larkin, director of credit analysis at Herbert J. Sims. But he doesn't believe the situation is symptomatic of larger problems in muniland.

"Hearing the commentary you would think that this is going to have a disastrous effect on the muni market, with widespread concern that maybe this is the tip of the iceberg," Larkin said. "I don't believe that at all. This is Detroit specific."

Detroit's debt problems were hardly a secret.

(Read more: Detroit bankruptcy could hit millions of retirees)

The city has been circling the bankruptcy drain for months, and the decision in March to retain an emergency manager sent a clear signal that Chapter 9 was clearly in the city's future.

Still, the actual decision to file still came as a bit of a shock and raised questions over where the municipal debt world is heading, particularly for those governments that share the large pension fund shortfalls that befell Detroit.

"This is Detroit specific for sure. But any city with underfunded pension liabilities really comes into focus," said Adam Buchanan, vice president of municipal institutional sales and trading at Ziegler Capital Markets in Chicago.

At the beginning of the year, the firm had identified three likely headwinds for municipal bonds, all of which have come to pass: Headline-grabbing bankruptcies from large cities; Washington's threats against muni tax-exempt status, and rising interest rates.

(Read more: Detroit joins list of US towns gone bust)

Amid that backdrop, investors have been pulling money from muni market funds, with $1.45 billion leaving last week to mark the eighth-straight week of outflows, according to Goldman Sachs and Lipper.

(Read more: Will everyone move to North Dakota?)

Governments also have been issuing less debt—at a time when corporate bond issuance has soared to records.

Muni debt offerings through Friday stood at $187.1 billion, a 10 percent drop from the same period in 2012, according to Thomson Reuters.

Performance-wise, the Barclays Municipal Bond Index is down 2.7 percent year to date.

It's enough to inspire at least some caution in the market.

"Know the individual CUSIPs you own," Buchanan advised, referring to the instruments' identification numbers. "The muni market has much more transparency than there had been five, six years ago. You can go out and do the research."

As for Detroit, the city's unique set of circumstances makes it both a tough bet for recovery and an unlikely template for future defaults.

(Read more: Detroit becomes largest U.S. city to file for bankruptcy)

In addition to a brutal economy, the city received little help at the state level, something that rankled several fixed income experts.

"Their problems almost entirely come from the economic demise of the city, the demise of the U.S. auto industry—the combination of those things and the spillover effect on the city's finances," said James Dearborn, head of municipal bonds at Columbia Management.

The Chapter 9 filing, in fact, sparked a call from some bond experts to use the opportunity to buy on dips.

Three companies came into view as financial guarantors at risk—MBIA, Ambac and Assured Guaranty, all of which traded lower in the wake of the Detroit news.

"We believe any material weakness in the bond insurers' shares due to Detroit's filing represents an opportunity for the initiated—or those simply willing to look at the facts—to take advantage of those who would sell based on conclusions drawn from a cursory glance at the headlines, or irrational fear," analysts at BTIG said in a research note.

Ramifications from the filing, though, likely will take quite a while to play out.

"Clearly, Mr. Orr [emergency manager Kevin Orr] would have rather avoided a Chapter 9 filing but doing so was likely close to impossible given the number of creditors, unions and other parties involved," MKM Partners said in a note. "Chapter 9 is typically a very expensive restructuring process that could take several years to complete."

(Read more: Detroit's Orr: We had to draw a line)

—By CNBC's Jeff Cox. Follow him @JeffCoxCNBCcom on Twitter.

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