Muni Bonds May Face Downgrade
Moody’s Investors Service assigned a negative outlook to the creditworthiness of all local governments in the United States, the agency said Tuesday, the first time it had ever issued such a blanket report on municipalities.
The report signaled how severely the economic downturn was affecting towns, counties and school districts across the nation.
While Moody’s regularly reports on the financial strength of various sectors of private industry, its analysts have in the past considered America’s tens of thousands of towns and local authorities too diverse for generalizations.
The report suggests that the ratings of many governments could be downgraded in the coming months, something that would make it more expensive for them to borrow money to finance their operations.
In the most extreme cases, municipalities might default on some of their obligations, as Jefferson County, Ala., has been threatening to do for a number of months.
Vallejo, Calif., declared bankruptcy last year and is being closely watched to see if it will set a legal precedent that other towns could follow.
Moody’s did not report on individual cities or towns, but its overview offered a general note of caution for investors who have bought municipal bonds seeking a safe stream of income in difficult financial markets.
In a special report made public on Tuesday, the agency cited revenues that are falling almost everywhere as a result of the economic downturn. But it also discussed the problems some municipalities had created for themselves by using complex financial products that seemed to be saving money at first, only to send costs soaring during the credit crisis.
In former boom states like California and Florida, the sharp decline in housing prices is translating into falling property-tax revenue, while in towns in Michigan, Indiana and Ohio, revenues are off because of the collapse of the auto industry. Many local governments in New York, New Jersey and Connecticut will lose significant revenue because they rely on the banking and financial services sectors for their tax bases. Moody’s said any municipality relying heavily on tourism, gambling or manufacturing was probably at risk of feeling a pinch.
The report suggested conflicts ahead between taxpayers struggling to keep their own households afloat and elected officials charged with balancing budgets, making their payrolls and protecting their credit ratings.
“Taxpayers, worried about their own financial condition, are more resistant than ever to increasing property or other local taxes,” the report observed.
The report’s publication coincided with the downgrading by Moody’s of the credit of the State of Illinois to the A level from double-A. Moody’s said Illinois was having difficulty managing its cash, and in recent weeks had been trying to push its scheduled pension contributions into the future. The state pension fund is already seriously underfunded.
The Federal Reserve chairman, Ben S. Bernanke, warned that local governments had probably lost their ability to lower their borrowing costs by linking their bonds to derivatives. Such bond packages had become popular in the last few years because they appeared to offer cities both the lower borrowing costs of variable-rate bonds and the predictability of fixed-rate bonds. But the structures broke down during last year’s market turmoil, leaving some municipalities staggering under more debt than they can afford.
Mr. Bernanke said he was aware that some governments with low credit ratings were completely shut out of the short-term financial markets, while others were stuck with a type of derivative called interest-rate swaps that no longer made sense for them.
Mr. Bernanke offered his remarks in a letter to members of Congress who had asked the Fed to create a facility to breathe new life into segments of the municipal bond market that were still paralyzed. But Mr. Bernanke said municipal debt had “unique characteristics” that made it “unlikely” that the Fed could be of much help.
He suggested that instead, Congress could consider setting up some other form of assistance for municipalities unable to restructure or refinance their debt, like a federal bond reinsurance program.
The bond markets took the Moody’s report in stride on Tuesday, apparently because institutional investors were already familiar with the problems described. New York City brought bonds to market on Tuesday and ended up selling much more than initially planned.
“New York City is potentially a poster child for economic woe, but that didn’t seem to bother investors,” said Thomas G. Doe, president of Municipal Market Advisors.
The Moody’s report “creates headline risk and a lot of confusion for investors,” he said, “but it’s not a sounding of the alarm for default.”