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Uh Oh: Mark Zandi Just Said There Is 'Zero' Chance of a Major Muni Default

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Photo by: John Carney

Just when I was starting to feel less worried about the municipal bond market, along comes Mark Zandi.

Bloomberg reports:

"The risk of a major default or round of defaults is close to zero, Mark Zandi, chief economist for Moodys Analytics Inc. in West Chester, Pennsylvania, said during a panel session at the National Governors Associations winter meeting in Washington."

Thats the kind of talk that sets off my complacency alarm bells.

How has Zandi come to this conclusion? Certainly the market is not pricing in close-to-zero chances of a default.

Heres the latest from Morningstar:

Municipal bond funds experienced another outflow last week as investors continued to reallocate funds away from tax-exempt municipal investments and into taxable fixed-income funds. Emblematic of the credit concerns in the municipal bond market, the spread over Treasuries that Illinois paid on its new issue taxable municipal bonds was significantly wider than similarly rated corporate bonds.

While the average credit rating the agencies assign to Illinois general obligations is A+ (the second-lowest-rated state behind California), the credit spreads on Illinois' new taxable municipal bonds tell another story. After being delayed earlier in the month, Illinois finally issued $3.7 billion of taxable municipal bonds to finance pension payments last week. The wide credit spreads required to sell these bonds highlight the market's significantly different perception of credit risk than the agencies. As a comparison, the longest-dated tranche of eight-year bonds sold at +240 basis points over Treasuries, while Morningstar's BBB- corporate bond index stood at +190.

Now, it is possible that the market is wrong and Zandi is right. But I cannot help but remember back when people were absolutely sure that their mortgage-backed securities were mispriced.

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