Friday, February 25, 2011

Muni Bonds and Wisconsin

Today, AIG announced that its Chartis unit faces a significant default risk in its municipal bond holdings, putting its parent company in danger of a liquidity crisis.  Municipal bonds, sold to finance everything from schools to traffic lights, have been the way towns and cities across the country have funded their infrastructure.  The pricing of many muni bonds are pegged to the credit ratings of the states in which they are located. The credit ratings of many states have taken a beating because the costs of public employee obligations and legislated entitlements have outstripped revenue production.  When the credit rating of a bond deteriorates, institutional holders may be obligated, under their investment rules, to trigger an early redemption call, putting the municipality in danger of default, and possibly bankruptcy.  If Wisconsin, Ohio, and other states trying to control the cost of public employee obligations do not succeed, the implication is not just unsustainable state budgets. A series of muni bond defaults may result, sending a lot of towns and cities to the poor house.

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